UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM10-K
FORM 10-K
ý | | |
þ | | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended ended:December 31, 2007
2008
¨ | | |
o | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ______________ to _______________
Commission File Number: 0-58514000-51584
BERKSHIRE HILLS BANCORP, INC.
(Exact name of registrant as specified in its charter)
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Delaware | | 04-3510455 |
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(State or other jurisdiction of incorporation or organization)
| | (I.R.S. Employer Identification No.) |
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24 North Street, Pittsfield, Massachusetts | | 01201 |
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(Address of principal executive offices) | | (Zip Code) |
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Registrant’s telephone number, including area code:(413) 443-5601
Securities registered pursuant to Section 12(b) of the Act:
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Title of each class | | Name of Exchange on which registered |
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Common stock, par value $0.01 per share | | NASDAQ Stock Market LLC |
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes¨o Noýþ
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes¨o Noýþ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesýþ No¨o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K.ýo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)
Large Accelerated Filer ¨
| Accelerated Filer ý
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Non-Accelerated Filer ¨
| Smaller Reporting Company ¨
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(Do not check if a smaller reporting company) | | | |
Large Accelerated Filero | | Accelerated Filerþ | | Non-Accelerated Filero | | Smaller Reporting Companyo |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes¨o Noýþ
The aggregate market value of the voting and non-voting common equity held by non-affiliates was approximately $279$218 million, based upon the closing price of $31.51$23.65 as quoted on the NASDAQ Global Select Market as of the last business day of the registrant’s most recently completed second fiscal quarter.
The number of shares outstanding of the registrant’s common stock as of March 5, 20086, 2009 was 10,515,102.12,259,578.
DOCUMENTS INCORPORATED BY REFERENCE
REFERENCE:Portions of the Proxy Statement for the 20082009 Annual Meeting of Shareholders are incorporated
by reference in Part III of this Form 10-K.
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FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of Berkshire Hills Bancorp, Inc., Berkshire Bank and Berkshire Insurance Group. This document may include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements, which are based on certain assumptions and describe future plans, strategies, and expectations of the Company, are generally identified by use of the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “seek,” “strive,” “try,” or future or conditional verbs such as “will,” “would,” “should,” “could,” “may,” or similar expressions. Although we believe that our plans, intentions and expectations, as reflected in these forward-looking statements are reasonable, we can give no assurance that these plans, intentions or expectations will be achieved or realized. Our abilityBy identifying these statements for you in this manner, we are alerting you to predictthe possibility that our actual results or the actual effects of our plans and strategies are inherently uncertain. Actual results, performance or achievements couldfinancial condition may differ, possibly materially, from those contemplated, expressed or implied by the anticipated results and financial condition indicated in these forward-looking statements contained in this Form 10-K.statements. Important factors that could cause our actual results and financial condition to differ materially from ourthose indicated in the forward-looking statements are set forthinclude, among others, those discussed below and under Item 1A. - “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K, and in other reports filed with the Securities and Exchange Commission. There are a number of factors, many of which are beyond our control, that could cause actual conditions, events, or results to differ significantly from those described in the forward-looking statements. These factors include, but are not limited to: general economic conditions, either nationally or locally in some or all of the areas in which we conduct our business; conditions in the securities markets or the banking industry; changes in interest rates and energy prices, which may affect our net income or future cash flows; changes in deposit flows, and in demand for deposit, loan, and investment products and other financial services in our local markets; changes in real estate values, which could impact the quality of the assets securing our loans; changes in the quality or composition of the loan or investment portfolios; changes in competitive pressures among financial institutions or from non-financial institutions; the ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames; our timely development of new and competitive products or services in a changing environment, and the acceptance of such products or services by our customers; the outcome of pending or threatened litigation or of other matters before regulatory agencies, whether currently existing or commencing in the future; changes in accounting principles, policies, practices, or guidelines; changes in legislation and regulation; operational issues and/or capital spending necessitated by the potential need to adapt to industry changes in information technology systems on which we are highly dependent; changes in the monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board; war or terrorist activities; and other economic, competitive, governmental, regulatory, and geopolitical factors affecting the Company’s operations, pricing, and services. Additionally, the timing and occurrence or non-occurrence of events may be subject to circumstances beyond our control.10-K. You should not place undue reliance on these forward-looking statements, which reflect our expectations only as of the date of this report. We do not assume any obligation to revise forward-looking statements except as may be required by law.
GENERAL
Berkshire Hills Bancorp, Inc. (the “Company” or “Berkshire Hills”) is a Delaware corporation and the holding company for Berkshire Bank.Bank (the “Bank”). Established in 1846, Berkshire Bank is one of Massachusetts'Massachusetts’ oldest and largest independent banks and is the largest banking institution based in Western Massachusetts. The Bank is headquartered in Pittsfield, Massachusetts and operates 3839 full-service banking offices serving communities throughout Western Massachusetts, Northeastern New York and in Southern Vermont. The Bank operates in four regions:
| · | The Berkshire County Region, with eleven offices in Berkshire County. |
| · | The Pioneer Valley Region with ten offices along the Connecticut River valley north and west of Springfield in Massachusetts. The Company entered this region through the acquisition of Woronoco Bancorp, Inc. in June 2005. |
| · | The New York Region with ten offices serving Albany and the surrounding area in Northeastern New York. This region represents a de novo expansion by the Bank begun in 2005. |
The Berkshire County Region, with twelve offices in Berkshire County. Berkshire County is the Company’s traditional market, where it has a leading market share in many of its product lines. Berkshire County is renowned for its combination of nature, culture, and harmony which make it a leisure and tourism destination and an attractive location for an emerging creative economy.
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The Pioneer Valley Region with ten offices along the Connecticut River valley north and west of Springfield, Massachusetts. The Company entered this region through the acquisition of Woronoco Bancorp, Inc. in June 2005. This region is the metropolitan hub of Western Massachusetts and part of the Hartford/Springfield economic region centrally located between Boston and New York City.IndexThe New York Region with ten offices serving Albany and the surrounding area in Northeastern New York. This region represents a de novo expansion by the Bank begun in 2005. Albany is the state capital and is part of New York’s Tech Valley which is gaining prominence as a world technology hub including leading edge nanotechnology initiatives representing a blend of private enterprise and public investment.The Vermont region with seven offices serving Southern Vermont. The Company entered this region through the acquisition of Factory Point Bancorp, Inc. in September 2007. The Southern Vermont region is contiguous to Berkshire County and shares similar characteristics, with a more pronounced focus on recreation activities in Vermont’s Green Mountains.
| · | The Vermont region with seven offices serving Southern Vermont. The Company entered this region through the acquisition of Factory Point Bancorp, Inc. in September 2007. |
These four regions are viewed as having favorable demographics and provide an attractive regional niche for the Bank to distinguish itself from larger super-regional banks and smaller community banks. The Company is pursuing growth through acquisitions, de novo branching, product development, and organic growth. It made acquisitions of insurance and financial planning providers in 2004 and 2005, followed by the acquisition of five insurance agencies in the fourth quarter of 2006. These insurance acquisitions were merged and integrated into the Berkshire Insurance Group, which was made a subsidiary of the Company. Berkshire Insurance Group operates from ten locations in the Berkshire County and Pioneer Valley regions in Massachusetts. The Bank promotes itself as “America’s Most Exciting Bank”. It has set out to change the financial service experience, and its vision is to establish itself as a world-class financial services company through an engaging and exciting environment where customers want to do business and employees want to work. This brand and culture statement is expected to drive customer delight, emotional engagement, loyalty, market share and profitability.
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The BankCompany offers a full-scalewide range of deposit, lending, investment, wealth management, and insurance products through a team of employees with extensive experienceto retail, commercial, not-for-profit, and municipal customers in its market areas. In addition to traditional retail and commercial banking insurance,products, the Company’s product offerings also include retail and investment management. The Company stresses quality control, including using Six Sigma tools to improve operational effectivenesscommercial electronic banking, commercial cash management, and efficiency. It is enhancing its credit and risk management functions to maintain strong asset quality and carefulcommercial interest rate management. Itswaps. The Company’s commercial banking products are offered within its regions and to commercial relationships in Massachusetts, Connecticut, and Rhode Island. The Company stresses a culture of teamwork and performance excellence to produce customer satisfaction to support its strategic growth and profitability. The Company utilizes Six Sigma tools to improve operational effectiveness and efficiency.
The Company has recruited executives with experience in regional management and has augmented its management team as it has expanded into a three state diversified regional financial services provider. The Company has invested in its infrastructure in order to position itself for further growth as a regional consolidator with an objective of filling in and expanding its footprint in its New England and New York markets. The Company has absorbed expenses related to its ten branch de novo expansion into the attractive New York market . Its acquisitions of banks, insurance agencies, and wealth management companies have resulted in near term dilution to per share tangible book value in order for the Company to achieve the scale, positioning, and momentum to support future beneficial growth.
The Company views its markets as geographically conservative, and these markets have experienced less exposure to speculative development, real estate inflation, and subprime lending activities compared to many other regions of the country. The Company’s markets are not contiguous with the densely populated Boston and New York City metropolitan areas. The Company believes that it has a closer and more consistent focus on its markets compared to national competitors.
COMPANY WEBSITE AND AVAILABILITY OF SECURITIES AND EXCHANGE COMMISSION FILINGS
The Company’s Internet website is its Investor Relations section atwww.berkshirebank.com. The Company makes available free of charge on or through its website, its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after the Company electronically files such material with the Securities and Exchange Commission. Information on the website is not incorporated by reference and is not a part of this annual report on Form 10-K.
ECONOMIC AND FINANCIAL EVENTS
In the second half of 2008, and continuing into 2009, there are economic and financial events in the United States and around the globe which are unprecedented since World War II. The contraction of household wealth, as measured by real estate values and investment values, was the largest decline since the Great Depression. Major financial institutions failed or were forced into mergers with other institutions or ownership by national governments. All of the major U.S. investment banking firms either merged with commercial banks or changed their charters to commercial bank charters, except for Lehman Brothers, which declared bankruptcy. This bankruptcy precipitated a financial panic which threatened the continued operation of the global financial system. Emergency federal rescue measures were undertaken, including large scale investments in financial institutions, guarantees of the liabilities of money market funds and other financial institution liabilities, expanded liquidity facilities made available by the Federal Reserve Bank, increases in the amount of FDIC insurance, mortgage foreclosure mitigation programs, economic stimulus spending, and various other measures. Emergency federal loans were also made to U.S. auto manufacturers in order to avoid major bankruptcies in this industry. Most countries are in recession and the financial system remains fragile early in 2009.
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COMPETITION
The Company is subject to strong competition from banks and other financial institutions and financial service providers. Its competition includes national and super-regional banks such as Bank of America, TD Banknorth, and Citizens Bank, which have substantially greater resources and lending limits. Non-bank competitors include credit unions, brokerage firms, insurance providers, financial planners, and the mutual fund industry. New technology is reshaping customer interaction with financial service providers and the increase of Internet-accessible financial institutions increases competition for the Company’s customers. The Company generally competes on the basis of customer service, relationship management, and the fair pricing of loan and deposit products and wealth management and asset management services. The location and convenience of branch offices is also a significant competitive factor, particularly regarding new offices. The Company does not rely on any individual, group, or entity for a material portion of its deposits.
The economic and financial events of 2008 have significantly impacted the competitive environment. The Federal Reserve System reduced short-term interest rates to close to zero and numerous financial companies converted to bank charters and began accepting FDIC insured deposits.
LENDING ACTIVITIES
General.The Bank originates loans in the four basic portfolio categories discussed below. Lending activities are limited by federal and state laws and regulations. Loan interest rates and other key loan terms are affected principally by the Bank’s asset/liability strategy, loan demand, competition, and the supply of money available for lending purposes. These factors, in turn, are affected by general and economic conditions, monetary policies of the federal government, including the Federal Reserve Board, legislative tax policies and governmental budgetary matters. The majorityMost of the Bank’s loans are made in its market areas and are secured by real estate in its market areas. Lending activities are therefore affected by activity in these real estate markets. The Bank does not engage in subprime lending activities targeted towards borrowers in high risk categories. The Bank monitors and limits the amount of long-term fixed-rate lending volume. Adjustable-rate loan products generally reduce interest rate risk but may produce higher loan losses in the
event of sustained rate increases. The Bank retains most of the loans it originates, although the Bank may sellgenerally sells its longer-term, fixed-rate, one- to four-family residential loans and sometimes buys and sells participations in some commercial loans.loans.
Loan Portfolio Analysis.The following table sets forth the year-end composition of the Bank’s loan portfolio in dollar amounts and as a percentage of the portfolio at the dates indicated.
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| | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
| | | | | | Percent | | | | | | | Percent | | | | | | | Percent | | | | | | | Percent | | | | | | | Percent | |
| | | | | | of | | | | | | | of | | | | | | | of | | | | | | of | | | | | | | of | |
(Dollars in millions) | | Amount | | | Total | | | Amount | | | Total | | | Amount | | | Total | | | Amount | | | Total | | | Amount | | | Total | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Residential mortgages | | $ | 677.2 | | | | 34 | % | | $ | 657.0 | | | | 34 | % | | $ | 599.2 | | | | 36 | % | | $ | 549.8 | | | | 39 | % | | $ | 235.2 | | | | 28 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial mortgages | | | 805.5 | | | | 40 | | | | 704.8 | | | | 36 | | | | 566.4 | | | | 33 | | | | 410.7 | | | | 29 | | | | 260.5 | | | | 32 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Commercial business | | | 178.9 | | | | 9 | | | | 203.6 | | | | 11 | | | | 190.5 | | | | 11 | | | | 158.7 | | | | 11 | | | | 150.9 | | | | 18 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total commercial loans | | | 984.4 | | | | 49 | | | | 908.4 | | | | 47 | | | | 756.9 | | | | 44 | | | | 569.4 | | | | 40 | | | | 411.4 | | | | 50 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Consumer | | | 345.5 | | | | 17 | | | | 378.6 | | | | 19 | | | | 342.9 | | | | 20 | | | | 301.0 | | | | 21 | | | | 181.5 | | | | 22 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total loans | | | 2,007.1 | | | | 100 | % | | | 1,944.0 | | | | 100 | % | | | 1,699.0 | | | | 100 | % | | | 1,420.2 | | | | 100 | % | | | 828.1 | | | | 100 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Allowance for loan losses | | | (22.9 | ) | | | | | | | (22.1 | ) | | | | | | | (19.4 | ) | | | | | | | (13.0 | ) | | | | | | | (9.3 | ) | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net loans | | $ | 1,984.2 | | | | | | | $ | 1,921.9 | | | | | | | $ | 1,679.6 | | | | | | | $ | 1,407.2 | | | | | | | $ | 818.8 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
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| | 2007 | | 2006 | | 2005 | | 2004 | | 2003 |
| | | | | Percent | | | | | Percent | | | | | Percent | | | | | Percent | | | | | Percent |
| | | | | of | | | | | of | | | | | of | | | | | of | | | | | of |
(Dollars in millions) | | Amount | | | Total | | Amount | | | Total | | Amount | | | Total | | Amount | | | Total | | Amount | | | Total |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Residential mortgages | | $ | 657.0 | | | | 34 | % | | $ | 599.2 | | | | 36 | % | | $ | 549.8 | | | | 39 | % | | $ | 235.2 | | | | 28 | % | | $ | 265.5 | | | | 34 | % |
Commercial mortgages | | | 704.8 | | | | 36 | | | | 566.4 | | | | 33 | | | | 410.7 | | | | 29 | | | | 260.5 | | | | 32 | | | | 206.4 | | | | 26 | |
Commercial business | | | 203.6 | | | | 11 | | | | 190.5 | | | | 11 | | | | 158.7 | | | | 11 | | | | 150.9 | | | | 18 | | | | 166.3 | | | | 21 | |
Total commercial loans | | | 908.4 | | | | 47 | | | | 756.9 | | | | 44 | | | | 569.4 | | | | 40 | | | | 411.4 | | | | 50 | | | | 372.7 | | | | 47 | |
Consumer | | | 378.6 | | | | 19 | | | | 342.9 | | | | 20 | | | | 301.0 | | | | 21 | | | | 181.5 | | | | 22 | | | | 154.0 | | | | 19 | |
Total loans | | | 1,944.0 | | | | 100 | % | | | 1,699.0 | | | | 100 | % | | | 1,420.2 | | | | 100 | % | | | 828.1 | | | | 100 | % | | | 792.2 | | | | 100 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Allowance for loan losses | | | (22.1 | ) | | | | | | | (19.4 | ) | | | | | | | (13.0 | ) | | | | | | | (9.3 | ) | | | | | | | (9.0 | ) | | | | |
Net loans | | $ | 1,921.9 | | | | | | | $ | 1,679.6 | | | | | | | $ | 1,407.2 | | | | | | | $ | 818.8 | | | | | | | $ | 783.2 | | | | | |
Residential mortgages.
The Bank offers conforming and a limited number of non-conforming, fixed-rate and adjustable-rate residential mortgage loans with maturities of up to 30 years. The Bank offers both fixed- and adjustable-rate conventional mortgage loans (“ARMs”) with terms of 10 to 30 years that are fully amortizing with monthly loan payments. One- to four-family residential mortgage loansResidential mortgages are generally underwritten according to Fannie Mae and Freddie Mac guidelines for loans they designate as “A” or “A-“. Loans that conform to such guidelines” (these are referred to as “conforming loans.” The Bank generally originates both fixed-rate and ARM loans in amounts up to the maximum conforming loan limits as established by Fannie Mae and Freddie Mac, which are currently $417,000 for single-family homes.loans”). Private mortgage insurance is generally required for loans with loan-to-value ratios in excess of 80%. The Bank also originates loans above conforming loan amount limits, referred to as “jumbo loans,” which are generally consistent with secondary market guidelines for these loans. The Bank does not actively engage in the business of sub-primeoffer subprime mortgage lending programs, but may from time to time originate residential mortgage loans with FICO scores below 660, or otherwise not consistent with conforming loan criteria, when merited by other underwriting considerations.
The Bank also originates loans above conforming limits, referred to as “jumbo loans,” which have been underwritten to the substantially same credit standards as conforming loans, which are generally eligible for sale to various firms that specialize in the purchase of such non-conforming loans. The Bank also originates loans other than jumbo loans that are not saleable to Fannie Mae or Freddie Mac, but are deemed to be acceptable risks.
The Bank activelyoften sells its newly originated fixed rate mortgages. It monitors its interest rate risk position to determine the desirable level of investment in fixed-rate mortgages, The Bankand sometimes may decide to sell all or a portion of suchexisting mortgage loans in the secondary mortgage marketmarket. During 2008, the Bank became approved as a direct seller to government-sponsored entities such as Fannie Mae, and Freddie Mac or other purchasers depending on market interest rates and our capital and liquidity position.
The Bank generally retainsretaining the servicing rights on large portfolio loan sales to generate fee income and reinforce our commitment to customer service, although therights. The Bank may also sell loans to mortgage banking companies,other secondary market investors, either on a servicing-releasedservicing retained or servicing released basis. The Bank sometimes originates loans for sale to the FHA, VA, and state housing agency programs. As of December 31, 2007,year-end 2008, residential mortgage loans serviced for others totaled $128.0$111 million.
The Bank currently offers several ARM loan products secured by residential properties with rates that are fixed for a period ranging fromadjustable rate (“ARM”) mortgages which do not contain interest-only or negative amortization features. After an initial term of six months to ten years. Afteryears, the initial term, if the loan is not already refinanced, the interest rates on these loans generally reset every year based upon a contractual spread or margin above the average yield on U.S. Treasury securities, adjusted to a constant maturity of one year, as published weekly by the Federal Reserve Board and subject to certain periodic and lifetime limitations onsecurities. ARM loan interest rate changes. ARM loans generally pose different credit risks than fixed-rate loans primarily because the underlying debt service payments of the borrowersrates may rise as interest rates
rise, thereby increasing the potential for default. At December 31, 2007, our2008, the Bank’s ARM portfolio totaled $338.3$372 million. The Bank’s adjustable rate loans do not have interest-only or negative amortization features.
The Bank requires title insurance on all its one- to four-family mortgage loans, and also requires that borrowers maintain fire and extended coverage or all risk casualty insurance (and, if appropriate, flood insurance) in an amount at least equal to the lesser of the loan balance or the replacement cost of the improvements, but in any event in an amount calculated to avoid the effect of any coinsurance clause. For loans with initial loan-to-value ratios in excess of 80%, the Bank generally requires private mortgage insurance.
The Bank originates loans to individuals for the construction and acquisition of personal residences. These loans generally provide fifteen-month construction periods followed by a permanent mortgage loan, and follow the Bank’s normal mortgage underwriting guidelines. Residential construction loans totaled $46.8$35 million at year-end 2007.2008.
Commercial Mortgages.The Bank originates commercial mortgages on properties used for business purposes such as small office buildings, industrial, healthcare, lodging, recreation, or retail facilities. This portfolio also includes commercial 1-4 family and multifamily properties. Loans may generally be made with terms of up to 25 years and with interest rates that adjust periodically (primarily from short-term to five years).
Berkshire Bank generally requires that borrowers have debt service coverage ratios (the ratio of available cash flows before debt service to debt service) of at least 1.25 times. Loans may be made up to 80% of appraised value. Generally, commercial mortgages require personal guarantees by the principals. Credit enhancements in the form of additional collateral or guarantees are normally considered for start-up businesses without a qualifying cash flow history.
Commercial mortgages generally involve larger principal amounts and a greater degree of risk than residential mortgages. They also often provide higher lending spreads. Because repayment is often dependent on the successful operation or management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy. Berkshire Bank seeks to minimize these risks through strict adherence to its underwriting standards and portfolio management processes.
In 2008, the Bank began offering interest rate swaps to certain larger commercial mortgage borrowers. These swaps allow the Bank to originate a mortgage based on short-term LIBOR rates and allow the borrower to swap into a longer term fixed rate. The Bank simultaneously sells an offsetting back-to-back swap to an investment grade national bank so that it does not retain this fixed-rate risk. The Bank also records fee income on these interest rate swaps. In 2008, the Bank also purchased one interest rate swap on a fixed-rate tax-advantaged economic development bond provided to a local borrower, which is being accounted for as a trading security.
The Bank originates land acquisition, development and construction loans to builders and commercial borrowers in our market area.and around its markets. These loans totaled $125.3$130 million, or 6.4%6% of the our total loan portfolio at December 31, 2007. Acquisition loans help finance the purchase of land intended for further development, including single-family houses, multi-family housing, and commercial income property. In some cases, the Bank may make an acquisition loan before the borrower has received approval to develop the land as planned. In general, the maximum loan-to-value ratio for a land acquisition loan is 50% of the appraised value of the property, although for certain borrowers deemed to be the lowest risk, higher loan-to-value ratios may be allowed. The Bank also makes development loans to builders in its market area to finance improvements to real estate, consisting mostly of single-family subdivisions, typically to finance the cost of utilities, roads, sewers and other development costs. Builders generally rely on the sale of single-family homes to repay development loans, although in some cases the improved building lots may be sold to another builder. The maximum amount loaned is generally limited to the cost of the improvements plus an interest reserve, if one is required. Advances are made in accordance with a schedule reflecting the cost of the improvements.
The Bank also grants construction loans to area builders, often in conjunction with development loans. In the case of residential subdivisions, theseyear-end 2008. Construction loans finance the costacquisition and/or improvement of completing homes on the improved property. Advances oncommercial and residential properties. The maximum loan to value limits for construction loans are made in accordance withgenerally follow FDIC supervisory limits, up to a schedule reflecting the costmaximum of construction. Repayment of construction loans on residential subdivisions is normally expected from the sale of units to individual purchasers. In the case of income-producing property, repayment is usually expected from permanent financing upon completion of construction.80%. The Bank commits to provide the permanent mortgage financing on most of our construction loans on income-producing property. Advances on construction loans are made in accordance with a schedule reflecting the cost of the improvements. Construction loans include land acquisition loans up to a maximum 65% loan to value on raw land.
Land acquisition, development and construction lending exposes the Bank toConstruction loans may have greater credit risk than permanent mortgage financing. Theloans. In many cases, the loan’s repayment of land acquisition, development and construction loans depends uponis dependent on the sale of the property to third parties or the availability of permanent financing upon completion of all improvements. In the event the Bank makes an acquisition loan on property that is not yet approved for the planned development, there is theconstruction and other real estate improvements, which entails risk that approvals willconstruction permits may be delayed or may not be grantedreceived, or willthat there may be delayed. These events may adversely affectdelays or cost overruns during construction. Repayment is also often dependent on the borrower and the collateral value of the property. Development and construction loans also expose the Bank to the risk that improvements will not be completed on time in accordance with specifications and projected costs. In addition, the ultimate sale or rental of the improved property, which depends on market conditions and the availability of permanent financing. Developers and contractors may also encounter liquidity risks or other risks related to other projects which are not occur as anticipated.being financed.
Commercial Business Loans.The Bank offers secured commercial term loans with repayment terms which are normally limited to the expected useful life of the asset being financed, generally not exceeding seven years. Berkshire Bank also offers revolving loans, lines of credit, letters of credit, time notes and Small Business Administration guaranteed loans. Business lines of credit have adjustable rates of interest and are payable on demand, subject to annual review and renewal.
Commercial lending policies regarding debt-service coverage ability and guarantees are similar to those which govern commercial real estate lending. Commercial business loans are generally secured by a variety of collateral such as accounts receivable, inventory and equipment, and are generally supported by personal guarantees. Loan to value ratios depend on the collateral type and generally do not exceed 95% of the liquidation value of the collateral. Some commercial loans may also be secured by liens on real estate. Berkshire Bank generally does not make unsecured commercial loans.
Commercial loans are of higher risk and are made primarily on the basis of the borrower’s ability to make repayment from the cash flows of its business. Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value. The Bank gives additional consideration to the borrower’s credit history and the guarantor’s capacity to help mitigate these risks. Commercial loans are often a central component of a total commercial banking relationship, and are therefore an important component of the Bank’s lending activities.
Consumer Loans.BerkshireThe Bank’s consumer lending strategy is focused onloans consist principally of prime indirect automobile loans and home equity loans. The Bank offers fixed-rateIn 2008, the Company substantially ended the origination of new indirect automobile loans with termsdue to its assessment of up to 72 months for newcredit and recent model used cars and up to 66 months for older model used cars. The Bank generally makes such loans up to 100% of the retail value shownpricing conditions in the NADA Used Car Guide. This program is targeted towards prime grade credits. The Bank does not offer subprime lending programs.that market. The automobile loans have produced a higher loan charge-off rate than the Bank’s other loan portfolios, which is viewed as normal for this segment. Collections are more sensitive to changes in borrower financial circumstances, and the collateral can depreciate or be damaged prior to repossession. Additionally, collections are more subject to the limitations of federal and state laws. Automobile loans outstanding totaled $190.6$135 million at year-end 2007.
2008.
The Bank’s home equity lines of credit are typically secured by first or second mortgages on borrowers’ residences. Home equity lines have an initial revolving period up to ten years, followed by an amortizing term up to fifteen years. These loans are normally indexed to the prime rate. Home equity loans also include amortizing fixed-rate second mortgages with terms up to fifteen years. Lending policies for combined debt service and collateral coverage are similar to those used for residential first mortgages, although underwriting verifications are more streamlined. The maximum combined loan-to-value is 80%. Home equity line credit risks are similar to those of adjustable-rate first mortgages, although these loans may be more sensitive to losses when interest rates are rising due to increased sensitivity to rate changes and increasedchanges. Additionally, there may be possible compression of collateral coverage on second liens.lien home equity lines. The Bank also includes all other consumer loans in this portfolio total, including personal secured and unsecured loans and overdraft protection facilities. Home equity and other loans outstanding at year-end 20072008 totaled $181.9$211 million.
Maturity and Sensitivity of Loan Portfolio.The following table shows contractual final maturities of selected loan categories at year-end 2007.2008. The contractual maturities do not reflect premiums, discounts, and deferred costs, and do not reflect prepayments.
December 31, 2007 | | | | | | | | | | | | | |
| | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Contractual Maturity | | One Year | | | More Than One | | | More Than | | | | | | One Year | | More than One | | More Than | | | |
(In Thousands) | | or Less | | | to Five Years | | | Five Years | | | Total | | |
(In thousands) | | | or Less | | to Five Years | | Five Years | | Total | |
| | | | | | | | | | | | | |
Construction Mortgage Loans: | | | | | | | | | | | | | |
Construction mortgage loans: | | |
Residential | | $ | 9,266 | | | $ | 37,548 | | | $ | ---- | | | $ | 46,814 | | | $ | 22,404 | | $ | 12,117 | | $ | — | | $ | 34,521 | |
Commercial | | | 36,854 | | | | 88,495 | | | | ---- | | | | 125,349 | | | 61,507 | | 68,197 | | — | | 129,704 | |
Commercial Business Loans | | | 92,262 | | | | 49,368 | | | | 61,934 | | | | 203,564 | | |
Commercial business loans | | | 87,310 | | 37,538 | | 54,086 | | 178,934 | |
| | | | | | | | | | |
Total | | $ | 138,382 | | | $ | 175,411 | | | $ | 61,934 | | | $ | 375,727 | | | $ | 171,221 | | $ | 117,852 | | $ | 54,086 | | $ | 343,159 | |
| | | | | | | | | | |
For the $237$172 million total of loans above which mature in more than one year, $101$54 million of these loans are fixed-rate and $136$118 million are variable-rate.variable rate.
Loan Administration.Lending activities are governed by a loan policy approved by the Board of Directors.Board’s Risk Management Committee. Internal staff perform post-closing loan documentation review, quality control, and ongoingmonitor commercial loan review.administration. The Banklending staff assigns a risk rating to all commercial loans, and loan review staff perform an ongoing program of loan and risk rating reviews.loans. Management also employs an independent third party forto review the risk ratings of the majority of commercial loan reviews, as discussed in “Allowance for Loan Losses.”
balances.
The Bank’s lending activities follow written, non-discriminatory underwriting standards and loan origination procedures established by Berkshire Bank’s Board of Directorsthe Board’s Risk Management Committee and management. The Board of DirectorsRisk Management Committee has approved individual and combined lending approval authorities up to specified limits. Above those limits the Board of Directors established Regional Loan Committeesfor loans with commercial approval authority generally up to $5 million.certain risk ratings. Management’s Executive Loan Committee is responsible for commercial loan approval above $5 million and residential mortgage approval above $2 million.
The Bank’s lending activities are conducted by its salaried and commissioned loan personnel and through its relationships with automobile dealers.personnel. From time to time, the Bank will purchase whole loans or participations in loans. These loans are underwritten according to Berkshire Bank’s underwriting criteria and procedures and are generally serviced by the originating lender under terms of the applicable participation agreement. The Bank from time to time will sell or securitize residential mortgages in the secondary market based on prevailing market interest rate conditions and an analysis of the composition and risk of the loan portfolio, the Bank’s interest rate risk profile and liquidity needs. The Bank sells a limited number of commercial loan participations on a non-recourse basis. The Bank issues loan commitments to its prospective borrowers conditioned on the occurrence of certain events. Loan origination commitments are made in writing on specified terms and conditions and are generally honored for up to sixty days from approval; some commercial commitments are made for longer terms. Total lending commitments, including lines and letters of credit, were $571$438 million at year-end 2007.
2008.
The loan policy sets certain limits on concentrations of credit and requires periodic reporting of concentrations to the Board.Risk Management Committee. Loans outstanding to the ten largest relationships totaled $159 millionwere 81% of risk based capital at year-end 2007.2008. Total year-end commercial construction loans outstanding were 74%52% of the Bank’s risk based capital at year-end, and total commercial mortgage outstandings (including certain owner-occupied loans) were estimated at 265%247% of risk based capital. The FDIC has recently established monitoring guidelines of 100% and 300% for these ratios, respectively. Above these guidelines, additional monitoring and risk management controls are required. The commercial construction and development loans primarily involve residential and condominium construction projects. Additionally, the Bank finances construction of lodging, leisure, and retail properties. For the majority of these loans, the Bank provides permanent or semi-permanent financing after the construction period.
Problem Assets.The Bank finances residential and condominium construction and development projects as well.
Problem Assets. While the Bank generally prefers to work with borrowers to resolve problems rather than proceeding to foreclosure. For commercial loans, this may result in a period of forbearance or restructuring of the loan. For residential mortgage loans, the Bank generally follows FDIC guidelines to attempt a restructuring that will enable an owner-occupant to remain in their home. However, if these processes fail to result in a performing loan, then the Bank generally will initiate foreclosure or other proceedings no later than the 90th day of a delinquency, as necessary, to minimize any potential loss. Management reports to the Board of Directors monthlyquarterly delinquent loans and nonperforming assets. Loans are generally removed from accruing status when they reach 90 days delinquent, except for certain loans which
are well secured and in the process of collection. Delinquent automobile loans are maintained on accrual until they reach 120 days delinquent, and then they are generally charged-off. Interest income that would have been recorded for 20072008 had nonaccruing loans been current according to their original terms, amounted to $0.8$0.9 million. The amount of interest income on those loans that was included in net income in 20072008 was $0.1 million.
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Real estate acquired by Berkshire Bank as a result of loan collections is classified as real estate owned until sold. When property is acquired it is recorded at fair market value less estimated selling costs at the date of foreclosure, establishing a new cost basis. Holding costs and decreases in fair value after acquisition are expensed. At year-end 2007, Berkshire Bank had two properties of residential2008, total foreclosed real estate totaling $866 thousand.
was $0.5 million.
The following table sets forth additional information on year-end problem assets.assets and accruing troubled debt restructurings.
| | | | | | | | | | | | | | | | | | | | |
(Dollars in thousands) | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
| | | | | | | | | | | | | | | | | | | | |
Nonaccruing loans: | | | | | | | | | | | | | | | | | | | | |
Residential mortgages | | $ | 1,646 | | | $ | 726 | | | $ | 15 | | | $ | 261 | | | $ | 327 | |
Commercial mortgages | | | 7,738 | | | | 5,177 | | | | 308 | | | | 271 | | | | 147 | |
Commercial business | | | 1,921 | | | | 4,164 | | | | 7,203 | | | | 553 | | | | 523 | |
Consumer | | | 866 | | | | 441 | | | | 66 | | | | 101 | | | | 155 | |
| | | | | | | | | | | | | | | |
Total nonperforming loans | | | 12,171 | | | | 10,508 | | | | 7,592 | | | | 1,186 | | | | 1,152 | |
Real estate owned | | | 498 | | | | 866 | | | | — | | | | — | | | | — | |
| | | | | | | | | | | | | | | |
Total nonperforming assets | | $ | 12,669 | | | $ | 11,374 | | | $ | 7,592 | | | $ | 1,186 | | | $ | 1,152 | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Troubled debt restructurings (accruing) | | $ | 7,456 | | | $ | 4,613 | | | $ | 5,268 | | | $ | 1,234 | | | $ | 510 | |
Accruing loans 90+ days past due | | | 923 | | | | 823 | | | | 281 | | | | 110 | | | | 65 | |
|
Total nonperforming loans/total loans | | | 0.61 | % | | | 0.54 | % | | | 0.45 | % | | | 0.08 | % | | | 0.14 | % |
Total nonperforming assets/total assets | | | 0.48 | % | | | 0.45 | % | | | 0.35 | % | | | 0.06 | % | | | 0.09 | % |
(Dollars in thousands) | | 2007 | | | 2006 | | | 2005 | | | 2004 | | | 2003 | |
| | | | | | | | | | | | | | | |
Nonaccruing loans: | | | | | | | | | | | | | | | |
Residential mortgages | | $ | 726 | | | $ | 15 | | | $ | 261 | | | $ | 327 | | | $ | 348 | |
Commercial mortgages | | | 5,177 | | | | 308 | | | | 271 | | | | 147 | | | | 496 | |
Commercial business | | | 4,164 | | | | 7,203 | | | | 553 | | | | 523 | | | | 1,887 | |
Consumer | | | 441 | | | | 66 | | | | 101 | | | | 155 | | | | 468 | |
Total nonperforming loans | | | 10,508 | | | | 7,592 | | | | 1,186 | | | | 1,152 | | | | 3,199 | |
Real estate owned | | | 866 | | | | - | | | | - | | | | - | | | | - | |
Total nonperforming assets | | $ | 11,374 | | | $ | 7,592 | | | $ | 1,186 | | | $ | 1,152 | | | $ | 3,199 | |
| | | | | | | | | | | | | | | | | | | | |
Troubled debt restructurings | | $ | 4,613 | | | $ | 5,268 | | | $ | 1,234 | | | $ | 510 | | | $ | 214 | |
Accruing loans 90+ days past due | | | 823 | | | | 281 | | | | 110 | | | | 65 | | | | 306 | |
| | | | | | | | | | | | | | | | | | | | |
Total nonperforming loans/total loans | | | 0.54 | % | | | 0.45 | % | | | 0.08 | % | | | 0.14 | % | | | 0.40 | % |
Total nonperforming assets/total assets | | | 0.45 | % | | | 0.35 | % | | | 0.06 | % | | | 0.09 | % | | | 0.26 | % |
Asset Classification and Delinquencies.The Bank performs an internal analysis of its loan portfolio and assets to classify such loans and assets similar to the manner in which such loans and assets are classified by the federal banking regulators. There are four classifications for problem assets:loans with higher than normal risk: loss, doubtful, substandard and special mention. An asset classified as “Loss” is normally fully charged-off. “Substandard” assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. “Doubtful” assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. Assets that do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated “Special Mention.”
Nonperforming loans increased from $7.6 million at year-end 2006 to $10.5 million at year-end 2007. The increase in nonperforming loans was due mainly to an increase in nonaccrual commercial mortgages offset by a decrease in nonaccrual commercial business loans. There was one commercial mortgage totaling $2.7 million and several commercial mortgages with balances less than $1.0 million placed on nonaccrual status during 2007. Nonperforming loans also were impacted by increases in residential mortgages of $0.7 million and consumer loans (home equity loans) of $0.4 million. The increase in these nonperforming loan categories was due mainly to softening economic conditions in portions of the Company’s market area.
At year-end 2007,2008, there were no loan balances classified as loss. The balance of loans classified as doubtful was $1.3 million having an impaired valuation allowance of $0.8$1 million. Loans classified as substandard totaled $30.7 million. There were $7.7$82 million, in loans classified as substandardincluding $73 million of accruing balances and reported as nonperforming at year-end 2007. Included in$9 million of non-accruing balances. Please see the substandard nonperforming category are two commercial businessadditional discussion of non-accruing and potential problem loans in excess of $1.0 million, which totaled $4.2 million with an impaired valuation allowance of $0.2 million. The remaining $3.5 million of substandard nonperforming loans are commercial mortgages with outstanding balances of less than $1.0 million and an impaired valuation allowance of $0.2 million at year-end 2007. The remaining $23.0 million in loans classified as substandard are collectively regarded as having the potential to be nonperforming in the future, which included 6 loans with
balances in excess of $1.0 million totaling $14.2 million at year-end 2007.Item 7. Loans rated special mention totaled $32.8 million at year end 2007. Loans delinquent 30 – 90 days totaled $7.6$67 million at year-end 2007.2008.
Allowance for Loan Losses.Berkshire Bank maintains an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance represents management’s estimate of inherent losses that are probable and estimable as of the date of the financial statements. The allowance includes a specific component for impaired loans, a general component for pools of outstanding loans and an unallocated component for estimated model imprecision.
The loan portfolio and other credit exposures are regularly reviewed by management to evaluate the adequacy of the allowance for loan losses. The methodology for assessing the appropriateness of the allowance includes comparison to actual losses, peer group comparisons, industry data and economic conditions. In addition, management employs an independent third party to perform an annual review of the risk ratings of all of Berkshire Bank’s commercial loan relationships exceeding $1 million, all material credits on Berkshire Bank’s watch list or classified as substandard, and a random sampling of new loans.
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In assessing the allowance for loan losses, loss factors are applied to various pools of outstanding loans. Loss factors are based on management’s judgment of losses inherent in the portfolio, including past loan loss experience, known and inherent risks in the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values and economic conditions. The loss factors may be adjusted for significant factors that, in management’s judgment, affect the losses inherent in the portfolio as of the evaluation date. Generally, nonaccruing commercial loans are deemed impaired and evaluated for specific valuation allowances. Berkshire Bank primarily segregates the loan portfolio according to the primary loan types: residential mortgages, commercial mortgages (including a pool for commercial construction loans), commercial business loans, and consumerauto loans, and also evaluates commercial construction loans as a pool.home equity loans. Reserves are assigned to impaired loans, and this is normally based on the fair value of collateral since most impaired loans are deemed to be collateral dependent.
In addition, management assesses the allowance using factors that cannot be associated with specific credit or loan categories. These factors include management’s subjective evaluation of local and national economic and business conditions, portfolio concentrationconcentrations, and changes in the character and size of the loan portfolio. The allowance methodology reflects management’s objective that the overall allowance appropriately reflects a margin forincludes an unallocated amount due to the imprecision necessarily inherent in estimates of expected credit losses.
Although management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making its determinations. Because the estimation of inherent losses cannot be made with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loan or loan portfolio category deteriorate as a result of the factors discussed above. Additionally, the regulatory agencies, as an integral part of their examination process, also periodically review Berkshire Bank’s allowance for loan losses. Such agencies may require Berkshire Bank to make additional provisions for estimated losses based upon judgments different from those of management. Any material increase in the allowance for loan losses may adversely affect Berkshire Bank’s financial condition and results of operations.
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The following table presents an analysis of the allowance for loan losses for the years indicated.
| | | | | | | | | | | | | | | | | | | | | |
(Dollars in thousands) | | 2007 | | | 2006 | | | 2005 | | | 2004 | | | 2003 | | | 2008 | | 2007 | | 2006 | | 2005 | | 2004 | |
| | | | | | | | | | | | | | | | |
Balance at beginning of year | | $ | 19,370 | | | $ | 13,001 | | | $ | 9,337 | | | $ | 8,969 | | | $ | 10,308 | | | $ | 22,116 | | $ | 19,370 | | $ | 13,001 | | $ | 9,337 | | $ | 8,969 | |
| | | | | | | | | | | | |
Charged-off loans: | | | | | | | | | | | | | | | | | | | | | |
Residential mortgages | | | 110 | | | | 27 | | | | - | | | | - | | | | - | | | 143 | | 110 | | 27 | | — | | — | |
Commercial mortgages | | | - | | | | - | | | | - | | | | 138 | | | | - | | | 1,384 | | — | | — | | — | | 138 | |
Commercial business | | | 4,850 | | | | 461 | | | | 432 | | | | 218 | | | | 157 | | | 884 | | 4,850 | | 461 | | 432 | | 218 | |
Consumer | | | 1,416 | | | | 1,288 | | | | 1,110 | | | | 1,846 | | | | 4,207 | | | 2,031 | | 1,416 | | 1,288 | | 1,110 | | 1,846 | |
| | | | | | | | | | | | |
Total charged-off loans | | | 6,376 | | | | 1,776 | | | | 1,542 | | | | 2,202 | | | | 4,364 | | | 4,442 | | 6,376 | | 1,776 | | 1,542 | | 2,202 | |
| | | | | | | | | | | | | | | | | | | | | |
Recoveries on charged-off loans: | | | | | | | | | | | | | | | | | | | | | |
Commercial mortgages | | | 100 | | — | | — | | — | | — | |
Commercial business | | | 13 | | | | 43 | | | | 55 | | | | 296 | | | | 440 | | | 290 | | 13 | | 43 | | 55 | | 296 | |
Consumer | | | 356 | | | | 667 | | | | 517 | | | | 709 | | | | 1,125 | | | 264 | | 356 | | 667 | | 517 | | 709 | |
| | | | | | | | | | | | |
Total recoveries | | | 369 | | | | 710 | | | | 572 | | | | 1,005 | | | | 1,565 | | | 654 | | 369 | | 710 | | 572 | | 1,005 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
Net loans charged-off | | | 6,007 | | | | 1,066 | | | | 970 | | | | 1,197 | | | | 2,799 | | | 3,788 | | 6,007 | | 1,066 | | 970 | | 1,197 | |
Allowance attributed to loans acquired by merger | | | 4,453 | | | | - | | | | 3,321 | | | | - | | | | - | | | — | | 4,453 | | — | | 3,321 | | — | |
Provision for loan losses | | | 4,300 | | | | 7,860 | | | | 1,313 | | | | 1,565 | | | | 1,460 | | | 4,580 | | 4,300 | | 7,860 | | 1,313 | | 1,565 | |
Transfer of commitment reserve | | | - | | | | (425 | ) | | | - | | | | - | | | | - | | | — | | — | | | (425 | ) | | — | | — | |
| | | | | | | | | | | | |
Allowance for loan losses, balance at end of year | | $ | 22,116 | | | $ | 19,370 | | | $ | 13,001 | | | $ | 9,337 | | | $ | 8,969 | | | $ | 22,908 | | $ | 22,116 | | $ | 19,370 | | $ | 13,001 | | $ | 9,337 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
Ratios: | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | |
Net loans charged-off/average total loans | | | 0.34 | % | | | 0.07 | % | | | 0.08 | % | | | 0.15 | % | | | 0.35 | % | | | 0.19 | % | | | 0.34 | % | | | 0.07 | % | | | 0.08 | % | | | 0.15 | % |
Recoveries/charged-off loans | | | 5.79 | | | | 39.98 | | | | 37.09 | | | | 45.64 | | | | 35.86 | | | 14.72 | | 5.79 | | 39.98 | | 37.09 | | 45.64 | |
Net loans charged-off/allowance for loan losses | | | 27.16 | | | | 5.50 | | | | 7.46 | | | | 12.82 | | | | 31.21 | | | 16.54 | | 27.16 | | 5.50 | | 7.46 | | 12.82 | |
Allowance for loan losses/total loans | | | 1.14 | | | | 1.14 | | | | 0.92 | | | | 1.13 | | | | 1.13 | | | 1.14 | | 1.14 | | 1.14 | | 0.92 | | 1.13 | |
Allowance for loan losses/nonperforming loans | | | 2.10 | x | | | 2.55 | x | | | 10.96 | x | | | 8.11 | x | | | 2.80 | x | | 1.88 | x | | 2.10 | x | | 2.55 | x | | 10.96 | x | | 8.11 | x |
The following table presents year-end data for the approximate allocation of the allowance for loan losses by loan categories at the dates indicated and the percentage of loans in each category.category (including an apportionment of the unallocated amount). Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance to each category is not indicative of future losses and does not restrict the use of any of the allowance to absorb losses in any category.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
| | | | | | Percent of | | | | | | | Percent of | | | | | | | Percent of | | | | | | | Percent of | | | | | | | Percent of | |
| | | | | | Loans | | | | | | | Loans | | | | | | | Loans | | | | | | | Loans | | | | | | | Loans | |
| | | | | | in Each | | | | | | | in Each | | | | | | | in Each | | | | | | | in Each | | | | | | | in Each | |
| | Amount | | | Category to | | | Amount | | | Category to | | | Amount | | | Category to | | | Amount | | | Category to | | | Amount | | | Category to | |
(Dollars in thousands) | | Allocated | | | Total Loans | | | Allocated | | | Total Loans | | | Allocated | | | Total Loans | | | Allocated | | | Total Loans | | | Allocated | | | Total Loans | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Residential mortgages | | $ | 2,006 | | | | 34 | % | | $ | 2,028 | | | | 34 | % | | $ | 1,845 | | | | 36 | % | | $ | 1,649 | | | | 39 | % | | $ | 435 | | | | 28 | % |
Commercial mortgages | | | 13,539 | | | | 40 | | | | 12,040 | | | | 36 | | | | 9,939 | | | | 33 | | | | 5,933 | | | | 29 | | | | 3,828 | | | | 32 | |
Commercial business | | | 4,184 | | | | 9 | | | | 5,787 | | | | 11 | | | | 5,199 | | | | 11 | | | | 3,517 | | | | 11 | | | | 3,344 | | | | 18 | |
Consumer | | | 3,179 | | | | 17 | | | | 2,261 | | | | 19 | | | | 2,387 | | | | 20 | | | | 1,902 | | | | 21 | | | | 1,730 | | | | 22 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 22,908 | | | | 100 | % | | $ | 22,116 | | | | 100 | % | | $ | 19,370 | | | | 100 | % | | $ | 13,001 | | | | 100 | % | | $ | 9,337 | | | | 100 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2007 | | 2006 | | 2005 | | 2004 | | 2003 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | Percent of | | | | | Percent of | | | | Percent of | | | | Percent of | | | | | Percent of |
| | | | | Loans | | | | | Loans | | | | | Loans | | | | | Loans | | | | | Loans |
| | | | | in Each | | | | | in Each | | | | | in Each | | | | | in Each | | | | | in Each |
| | Amount | | | Category to | | Amount | | | Category to | | Amount | | | Category to | | Amount | | | Category to | | Amount | | | Category to |
(Dollars in thousands) | | Allocated | | | Total Loans | | Allocated | | | Total Loans | | Allocated | | | Total Loans | | Allocated | | | Total Loans | | Allocated | | | Total Loans |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Residential mortgages | | $ | 2,028 | | | | 34 | % | | $ | 1,845 | | | | 36 | % | | $ | 1,649 | | | | 39 | % | | $ | 435 | | | | 28 | % | | $ | 491 | | | | 34 | % |
Commercial mortgages | | | 12,040 | | | | 36 | | | | 9,939 | | | | 33 | | | | 5,933 | | | | 29 | | | | 3,828 | | | | 32 | | | | 2,945 | | | | 26 | |
Commercial business | | | 5,787 | | | | 11 | | | | 5,199 | | | | 11 | | | | 3,517 | | | | 11 | | | | 3,344 | | | | 18 | | | | 3,362 | | | | 21 | |
Consumer | | | 2,261 | | | | 19 | | | | 2,387 | | | | 20 | | | | 1,902 | | | | 21 | | | | 1,730 | | | | 22 | | | | 2,171 | | | | 19 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 22,116 | | | | 100 | % | | $ | 19,370 | | | | 100 | % | | $ | 13,001 | | | | 100 | % | | $ | 9,337 | | | | 100 | % | | $ | 8,969 | | | | 100 | % |
INVESTMENT SECURITIES ACTIVITIES
The investment securities portfolio is primarily used to provide for Berkshire Bank’sprovides cash flow needs, to provide adequateand liquidity to protect the safety of customer deposits,deposits. The portfolio is also used to manage interest rate risk and to earn a reasonable return on investment. The average maturity or repricing and the types of securities maintained are based upon the composition, maturity and quality of the loan portfolio, interest rate risk and Berkshire Bank’s liquidity position and deposit structure.
The Risk Management Committee of the Board of Directors is responsible for developing and reviewing Berkshire Bank’s investment policy. Investment decisions are made in accordance with the Bank’s investment policy and are based upon the qualityinclude consideration of a particular investment, its inherent risks, the Bank’s liquidity needs, prospects for yield and/or appreciationrisk, return, duration, and the potential tax consequences. General investment strategies are developed and authorized by the Risk Management Committee. The execution of specific investment actions and the day-to-dayportfolio concentrations. Day-to-day oversight of the
Bank’s investment portfolio rests with the PresidentChief Financial Officer and the Assistant Treasurer. The Asset/Liability Committee meets monthly and reviews investment strategies. The Risk Management Committee of the Board of Directors receives a quarterly report ofreviews all securities transactions made during the period.
The majorityand provides general oversight of the Bank’s investments have been in mortgage-backed securities issued or guaranteed by U.S. Government sponsored enterprises. investment function.
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The Bank has focused on mortgaged backedhistorically maintained a high-quality portfolio of limited duration mortgage-backed securities, that have an average duration between twotogether with a portfolio of municipal bonds including national and local issuers and local economic development bonds issued to four years and that offer a steady stream of principal and interest payments that can be reinvested at current market rates. Generally, in 2007, these securities consisted of purchases of collateralized mortgage obligation PACs for shorter durations and ten-year fixed-rate mortgage pass-through securities for slightly longer duration.non-profit organizations. Nearly all of the mortgage-backed securities owned by the Bank are issued by Fannie Mae or Freddie Mac. NoMac, and they generally have an average duration of two to four years. They principally consist of collateralized mortgage obligation PACs and hybrid ARM pass-through securities. Other than securities issued by Fannie Mae and Freddie Mac, no other issuer concentrations exceeding 10% of stockholders’ equity existed at year-end 2007.2008. The Bank also purchases municipal portfolio provides tax-advantaged yield, and the local economic development bonds and obligations, and purchases and originates industrial revenue bonds. Somewere originated by the Company to area borrowers. All of the Bank’s available for sale municipal securities are investment grade rated. Over 85% of these securities support local municipal relationships and these securities provide a tax-advantaged yield.have underlying ratings of A of better based on the issuer; over 90% of the portfolio also carries credit enhancement protection. Other corporate bonds are primarily investment gradeinclude financial institution trust preferred securities issued bybonds totaling $6 million, other financial institutions.institution bonds totaling $13 million, and other high grade corporate bonds totaling $2 million. The Bank owns $21 million of equity securities portfolio consists primarily of investments in the common stock of the Federal Home Loan Bank of Boston (“FHLBB”). The BankThis investment is based on the operating relationship with the FHLBB and historically has substantially liquidated its actively managed portfolio of exchange traded equity securities of bank, utility and industrial stocks. In 2006 and 2007,paid dividends based on current money market rates. It is carried on the cost basis since the FHLBB is expected to repurchase it at cost if the Bank executed deleveraging programsterminates the operating relationship. Due to stresses in the U.S. financial system, the Federal Home Loan Banks are expected to reduce leverage, improve yield,their dividends in 2009 and improvemay need to consider other capital strategies in order to maintain their safety and soundness. During 2008, the Bank entered into an interest rate sensitivity.swap against a $15 million economic development bond issued to a local non-profit organization, and as a result this security is carried as a trading account security. None of the Company’s investment securities were other than temporarily impaired at year-end, and the Bank did not record any material losses or write-downs of investment securities during the year.
The following table presents the year-end amortized cost and fair value of Berkshire Bank’s securities, by type of security, for the years indicated.
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2007 | | | 2006 | | | 2005 | | | 2008 | | 2007 | | 2006 | |
| | Amortized | | | Fair | | | Amortized | | | Fair | | | Amortized | | | Fair | | | Amortized | | Fair | | Amortized | | Fair | | Amortized | | Fair | |
(In thousands) | | Cost | | | Value | | | Cost | | | Value | | | Cost | | | Value | | | Cost | | Value | | Cost | | Value | | Cost | | Value | |
Available for sale securities | | | | | | | | | | | | | | | | | | | |
U.S. Government agencies | | $ | - | | | $ | - | | | $ | - | | | $ | - | | | $ | 69 | | | $ | 63 | | |
Municipal bonds and obligations | | | 74,223 | | | | 75,186 | | | | 63,788 | | | | 64,503 | | | | 63,701 | | | | 63,673 | | | $ | 76,843 | | $ | 75,414 | | $ | 74,223 | | $ | 75,186 | | $ | 63,788 | | $ | 64,503 | |
Mortgage-backed securities | | | 103,387 | | | | 104,518 | | | | 85,102 | | | | 84,334 | | | | 264,705 | | | | 258,504 | | | 174,896 | | 176,978 | | 103,387 | | 104,518 | | 85,102 | | 84,334 | |
Other bonds and obligations | | | 15,601 | | | | 15,265 | | | | 20,392 | | | | 20,439 | | | | 24,356 | | | | 24,703 | | | 24,341 | | 20,889 | | 15,601 | | 15,265 | | 20,392 | | 20,439 | |
Equity securities | | | 23,913 | | | | 24,073 | | | | 24,687 | | | | 24,930 | | | | 41,667 | | | | 43,933 | | | 1,177 | | 1,099 | | 793 | | 952 | | 878 | | 1,121 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | |
Total available for sale securities | | $ | 217,124 | | | $ | 219,042 | | | $ | 193,969 | | | $ | 194,206 | | | $ | 394,498 | | | $ | 390,876 | | | $ | 277,257 | | $ | 274,380 | | $ | 194,004 | | $ | 195,921 | | $ | 170,160 | | $ | 170,397 | |
| | | | | | | | | | | | | | |
| | |
Held to maturity securities | | | | | | | | | | | | | | | | | | | | | | | | | |
Municipal bonds and obligations | | $ | 36,981 | | | $ | 37,233 | | | $ | 35,572 | | | $ | 35,286 | | | $ | 23,851 | | | $ | 23,851 | | | $ | 25,066 | | $ | 25,926 | | $ | 36,981 | | $ | 37,233 | | $ | 35,572 | | $ | 35,286 | |
Mortgage-backed securities | | | 2,475 | | | | 2,456 | | | | 4,396 | | | | 4,400 | | | | 6,057 | | | | 5,912 | | | 806 | | 803 | | 2,475 | | 2,456 | | 4,396 | | 4,400 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | |
Total held to maturity securities | | $ | 39,456 | | | $ | 39,689 | | | $ | 39,968 | | | $ | 39,686 | | | $ | 29,908 | | | $ | 29,763 | | | $ | 25,872 | | $ | 26,729 | | $ | 39,456 | | $ | 39,689 | | $ | 39,968 | | $ | 39,686 | |
| | | | | | | | | | | | | | |
| | |
Trading account security | | | $ | 15,000 | | $ | 18,144 | | $ | — | | $ | — | | $ | — | | $ | — | |
| | |
Restricted equity securities | | | $ | 23,120 | | $ | 23,120 | | $ | 23,120 | | $ | 23,120 | | $ | 23,809 | | $ | 23,809 | |
The following table summarizes year-end 20072008 amortized cost, weighted average yields and contractual maturities of debt securities.securities available for sale and held to maturity. Yields are stated on a book basis (not fully taxable equivalent). Mortgage-backed securities may mature sooner for planned amortization class bonds.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | More than One Year | | More than Five Years | | | | |
| | One Year or Less | | to Five Years | | to Ten Years | | More than Ten Years | | Total |
| | | | | | Weighted | | | | | | Weighted | | | | | | Weighted | | | | | | Weighted | | | | | | Weighted |
| | Amortized | | Average | | Amortized | | Average | | Amortized | | Average | | Amortized | | Average | | Amortized | | Average |
(Dollars in millions) | | Cost | | Yield | | Cost | | Yield | | Cost | | Yield | | Cost | | Yield | | Cost | | Yield |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Municipal bonds and obligations | | $ | 10.0 | | | | 2.83 | % | | $ | 5.1 | | | | 3.62 | % | | $ | 26.6 | | | | 2.82 | % | | $ | 60.2 | | | | 4.39 | % | | $ | 101.9 | | | | 3.79 | % |
Mortgage-backed securities | | | 0.5 | | | | 3.30 | | | | 8.9 | | | | 3.31 | | | | 25.9 | | | | 5.25 | | | | 140.4 | | | | 4.69 | | | | 175.7 | | | | 4.70 | |
Other bonds and obligations | | | — | | | | — | | | | 11.8 | | | | 6.24 | | | | 3.0 | | | | 5.18 | | | | 9.5 | | | | 5.25 | | | | 24.3 | | | | 5.72 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 10.5 | | | | 2.86 | % | | $ | 25.8 | | | | 4.71 | % | | $ | 55.5 | | | | 4.08 | % | | $ | 210.1 | | | | 4.63 | % | | $ | 301.9 | | | | 4.47 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
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| | | | | | | | More than One | | More than Five Years | | | | | | | | | | | | |
| | One Year or Less | | Year to Five Years | | to Ten Years | | More than Ten Years | | Total |
| | | | | Weighted | | | | | Weighted | | | | | Weighted | | | | | Weighted | | | | | Weighted |
| | Amortized | | | Average | | Amortized | | | Average | | Amortized | | | Average | | Amortized | | | Average | | Amortized | | | Average |
(Dollars in millions) | | Cost | | | Yield | | Cost | | | Yield | | Cost | | | Yield | | Cost | | | Yield | | Cost | | | Yield |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Municipal bonds and obligations | | $ | 10.5 | | | | 4.02 | % | | $ | 6.5 | | | | 3.87 | % | | $ | 18.8 | | | | 3.90 | % | | $ | 75.4 | | | | 4.47 | % | | $ | 111.2 | | | | 4.08 | % |
Mortgage-backed securities | | | 1.4 | | | | 4.53 | | | | 2.4 | | | | 4.08 | | | | 23.0 | | | | 5.26 | | | | 79.1 | | | | 5.17 | | | | 105.9 | | | | 5.11 | |
Other bonds and obligations | | | 1.0 | | | | 5.48 | | | | 2.0 | | | | 5.31 | | | | 3.0 | | | | 5.18 | | | | 9.6 | | | | 6.60 | | | | 15.6 | | | | 6.09 | |
Total | | $ | 12.9 | | | | 4.19 | % | | $ | 10.9 | | | | 4.17 | % | | $ | 44.8 | | | | 4.68 | % | | $ | 164.1 | | | | 4.93 | % | | $ | 232.7 | | | | 4.69 | % |
DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS
Deposits are the major source of funds for Berkshire Bank’s lending and investment activities. Deposit accounts are the primary product and service interaction with the Bank’s customers. The Bank also uses borrowings from the FHLBB as an additional source of funding, particularly for daily cash managementserves personal, commercial, non-profit, and for funding longer duration assets. FHLBB advances also provide more pricing and option alternatives for particular asset/liability needs. In 2005, the Company created a trust subsidiary to issue $15.0 million in trust preferred securities, which provided funds which were invested in the Bank as additional paid in capital, thereby increasing its regulatory capital. The holding company has $50 million available in lines of credit and term loans and $35 million outstanding against the lines and term loans at December 31, 2007. The lines of credit at the holding company were used to fund the cash portion of the Factory Point acquisition as well as repurchases of its common stock.
municipal deposit customers. Most of the Bank’s deposits are generated from the areas surrounding its branch offices. The Bank offers a wide variety of deposit accounts with a range of interest rates and terms. The Bank also periodically offers promotional interest rates and terms for limited periods of time. Berkshire Bank’s deposit accounts consist of interest-bearing checking, noninterest-bearing checking, regular savings, money market savings and time certificates of deposit. The Bank emphasizes its transaction deposits –— checking and NOW accounts for personal accounts and checking accounts promoted to businesses. These accounts have the lowest marginal cost to the Bank and are also often a core account for a customer relationship. The Bank offers a courtesy overdraft program to improve customer service, and also provides debit cards and other electronic fee producing payment services to transaction account customers. The Bank is promoting remote deposit capture devices so that commercial accounts can make deposits from their place of business. Money market accounts have increased in popularity due to their interest rate structure. Savings accounts include traditional passbook and statement accounts. The Bank’s time accounts provide maturities from three months to ten years. Additionally, the Bank offers a variety of retirement deposit accounts to personal and business customers. Deposit service fee income also includes other miscellaneous transaction and convenience services sold to customers through the branch system as part of an overall service relationship.
The Bank offers 100% insurance on all deposits as a result of a combination of insurance from the FDIC and the Massachusetts Depositors Insurance Fund, a mutual insurance fund sponsored by Massachusetts-chartered savings banks. This provides a competitive advantage compared to banks which do not offer this insurance. In the fourth quarter of 2008, the FDIC temporarily increased its insurance limits from $100 thousand per person to $250 thousand per person. Additionally, the FDIC optionally offered unlimited insurance on most categories of transaction deposit accounts, and the Bank opted to participate in this program. These higher FDIC insurance amounts currently have a targeted expiration of year-end 2009.
The following table presents information concerning average balances and weighted average interest rates on Berkshire Bank’s interest-bearing deposit accounts for the years indicated.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2007 | | 2006 | | 2005 | | 2008 | | 2007 | | 2006 | |
| | | | | Percent | | | | | | | | Percent | | | | | | | | Percent | | | | | Percent | | Percent | | Percent | | | |
| | | | | of Total | | Weighted | | | | | of Total | | Weighted | | | | | of Total | | Weighted | | of Total | | Weighted | | of Total | | Weighted | | of Total | | Weighted | |
| | Average | | | Average | | Average | | Average | | | Average | | Average | | Average | | | Average | | Average | | Average | | Average | | Average | | Average | | Average | | Average | | Average | | Average | | Average | |
(Dollars in millions) | | Balance | | | Deposits | | Rate | | Balance | | | Deposits | | Rate | | Balance | | | Deposits | | Rate | | Balance | | Deposits | | Rate | | Balance | | Deposits | | Rate | | Balance | | Deposits | | Rate | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Demand | | $ | 190.4 | | | | 12 | % | | | - | % | | $ | 174.5 | | | | 12 | % | | | - | % | | $ | 149.6 | | | | 13 | % | | | - | % | | $ | 225.2 | | | 12 | % | | | — | % | | $ | 190.4 | | | 12 | % | | | — | % | | $ | 174.5 | | | 12 | % | | | — | % |
NOW | | | 157.9 | | | | 10 | | | | 1.46 | | | | 137.8 | | | | 9 | | | | 1.09 | | | | 121.7 | | | | 11 | | | | 0.39 | | | 200.1 | | 11 | | 0.75 | | 157.9 | | 10 | | 1.46 | | 137.8 | | 9 | | 1.09 | |
Money market | | | 339.2 | | | | 21 | | | | 3.60 | | | | 284.4 | | | | 19 | | | | 3.41 | | | | 209.0 | | | | 18 | | | | 2.13 | | | 464.9 | | 25 | | 2.15 | | 339.2 | | 21 | | 3.60 | | 284.4 | | 19 | | 3.41 | |
Savings | | | 201.6 | | | | 13 | | | | 1.09 | | | | 210.6 | | | | 14 | | | | 0.90 | | | | 205.8 | | | | 18 | | | | 0.90 | | | 216.4 | | 12 | | 0.74 | | 201.6 | | 13 | | 1.09 | | 210.6 | | 14 | | 0.90 | |
Time | | | 714.1 | | | | 44 | | | | 4.75 | | | | 651.7 | | | | 46 | | | | 4.28 | | | | 445.2 | | | | 40 | | | | 3.20 | | | 725.4 | | 40 | | 3.94 | | 714.1 | | 44 | | 4.75 | | 651.7 | | 46 | | 4.28 | |
| | | | | | | | | | | | | | | | | | | | |
Total | | $ | 1,603.2 | | | | 100 | % | | | 3.16 | % | | $ | 1,459.0 | | | | 100 | % | | | 2.81 | % | | $ | 1,131.3 | | | | 100 | % | | | 1.86 | % | | $ | 1,832.0 | | | 100 | % | | | 2.28 | % | | $ | 1,603.2 | | | 100 | % | | | 3.16 | % | | $ | 1,459.0 | | | 100 | % | | | 2.81 | % |
| | | | | | | | | | | | | | | | | | | | |
At year-end 2007,2008, Berkshire Bank had time deposit accounts in amounts of $100 thousand or more maturing as follows:
| | | | | | | | |
| | | | | | |
| | | | | | Weighted | |
Maturity Period | | | | | | Average | |
(Dollars in thousands) | | Amount | | | Rate | |
Three months or less | | $ | 56,422 | | | | 3.18 | % |
Over 3 months through 6 months | | | 35,338 | | | | 3.14 | |
Over 6 months through 12 months | | | 102,815 | | | | 3.48 | |
Over 12 months | | | 157,088 | | | | 4.18 | |
| | | | | | |
Total | | $ | 351,663 | | | | 3.71 | % |
| | | | | | |
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| | | | | Weighted |
| | | | | Average |
Maturity Period | | Amount | | | Rate |
(Dollars in thousands) | | | | | | |
Three months or less | | $ | 100,607 | | | | 4.83 | % |
Over 3 months through 6 months | | | 65,520 | | | | 4.49 | |
Over 6 months through 12 months | | | 81,992 | | | | 4.80 | |
Over 12 months | | | 49,889 | | | | 4.96 | |
Total | | $ | 298,008 | | | | 4.77 | % |
The Bank also uses borrowings from the FHLBB as an additional source of funding, particularly for daily cash management and for funding longer duration assets. FHLBB advances also provide more pricing and option alternatives for particular asset/liability needs. The FHLBB functions as a central reserve bank providing credit for member institutions. As an FHLBB member, Berkshire Bank is required to own capital stock of the FHLBB. FHLBB borrowings are secured by a blanket lien on most of the Bank’s mortgage loans and mortgage-related securities, as well as certain other assets. Advances are made under several different credit programs with different lending standards, interest rates, and range of maturities.
The Company maintains a $15 million line of credit, which was unused at year-end 2008. The holding company also has outstanding bank term loans totaling $17 million and a $15 million trust preferred debenture. The holding company also utilized notes payableissued common stock and junior subordinated debenturespreferred stock in 2008.
DERIVATIVE FINANCIAL INSTRUMENTS
In 2008, the Company began using interest rate swap instruments for its own account and also offering them for sale to commercial customers for their own accounts. Previously, the only derivative financial instruments used by the Company were mortgage banking related commitments, and interest rate swaps owned as additional funding sources.a result of the acquisition of another bank in 2005. At year-end 2008, the Company had $243 million in the gross notional amount of interest rate swaps outstanding. The Company developed a policy for managing its derivative financial instruments, and the policy and program activity are overseen by the Risk Management Committee of the Board of Directors. Swap counterparties are limited to a select number of national financial institutions and commercial borrower customers. Collateral may be required based on financial condition tests. The Company works with a third-party firm which assists in marketing swap transactions, documenting transactions, and providing information for bookkeeping and accounting purposes.
WEALTH MANAGEMENT SERVICES
The Bank’s Asset Management/Trust Group provides consultative investment management and trust relationships to individuals, businesses, and institutions, with an emphasis on personal investment management. The groupGroup has built a track record over more than a decade with its dedicated in-house investment management team. At year-end 2007,2008, assets under management totaled $781$670 million. Specialized wealth management services offered include investment management, trust administration, estate planning, and private banking. The groupGroup provides a full line of investment products, financial planning, investment management and brokerage services utilizing Commonwealth Financial Network as the broker/dealer.
INSURANCE
Expanding on its existing insurance operations, and those acquired as part In January 2008, the Group expanded into the Albany area with the acquisition of the Woronoco Bancorp acquisition in 2005, Berkshire Insurance Group, Inc. acquired five agencies with eight locations at the end of October 2006. The resulting agency has 94 full-time equivalent employees in ten locations in Berkshire, Franklin and Hampden Counties, Massachusetts. Center for Financial Planning.
INSURANCE
Berkshire Insurance Group is one of the largest and fastest growing insurance agencies in Western Massachusetts. OneAs an independent insurance agent, it represents a carefully selected group of the acquired agencies wasfinancially sound, reputable insurance companies offering attractive coverage at competitive prices. When there is a Best Practicesloss, Berkshire Insurance Group works with its customers to assure that claims are processed fairly and Five Star designee which bolstered the administrativepromptly. The Group offers a full line of personal and efficiency expertise,commercial property and onecasualty insurance. It also offers employee benefits insurance and a full line of the agencies had a strong sales selection, trainingpersonal life, health, and oversight process in place.financial services insurance products. The executive team draws on over 175 years of independent agency management and sales experience and manages a combined sales force of fifteen agents. Berkshire Insurance Group sells all lines of insurance (personal, commercial, employee benefits, and life insurance) in westernWestern Massachusetts, southernSouthern Vermont, upstateUpstate New York and northwesternNorthwestern Connecticut. Berkshire InsuranceThe Group has instituted an aggressive cross selloperates a focused cross-sell program of insurance and banking products through all offices and branches.branches of Berkshire Bank.
GOVERNMENT BANKING
Berkshire Bank offers full-service government banking for cities, towns and municipal school districts in its primary markets. In October 2005, Berkshire Bank opened Berkshire Municipal Bank, an FDIC-insured, New York-chartered limited purpose commercial bank, organized principally to accept deposits from New York municipalities and other governmental entities. Berkshire Municipal Bank was renamed Berkshire Bank Municipal Bank in February 2008.
PERSONNEL
At year-end 2007,2008, the Company had 560610 full-time equivalent employees, representing an increase of 3850 from 522560 at year-end 2006.2007. This growth was primarily due to the Factory Pointa first quarter Asset Management acquisition of Center for Financial Planning, as well as increased headcount in the third quarter.our Insurance Group, Risk Management and Commercial Lending areas. Year-end personnel included 94100 full-time equivalent employees in Berkshire Insurance Group and 466510 in the Bank. The employees are not represented by a collective bargaining unit and the Bank will strive to continue its strong relationship with its employees.
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SUBSIDIARY ACTIVITIES
Berkshire Hills Bancorp, Inc. wholly owns three active subsidiaries: Berkshire Bank, Berkshire Insurance Group, Inc., and Berkshire Hills Capital Trust I. The capital trust subsidiary was created under Delaware law in 2005 to facilitate the issuance of trust preferred securities. The Berkshire Insurance Group, Inc. is incorporated in Massachusetts. It was contributed to the Company by the Bank in October, 2006 in conjunction with the insurance agency purchases, and was previously discussed under “Insurance”. The Company also owns one dormant Massachusetts subsidiary, Berkshire Hills Technology, Inc., which discontinued operations in 2004.
Berkshire Bank is a Massachusetts chartered savings bank which wholly owns five subsidiaries. The Bank owns three subsidiaries which are qualified as “securities corporations” for Massachusetts income tax purposes: North Street Securities Corporation, Woodland Securities, Inc., and Gold Leaf Securities Corporation. Berkshire Bank also owns Berkshire Bank Municipal Bank, which was previously discussed under “Government Banking”.chartered in the state of New York. Additionally, the Bank owns the inactive subsidiary, Berkshire Financial Planning, Inc., which ceased offering brokerage services in 2004. Except for Berkshire Bank Municipal Bank, all subsidiaries of Berkshire Bank are incorporated in Massachusetts.
During 2007, the Company acquired Factory Point Bancorp, Inc. Between the acquisition date and the end of the year,2007, all of the Factory Point subsidiaries were merged into existing Berkshire Hills entities. During 2005, the Company acquired Woronoco Bancorp. Between the acquisition date and the end of 2005, all of the Woronoco subsidiaries were merged into existing Berkshire Hills entities, except for Woronoco Insurance Group, Inc., which was acquired by Berkshire Bank and renamed Berkshire Insurance Group, Inc.
SEGMENT REPORTING
The Company has two reportable operating segments, Banking and Insurance, which are delineated by the consolidated subsidiaries of Berkshire Hills Bancorp. Banking includes the activities of Berkshire Bank and its subsidiaries, which provide commercial and consumerpersonal banking services. Insurance includes the activities of Berkshire Insurance Group, which provides commercial and consumerpersonal insurance services. The only other consolidated financial activity of the Company is the Parent, which consists of the transactions of Berkshire Hills Bancorp. For more information about the Company’s reportable operating segments, see Footnote 17the segments note in the financial statements in Item 8.8 of this Form 10-K.
REGULATION AND SUPERVISION
The following discussion describes elements of an extensive regulatory framework applicable to savings and loan holding companies and banks and specific information about the CompanyBerkshire Hills and its subsidiaries. Federal and state regulation of savings banks and their holding companies is intended primarily for the protection of depositors and the Deposit Insurance Funddeposit insurance funds rather than for the protection of stockholders and creditors.
GENERAL
AsBerkshire Bank is a Massachusetts-chartered stock savings bank and wholly-owned subsidiary of Berkshire Hills, a Delaware corporation and savings and loan holding company Berkshire Hills is required by federal law to file reportsregistered with and otherwise comply with the rules and regulations of, the Office of Thrift Supervision (“OTS”). As a savings bank charteredBerkshire Bank’s deposits are insured up to applicable limits by the CommonwealthFederal Deposit Insurance Corporation (“FDIC”) and by the Depositors Insurance Fund of Massachusetts for amounts in excess of the FDIC insurance limits. Berkshire Bank is subject to extensive regulation examination and supervision by the Massachusetts Commissioner of Banks (the “Commissioner”), as its primary regulator,chartering agency, and by the Federal Deposit Insurance Corporation (“FDIC”),FDIC, as theits deposit insurer. Berkshire Bank is a member of the Federal Home Loan Bank system and, with respectrequired to deposit insurance, of the Bank Insurance Fund managed by the FDIC. Berkshire Bank must file reports with the Commissioner and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other savings institutions. The Commissioner and/orand the FDIC conduct periodic examinations to test Berkshire Bank’s safety and soundness and compliance with various regulatory requirements. As a savings and loan holding company, Berkshire Hills is required by federal law to file reports with, and otherwise comply with the rules and regulations of, the OTS. The regulatory structure gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the Commissioner, the Massachusetts legislature, the FDIC, the OTS or Congress, could have a material adverse impact on the Company, theBerkshire Hills, Berkshire Bank and their operations.
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Certain regulatory requirements applicable to Berkshire Bank and to the CompanyBerkshire Hills are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on Berkshire Bank and Berkshire Hills and is qualified in its entirety by reference to the actual laws and regulations.
Massachusetts Banking Laws and Supervision
MASSACHUSETTS BANKING LAWS AND SUPERVISION
MassachusettsGeneral.As a Massachusetts-chartered savings banks are regulatedbank, Berkshire Bank is subject to supervision, regulation and supervisedexamination by the Commissioner who oversees regular bank examinations.and to various Massachusetts statutes and regulations which govern, among other things, investment powers, lending and deposit-taking activities, borrowings, maintenance of surplus and reserve accounts, distribution of earnings and payment of dividends. In addition, Berkshire Bank is subject to Massachusetts consumer protection and civil rights laws and regulations. The Commissioner’s approval of the Commissioner is required for a Massachusetts-chartered bank to establish or close branches, to merge with other financial institutions, organize a holding company, issue stock and undertake certain other activities.
Massachusetts regulations generally allow Massachusetts banks to engage in activities permissible for federally chartered banks or banks chartered by another state. The Commissioner has adopted procedures reducing regulatory burdens and expense and expediting branching by well-capitalized and well-managed banks.
Dividends.A Massachusetts stock bank may declare from net profits cash dividends not more frequently than quarterly and non-cash dividends at any time. No dividends may be declared, credited or paid if the bank’s capital stock is impaired. The approval of the Commissioner is required if the total of all dividends declared in any calendar year exceeds the total of its net profits for that year combined with its retained net profits of the preceding two years. Net profits for this purpose means the remainder of all earnings from current operations plus actual recoveries on loans and investments and other assets after deducting from the total thereof all current operating expenses, actual losses, accrued dividends on preferred stock, if any, and all federal and state taxes.
Loans to One Borrower Limitations.Massachusetts banking law grants broad lending authority. However, with certain limited exceptions, total obligations of one borrower to a bank may not exceed 20.0% of the total of the bank’s capital, which is defined under Massachusetts law as the sum of the bank’s capital stock, surplus account and undivided profits.
Loans to a Bank’s Insiders.The Massachusetts banking laws prohibit any executive officer, director or trustee from borrowing, otherwise becoming indebted, or becoming liable for a loan or other extension of credit by such bank to issueany other person, except for any of the following loans or extensions of credit: (i) loans or extensions of credit, secured or unsecured, to an officer of the bank in an amount not exceeding $100,000; (ii) loans or extensions of credit intended or secured for educational purposes to an officer of the bank in an amount not exceeding $200,000; (iii) loans or extensions of credit secured by a mortgage on residential real estate to be occupied in whole or in part by the officer to whom the loan or extension of credit is made, in an amount not exceeding $750,000; and (iv) loans or extensions of credit to a director or trustee of the bank who is not also an officer of the bank in an amount permissible under the bank’s loan to one borrower limit.
The loans listed above require approval of the majority of the members of Berkshire Bank’s Board of Directors, excluding any member involved in the loan or extension of credit. No such loan or extension of credit may be granted with an interest rate or other terms that are preferential in comparison to loans granted to persons not affiliated with the savings bank.
Investment Activities.In general, Massachusetts-chartered savings banks may invest in preferred and common stock of any corporation organized under the laws of the United States or any state provided such investments do not involve control of any corporation and do not, in the aggregate, exceed 4.0% of the bank’s deposits. Massachusetts-chartered savings banks may in addition invest an amount equal to undertake many other activities. 1.0% of their deposits in stocks of Massachusetts corporations or companies with substantial employment in Massachusetts which have pledged to the Commissioner that such monies will be used for further development within the Commonwealth. However, these powers are constrained by federal law. See“—Federal Regulations—Investment Activities”for federal restrictions on equity investments.
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Regulatory Enforcement Authority.Any MassachusettsMassachusetts-chartered bank that does not operate in accordance with the Commissioner’s regulations, policies and directives of the Commissioner may be sanctioned.subject to sanctions for non-compliance, including seizure of the property and business of the bank and suspension or revocation of its charter. The Commissioner may under certain circumstances suspend or remove directorsofficers or officers of a bankdirectors who have violated the law, conducted athe bank’s business in a manner thatwhich is unsafe, unsound or contrary to the depositors’depositors interests or been negligent in the performance of their duties. In addition, upon finding that a bank has engaged in an unfair or deceptive act or practice, the Commissioner has the authoritymay issue an order to appointcease and desist and impose a receiver or conservator if it is determined thatfine on the bank is conducting its businessconcerned. Finally, Massachusetts consumer protection and civil rights statutes applicable to Berkshire Bank permit private individual and class action law suits and provide for the rescission of consumer transactions, including loans, and the recovery of statutory and punitive damage and attorney’s fees in an unsafe or unauthorized manner, and underthe case of certain other circumstances.violations of those statutes.
Depositors Insurance Fund.All Massachusetts-chartered savings banks are required to be members of the Depositors Insurance Fund, a private deposit insurer, whichcorporation that insures allsavings bank deposits in member banks in excess of FDICfederal deposit insurance limits. Membercoverage. The Depositors Insurance Fund is authorized to charge savings banks an annual assessment of up to 1/50th of 1.0% of a savings bank’s deposit balances in excess of amounts insured by the FDIC.
Massachusetts has other statutes or regulations that are required to pay fund assessments. In addition, the Mutual Savings Central Fund acts as a source of liquidity to its members in supplying them with low-cost funds, and purchasing qualifying obligations from them.
Berkshire Bank must adheresimilar to the Massachusetts banking laws, which govern activities such as authorized investments, lending activities and dividend payments. In particular, a Massachusetts savings bank may only pay dividends on its capital stock if such payment would not impair the bank’s capital. No dividends may be paid to stockholders of a bank if such dividends would reduce stockholders’ equity of the bank below the amount of the liquidation account required by the Massachusetts conversion regulations. Additionally, the Commissioner may restrict the payment of dividends by a bank if it is determined that such payment would result in safety and soundness concerns.federal provisions discussed below.
Federal Regulations
FEDERAL REGULATIONS
CAPITAL REQUIREMENTS
Capital Requirements.Under FDIC regulations, federally insured state-chartered banks that are not members of the Federal Reserve System (“state non-member banks”), such as Berkshire Bank, are required to comply with minimum leverage capital requirements. For an institution determined by the FDIC to not be anticipating or experiencing significant growth and to be in general a strong banking organization, rated composite 1 under the Uniform Financial Institutions Rating System established by the Federal Financial Institutions Examination Council, the minimum capital leverage requirement is a ratio of Tier 1 capital to total average assets (as defined) of 3%. For all other institutions, the minimum leverage capital ratio is not less than 4%. Tier 1 capital is the sum of common stockholders’ equity, noncumulative perpetual preferred stock
(including (including any related surplus) and minority investments in certain subsidiaries, less intangible assets (except for certain servicing rights and credit card relationships) and a percentage of certain nonfinancial equity investments.
other items. Berkshire Bank must also comply with the FDIC risk-based capital guidelines. The FDIC guidelines require state non-member banks to maintain certain levels of regulatory capital in relation to regulatory risk-weighted assets. Risk-based capital ratios are determined by allocating assets and specified off-balance sheet items to four risk-weighted categories ranging from 0% to 100%, with higher levels of capital being required for the categories perceived as representing greater risk.
State non-member banks must maintain a minimum ratio of total capital to risk-weighted assets of at least 8%, of which at least one-half must be Tier 1 capital. Total capital consists of Tier 1 capital plus Tier 2 or supplementary capital items, which include allowances for loan losses in an amount of up to 1.25% of risk-weighted assets, cumulative preferred stock, a portion of the net unrealized gain on equity securities and other capital instruments. The includable amount of Tier 2 capital cannot exceed the amount of the institution’s Tier 1 capital.
As a savings and loan holding company regulated by the OTS, Berkshire Hills is not subject to any separate regulatory capital requirements. Berkshire Bank’s regulatory capital is included in the Stockholders’ Equity note of the Company’s financial statements in Item 8 of this report. For the dates shown,At December 31, 2008, Berkshire Bank met each of its capital requirements.
INTERSTATE BANKING AND BRANCHING
Interstate Banking and Branching.Federal law permits a bank, such as Berkshire Bank, to acquire an institution by merger in a state other than Massachusetts unless the other state has opted out. Federal law also authorizes de novo branching into another state if the host state enacts a law expressly permitting out of state banks to establish such branches within its borders. In 2004, Berkshire Bank purchased a branchoperates branches in Oriskany Falls, New York. At year-end 2005, Berkshire Bank had received regulatory approval for a new branch in East Greenbush, New York and was in the process of obtaining regulatory approval for new branches in Delmar and Guilderland, New York. Since 2005, Berkshire Bank opened nine branches in upstate New York’s capital region.Vermont. At its interstate branches, Berkshire Bank may conduct any activity that is authorized under Massachusetts law that is permissible either for a savings bank chartered in that state (subject to applicable federal restrictions) or a branch in that state of an out-of-state national bank. The New York State Superintendent of Banks and the Vermont Commissioner of Banking and Insurance may exercise certain regulatory authority over the Bank’s New York and Vermont branches.
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PROMPT CORRECTIVE REGULATORY ACTION
Prompt Corrective Regulatory Action.Federal law requires, among other things, that federal bank regulatory authorities take “prompt corrective action” with respect to banks that do not meet minimum capital requirements. For these purposes, the law establishes three categories of capital deficient institutions: undercapitalized, significantly undercapitalized and critically undercapitalized.
The FDIC has adopted regulations to implement the prompt corrective action legislation. An institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a leverage ratio of 5% or greater. An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater and generally a leverage ratio of 4% or greater. An institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital ratio of less than 4%, or generally a leverage ratio of less than 4% (3% or less for institutions with the highest examination rating). An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, or a leverage ratio of less than 3%. An institution is considered to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2%. As of December 31, 2007,2008, Berkshire Bank met the conditions to be classified as a “well capitalized” institution.
“Undercapitalized” banks must adhere to growth, capital distribution (including dividend) and other limitations and are required to submit a capital restoration plan. No institution may make a capital distribution, including payment as a dividend, if it would be “undercapitalized” after the payment. A bank’s compliance with such plans is required to be guaranteed by its parent holding company in an amount equal to the lesser of 5% of the institution’s total assets when deemed undercapitalized or the amount needed to comply with regulatory capital requirements. If an “undercapitalized”
bank fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.” “Significantly undercapitalized” banks must comply with one or more of a number of additional restrictions, including but not limited to an order by the FDIC to sell sufficient voting stock to become adequately capitalized, requirements to reduce assets and cease receipt of deposits from correspondent banks or dismiss directors or officers, and restrictions on interest rates paid on deposits, compensation of executive officers and capital distributions by the parent holding company. “Critically undercapitalized” institutions must comply with additional sanctions including, subject to a narrow exception, the appointment of a receiver or conservator within 270 days after it obtains such status.
TRANSACTIONS WITH AFFILIATES
Transactions with Affiliates.Under current federal law, transactions between depository institutions and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. In a holding company context, at a minimum, the parent holding company of a savings bank and any companies which are controlled by such parent holding company are affiliates of the savings bank. Generally, Section 23A limits the extent to which the savings bank or its subsidiaries may engage in “covered transactions,” such as loans, with any one affiliate to 10% of such savings bank’s capital stock and surplus, and contains an aggregate limit on all such transactions with all affiliates to 20% of capital stock and surplus. Loans to affiliates and certain other specified transactions must comply with specified collateralization requirements. Section 23B requires that transactions with affiliates be on terms that are no less favorable to the savings bank or its subsidiary as similar transactions with non-affiliates.
Further, federal law restricts an institution with respect to loans to directors, executive officers, and principal stockholders (“insiders”). Loans to insiders and their related interests may not exceed, together with all other outstanding loans to such persons and affiliated entities, the institution’s total capital and surplus. Loans to insiders above specified amounts must receive the prior approval of the board of directors. Further, loans to insiders must be made on terms substantially the same as offered in comparable transactions to other persons, except that such insiders may receive preferential loans made under a benefit or compensation program that is widely available to Berkshire Bank’s employees and does not give preference to the insider over the employees. Federal law places additional limitations on loans to executive officers.
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ENFORCEMENT
Enforcement.The FDIC has extensive enforcement authority over insured savings banks, including Berkshire Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease and desist orders and to remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and unsafe or unsound practices. The FDIC has authority under federal law to appoint a conservator or receiver for an insured bank under limited circumstances.
INSURANCE OF DEPOSIT ACCOUNTS
The Bank’s depositsInsurance of Deposit Accounts.Our deposit accounts are insured by the FDIC up to applicable legal limits, and, as discussed above under “—Massachusetts Banking Laws and Supervision—Depositors Insurance Fund”, by the DepositMassachusetts Depositors Insurance Fund for amounts in excess of the Federal Deposit Insurance Corporation. The Deposit Insurance Fund is the successorfederal deposit insurance coverage.
In February 2006, federal legislation to the Bank Insurance Fund andreform federal deposit insurance was signed into law. This legislation merged the Savings Association Insurance Fund which were merged in 2006. The Federaland the Bank Insurance Fund into a unified Deposit Insurance Corporation recently amended its risk-based assessment system in 2007Fund; increased the deposit insurance limit for certain retirement accounts to implement authority granted by the Federal Deposit Insurance Reform Act$250,000 and indexed that limit to inflation; established a range of 2005 (“Reform Act”). Under the revised system, insured institutions are assigned1.15% to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors. An institution’s assessment rate depends upon the category to which it is assigned. Risk category I, which contains the least risky depository institutions, is expected to include more than 90% of all institutions. Unlike the other categories, Risk Category I contains further risk differentiation based on the Federal Deposit Insurance Corporation’s analysis of financial ratios, examination component ratings and other information. Assessment rates are determined by the Federal Deposit Insurance Corporation and currently range from five to seven basis points1.50% for the healthiest institutions (Risk Category I)FDIC’s designated reserve ratio; and granted the FDIC discretion to 43 basis points of assessable deposits for the riskiest (Risk Category IV). The Federal Deposit Insurance Corporation may adjustset insurance premium rates uniformly from one quarteraccording to the next, except that no single adjustment can exceed three basis points. No institution may pay a dividend if in defaultrisk for all insured banks regardless of the FDIC assessment.
level of the reserve ratio. The Reform Actlegislation also provided forgranted a one-time initial assessment credit to certain banks in recognition of their past contributions to the fund. The Bank received a one-time credit for eligible institutions based on their assessment base as of December 31, 1996. Subject to certain limitations with respect to institutions that are exhibiting weaknesses, credits can be used to offset assessments until exhausted. The Bank’s one-time credit was $1.2 million, of which $0.7 million was used in 2007 and the remaining $0.5 million remainswas used in 2008.
The FDIC imposes an assessment on all depository institutions for use in 2008.. The Reform Act also provideddeposit insurance. This assessment is based on the risk category of the institution and, prior to 2009, ranged from five to 43 basis points of the institution’s deposits. On December 22, 2008, the FDIC published a final rule that raises the current deposit insurance assessment rates uniformly for all institutions by 7 basis points (to a range from 12 to 50 basis points) effective for the possibilityfirst quarter of 2009. On February 27, 2009, the FDIC also issued a final rule that revises the way the FDIC calculates federal deposit insurance assessment rates beginning in the second quarter of 2009. Under the new rule, the FDIC will first establish an institution’s initial base assessment rate. This initial base assessment rate will range, depending on the risk category of the institution, from 12 to 45 basis points. The FDIC will then adjust the initial base assessment (higher or lower) to obtain the total base assessment rate. The adjustments to the initial base assessment rate will be based upon an institution’s levels of unsecured debt, secured liabilities, and brokered deposits. The total base assessment rate will range from 7 to 77.5 basis points of the institution’s deposits. Additionally, the FDIC issued an interim rule that would impose a special 20 basis points assessment on June 30, 2009, which would be collected on September 30, 2009. The interim rule also allows for additional special assessments.
Federal Deposit Insurance Corporation may pay dividendsIn conjunction with the October 2008 enactment of the Emergency Economic Stabilization Act of 2008 (“EESA”), the limit on FDIC insurance coverage was increased to insured institutions once$250,000 for all accounts through December 31, 2009. This legislation, along with the Deposit Insurance fund reserve ratio equals or exceeds 1.35%rate increases and the use of estimated insured deposits.
our remaining credit will cause significant increases to our FDIC insurance premiums in 2009.
In addition to the assessment for deposit insurance, institutions are required to make payments on bonds issued in the late 1980s by the Financing Corporation to recapitalize a predecessor deposit insurance fund. This payment is established quarterly and during the calendar year ending December 31, 20072008 averaged 1.181.10 basis points of assessable deposits.
The Reform Act provided the Federal Deposit Insurance Corporation with authority to adjust the Deposit Insurance Fund ratio to insured deposits within a range of 1.15% and 1.50%, in contrast to the prior statutorily fixed ratio of 1.25%. The ratio, which is viewed by the Federal Deposit Insurance Corporation as the level that the fund should achieve, was established by the agency at 1.25% for 2008, which was unchanged from 2007.
The Federal Deposit Insurance Corporation has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.
Insurance of deposits may be terminated by the Federal Deposit Insurance CorporationFDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the Federal Deposit Insurance CorporationFDIC or the Office of Thrift Supervision.OTS. The management of theBerkshire Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
FDIC—Temporary Liquidity Guarantee Program.On October 14, 2008, the FDIC announced a new program — the Temporary Liquidity Guarantee Program (“TLGP”). This program has two components. One guarantees newly issued senior unsecured debt of the participating organizations, up to certain limits established for each institution, issued between October 14, 2008 and June 30, 2009. The FDIC will pay the unpaid principal and interest on an FDIC-guaranteed debt instrument upon the uncured failure of the participating entity to make a timely payment of principal or interest in accordance with the terms of the instrument. The guarantee will remain in effect until June 30, 2012. On February 27, 2009, the FDIC issued an interim rule allowing participants to apply to have the FDIC guarantee newly issued senior unsecured debt that mandatorily converts into common shares on a specified date that is on or before June 30, 2012. This amendment will not change an eligible entity’s existing debt guarantee cap. In return for the FDIC’s guarantee, participating institutions will pay the FDIC a fee based on the amount and maturity of the debt. The Company and the Bank have opted to participate in this component of the TLGP, although their initial eligibility to issue FDIC guaranteed debt was immaterial.
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The other component of the program provides full FDIC insurance coverage for non-interest bearing transaction deposit accounts, regardless of dollar amount, until December 31, 2009. An annualized 10 basis point assessment on balances in noninterest-bearing transaction accounts that exceed the existing deposit insurance limit of $250,000 will be assessed on a quarterly basis to insured depository institutions that have not opted out of this component of the TLGP. Berkshire Bank chose to not opt out of this program, and therefore is providing the full FDIC insurance coverage on the related transaction deposit accounts until year-end 2009.
FEDERAL HOME LOAN BANK SYSTEM
Federal Home Loan Bank System.The Bank is a member of the Federal Home Loan Bank system, which consists of 12 regional Federal Home Loan Banks that provide a central credit facility primarily for member institutions. Berkshire Bank, as a member, is required to acquire and hold shares of capital stock in the Federal Home Loan Bank of Boston. Berkshire Bank was in compliance with this requirement with an investment in Federal Home Loan Bank of Boston stock at year-end 20072008 of $21.1$21 million.
The Federal Home Loan Banks are required to provide funds for certain purposes including contributing funds for affordable housing programs. These requirements could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. For the years 2008, 2007, 2006, 2005 2004, and 2003,2004, cash dividends from the Federal Home Loan Bank of Boston to Berkshire Bank amounted to approximately $0.8 million, $1.4 million, $1.6 million, $1.3 million and $0.5 million, and $0.2 million, respectively. Due to losses reported in the fourth quarter of 2008, the Federal Home Loan Bank of Boston has notified its members that it has suspended its dividend beginning in the first quarter of 2009.
Holding Company Regulation
HOLDING COMPANY REGULATION
General.Federal law allows a state savings bank that qualifies as a “Qualified Thrift Lender,” discussed below, to elect to be treated as a savings association for purposes of the savings and loan holding company provisions of federal law. Such election allows its holding company to be regulated as a savings and loan holding company by the OTS rather than as a bank holding company by the Federal Reserve Board. Berkshire Bank made such election and the Company is a non-diversified unitary savings and loan holding company within the meaning of federal law. As such, the Company is registered with the OTS and must adhere to the OTS’s regulations and reporting requirements. In addition, the OTS may examine, supervise and take enforcement action against the Company and has enforcement authority over the Company and its non-savings institution subsidiaries. Among other things, this authority permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution. Additionally, Berkshire Bank is required to notify the OTS at least 30 days before declaring any dividend to the Company. By regulation, the OTS may restrict or prohibit the Bank from paying dividends.
As a unitary savings and loan holding company, the Company is generally unrestricted under existing laws as to the types of business activities in which it may engage. The Gramm-Leach-Bliley Act of 1999 provided that unitary savings and loan holding companies may only engage in activities permitted to a financial holding company under that legislation and those permitted for a multiple savings and loan holding company. Unitary savings and loan companies existing prior to May 4, 1999, such as the Company, were grandfathered as to the unrestricted activities. The Company
would become subject to activities restrictions upon the acquisition of another savings institution that is held as a separate subsidiary.
Federal law prohibits a savings and loan holding company from, directly or indirectly, acquiring more than 5% of the voting stock of another savings association or savings and loan holding company or from acquiring such an institution or company by merger, consolidation or purchase of its assets, without prior written approval of the OTS. In evaluating applications by holding companies to acquire savings associations, the OTS considers the financial and managerial resources and future prospects of the Company and the institution involved, the effect of the acquisition on the risk to the insurance fund, the convenience and needs of the community and competitive factors.
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To be regulated as a savings and loan holding company by the OTS (rather than as a bank holding company by the Federal Reserve Board), the Bank must qualify as a Qualified Thrift Lender. To qualify as a Qualified Thrift Lender, the Bank must maintain compliance with the test for a “domestic building and loan association,” as defined in the Internal Revenue Code, or with a Qualified Thrift Lender Test. Under the Qualified Thrift Lender Test (the “QLT“QTL Test”), a savings institution is required to maintain at least 65% of its “portfolio assets” (total assets less: (1) specified liquid assets up to 20% of total assets; (2) intangibles, including goodwill; and (3) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential and commercial mortgages and related investments, including certain mortgage-backed and related securities) in at least 9 months out of each 12-month period. At year-end 2007,2008, Berkshire Bank maintained 77% of its portfolio assets in qualified thrift investments. Berkshire Bank also met the QTL Test in each of the prior twelve months and, therefore, met the QTL Test.
Acquisition of the Company.Under the Federal Change in Bank Control Act, a notice must be submitted to the OTS if any person (including a company), or group acting in concert, seeks to acquire “control” of a savings and loan holding company. Under certain circumstances, a change in control may occur, and prior notice is required, upon the acquisition of 10% or more of the Company’s outstanding voting stock, unless the OTS has found that the acquisition will not result in a change of control of the Company.
Massachusetts Holding Company Regulation.In addition to the federal holding company regulations, a bank holding company organized or doing business in Massachusetts must comply with regulations under Massachusetts law. Approval of the Massachusetts regulatory authorities would be required for the Company to acquire 25% or more of the voting stock of another depository institution. Similarly, prior regulatory approval would be necessary for any person or company to acquire 25% or more of the voting stock of the Company. The term “bank holding company,” for the purpose of Massachusetts law, is defined generally to include any company which, directly or indirectly, owns, controls or holds with power to vote more than 25% of the voting stock of each of two or more banking institutions, including commercial banks and state co-operative banks, savings banks and savings and loan association and national banks, federal savings banks and federal savings and loan associations. In general, a holding company controlling, directly or indirectly, only one banking institution will not be deemed to be a bank holding company for the purposes of Massachusetts law. Under Massachusetts law, the prior approval of the Board of Bank Incorporation is required before any of the following: any company becoming a bank holding company; any bank holding company acquiring direct or indirect ownership or control of more than 5% of the voting stock of, or all or substantially all of the assets of, a banking institution; or any bank holding company merging with another bank holding company. Although the Company is not a bank holding company for purposes of Massachusetts law, any future acquisition of ownership, control, or the power to vote 25% or more of the voting stock of another banking institution or bank holding company would cause it to become such.
BERKSHIRE BANK MUNICIPAL BANK
Berkshire Bank Municipal Bank
In 2005, Berkshire Bank established a new subsidiary, Berkshire Municipal Bank, as a state chartered limited purpose commercial bank in New York, to accept deposits of municipalities and other governmental entities in the State of New York. In February 2008, Berkshire Municipal Bank was renamed Berkshire Bank Municipal Bank. Berkshire Bank Municipal Bank is subject to extensive regulation, examination and supervision by the New York State Superintendent of Banks, as its primary regulator and the FDIC, as the deposit insurer. It is also subject to regulation as to certain matters by the Federal Reserve.
Other Regulations
Troubled Assets Relief Program—Capital Purchase Program.On October 14, 2008, the Treasury announced the Capital Purchase Program (“CPP”) under the Troubled Assets Relief Program (“TARP”), part of the EESA enacted on October 3, 2008. As a participant in the CPP, on December 19, 2008 we sold to the Treasury for an aggregate purchase price of $40 million, 4,000 shares of preferred stock and a warrant to purchase 226,330 shares of common stock. Under the original terms of the CPP, prior to December 19, 2011 we could not redeem the preferred stock except with the proceeds from a qualified equity offering. However, upon the February 17, 2009 enactment of the American Recovery and Reinvestment Act of 2009, we may now redeem the preferred stock at any time, and without regard to having proceeds from a qualified equity offering, subject to consultation with our primary federal regulator. In addition, the terms of the CPP prohibit us from increasing the dividends on our common stock as well as from making repurchases of our common stock without the Treasury’s consent prior to December 19, 2011 unless we have fully redeemed the preferred stock. Furthermore, participation in the CPP limits the compensation and tax deductibility of the compensation we pay to certain of our executives.
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On February 10, 2009, the U.S. Department of the Treasury announced its Capital Assistance Program (“CAP”) under which the U. S. Treasury will make capital available to financial institutions through Treasury’s purchase of cumulative mandatorily convertible preferred stock. The preferred shares will mandatorily convert to common stock after seven years. Prior to that time, the preferred shares are convertible in whole or in part at the option of the institution, subject to the approval of the institution’s primary federal regulator. The minimum investment is an amount equal to 1% of risk-weighted assets and the maximum is an amount equal to 2% of risk-weighted assets. Institutions may receive additional capital to the extent such funds are used to redeem preferred shares issued in the CPP, effectively exchanging the CAP convertible preferred stock for the preferred stock sold under the CPP. Berkshire Bancorp has not yet determined whether it will participate in the CAP, or the amount of any investment it will apply for if it does decide to participate. The deadline for applying for participation in the CAP is May 25, 2009. -20-On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (“ARRA”) was enacted. ARRA is intended to provide a stimulus to the U.S. economy in the wake of the current economic downturn. The new law includes additional corporate governance requirements and limitations on executive compensation that are applicable to financial institutions, such as Berkshire Hills Bancorp, that have received investments from Treasury.
OTHER REGULATIONS
Consumer Protection Laws.Berkshire Bank is subject to federal and state consumer protection statues and regulations promulgated under these laws, including, but not limited to, the:
Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers; Home Mortgage Disclosure Act, requiring financial institutions to provide certain information about home mortgage and refinance loans; Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
| · | Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers; Home Mortgage Disclosure Act, requiring financial institutions to provide certain information about home mortgage and refinance loans; Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit; |
Fair Credit Reporting Act, governing the provision of consumer information to credit reporting agencies and the use of consumer information;
Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and
| · | Fair Credit Reporting Act, governing the provision of consumer information to credit reporting agencies and the use of consumer information; |
Electronic Funds Transfer Act, governing automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.
| · | Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and |
| · | Electronic Funds Transfer Act, governing automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services. |
Berkshire Bank also is subject to federal laws protecting the confidentiality of consumer financial records, and limiting the ability of the institution to share non-public personal information with third parties.
Finally, Anti-Money Laundering Laws.Berkshire Bank is subject to extensive anti-money laundering provisions and requirements, which require the institution to have in place a comprehensive customer identification program and an anti-money laundering program and procedures. These laws and regulations also prohibit financial institutions from engaging in business with foreign shell banks; require financial institutions to have due diligence procedures and, in some cases, enhanced due diligence procedures for foreign correspondent and private banking accounts; and improve information sharing between financial institutions and the U.S. government. The Bank has established polices and procedures intended to comply with these provisions.
FEDERAL AND MASSACHUSETTS INCOME TAXATION
The Company and the Bank report their income on a calendar year basis using the accrual method of accounting. The federal income tax laws apply to the Company and Berkshire Bank in the same manner as duethey do to other corporations with some exceptions, including particularly Berkshire Bank’s reserve for bad debts discussed below. This discussion of tax matters is only a summary and is not a comprehensive description of the tax rules applicable to the Company and its subsidiaries.
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Prior to 1995, the Bank was permitted to use certain favorable provisions to calculate deductions from taxable income for annual additions to its bad debt reserve. Federal legislation in 1996 repealed this reserve method and required savings institutions to recapture or take into income certain portions of their accumulated bad debt reserves. Approximately $844 thousand of the Bank’s accumulated bad debt reserves will not be recaptured into taxable income unless the Bank makes a “nondividend“non-dividend distribution” to the Company, including distributions in excess of the Bank’s current and accumulated earnings and profits. In the event of a nondividendnon-dividend distribution, approximately 150% of the amount of the distribution up to $844 thousand would be includable in income for federal income tax purposes, resulting in an increase in tax of $346 thousand assuming a marginal federal and state tax rate of 41%. The Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserves.
The Massachusetts excise tax rate for savings banks is currently 10.5% of federal taxable income, adjusted for certain items. TaxableOn July 3, 2008 legislation was signed into law whereby the Massachusetts excise tax will be reduced to 10% in 2010, 9.5% in 2011, and 9% in 2012 and thereafter. The taxable income includes gross income as defined under the Internal Revenue Code, plus interest from municipal obligations of any state, less deductions, but not the credits, allowable under the provisions of the Internal Revenue Code, except no deduction is allowed for bonus depreciation or state income taxes. Carry forwards and carry backs of net operating losses are not allowed. A qualifying limited purpose corporation is generally entitled to special tax treatment as a “securities corporation.” The Bank’s three securities corporations all qualify for this treatment, and are taxed at a 1.3% rate on their gross income.
ITEM 1A. RISK FACTORSFACTORS
Overall Business RisksThe Company’s Business May Be Adversely Affected by Conditions in the Financial Markets and Economic Conditions Generally.
An investmentSince December 2007, the United States has been in our common stock involves risk. You should carefully considera recession. Business activity across a wide range of industries and regions is greatly reduced and local governments and many businesses are in serious difficulty due to declines in revenues, the risks described belowlack of consumer spending and all other information containedthe lack of liquidity in this annual report on Form 10-K before you decidethe credit markets. Unemployment has increased significantly. Overall, during 2008, the business environment has been adverse for many households and businesses in the United States and worldwide. The business environment in the markets in which the Company operates has been less adverse than in the United States generally but continues to buy our common stock.deteriorate. It is possibleexpected that risks and uncertainties not listed below may arise or become materialthe business environment in the futureCompany’s markets, the United States and worldwide will continue to weaken for the near future. There can be no assurance that these conditions will improve in the near term. Such conditions could adversely affect the credit quality of the Company’s loans, results of operations and financial condition.
Since mid-2007, and particularly during the second half of 2008, the financial services industry and the securities markets generally were materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity. This was initially triggered by declines in home prices and the values of subprime mortgages, but spread to all mortgage and real estate asset classes, to leveraged bank loans and to nearly all asset classes, including equities. The global markets have been characterized by substantially increased volatility and short-selling and an overall loss of investor confidence, initially in financial institutions, but more recently in companies in a number of other industries and in the broader markets.
Market conditions have also led to the failure or merger of a number of prominent financial institutions. Financial institution failures or near-failures have resulted in further losses as a consequence of defaults on securities issued by them and defaults under contracts entered into with such entities as counterparties. Furthermore, declining asset values, defaults on mortgages and consumer loans, and the lack of market and investor confidence, as well as other factors, have all combined to increase credit default swap spreads, to cause rating agencies to lower credit ratings, and to otherwise increase the cost and decrease the availability of liquidity, despite very significant declines in Federal Reserve borrowing rates and other government actions. Some banks and other lenders have suffered significant losses and have become reluctant to lend, even on a secured basis, due to the increased risk of default and the impact of declining asset values on the value of collateral. The foregoing has significantly weakened the strength and liquidity of some financial institutions worldwide. In 2008, the U.S. government, the Federal Reserve and other regulators have taken numerous steps to increase liquidity and to restore investor confidence, including investing significantly in the equity of banking organizations, but asset values have continued to decline and access to liquidity continues to be very limited.
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Lending
Continued and Prolonged Deterioration in the Housing Sector and Related Markets and the Economy May Adversely Affect Our Business and Financial Results.
Residential real estate markets continued to decline throughout 2008. Economic measures declined at an accelerating rate, leading to a 6.2% preliminary estimated annualized decline in the U.S. GDP in the fourth quarter. Unemployment rose as economic conditions deteriorated. We do not expect improvement in the economy or in real estate and financial market conditions in the near future. A worsening of these negative conditions could adversely impact the ability of our borrowers to service their debt, along with the value and liquidity of collateral and other forms of loan support. The quality and value of our investment securities may also be impacted. Emergency government measures may affect our business.rights as creditors and owners of securities. Adverse developments could affect our net interest income, charge-offs, loan loss provision, asset and goodwill valuations, and our prospects for growth. Regulatory promulgations could affect our operations and financial condition.
Our Emphasis on Commercial Lending May Expose Us to Increased Lending Risks, Which Could Hurt Our Profits.
Lending
Our emphasis on commercial lending may expose us to increased lending risks, which could hurt our profits.
Our commercial loan portfolio, which consists of commercial real estate loans, construction and development loans and commercial business loans, has increased from $757 million at year-end 2006 to $908 million at year-end 2007. A significant portion of this growth has included construction and development loans that may have higher risk, and loans in new markets, where the Company has less historic knowledge of the market. Also, commercialCommercial loans are historically more sensitive to economic downturns and the possible impact of higher interest rates.downturns. Such sensitivity includes potentially higher default rates and possible reduction of collateral values. Some of the growth in commercial loans is also attributable toCommercial lending involves larger loan sizes and larger relationship exposures, which can have a greater impact on profits in the event of adverse loan performance. Commercial lending also involves more development financing, which is dependent on the future success of new operations. Additionally,Residential construction loans depend significantly on the Company has expanded its commercialresidential real estate and lending teammarkets for the repayment of these loans. Commercial loans also include lending to accomplish this growth, and this has the potentialnonprofit organizations which in some cases are particularly sensitive to increase risk relating to underwriting and administrative controls as new lenders are integrated into the control environment. These and other factors may result in errors in judging the collectability of commercial loans, which may lead to additional provisions or charge-offs. Construction lending depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs provesnegative economic events.
Our Allowance for Loan Losses May Prove to be inaccurate, the Company may be requiredInsufficient to advance funds beyond the amount originally committed to permit completion of the building project. If the estimate of value proves to be inaccurate, the Company may be confronted, at or before the maturity of the loan, with a building having a value which is insufficient to assure full repayment. If the Company is forced to foreclose on collateral before or at completion due to a default, there can be no assurance that it will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.
Absorb Losses in Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
Loan Portfolio.
Like all financial institutions, we maintain an allowance for loan losses to provide for loans in our portfolio that may not be repaid in their entirety. We believe that our allowance for loan losses is maintained at a level adequate to absorb probable losses inherent in our loan portfolio as of the corresponding balance sheet date. However, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially and adversely affect our operating results.
In evaluating the adequacy of our allowance for loan losses, we consider numerous quantitative factors, including our historical charge-off experience, growth of our loan portfolio, changes The Company has seen a significant increase in the compositionlevel of our loan portfoliopotential problem loans and other loans with higher than normal risk. The Company expects to receive more frequent requests from borrowers to modify residential mortgage and consumer loans. The related accounting measurements related to impairment and the volume of delinquent and classified loans. In addition, we use information about specific borrower situations, including their financial position and estimated collateral values, to estimate the risk and amount ofloan loss for those borrowers. Finally, we also consider many qualitative factors, including general and economic business conditions, the local residential real estate market, the interest rate environment, fiscal and monetary policy of the United States government, energy prices, commercial real estate conditions, the duration of the current business cycle, current general market collateral valuations, trends apparent in any of the factors we take into account and other matters,allowance require significant estimates which are by nature more subjectivesubject to uncertainty and fluid.changes relating to new information and changing circumstances. Our estimates of the risk of loss and amount of loss on any loan are complicated by the significant uncertainties surrounding our borrowers’ abilities to successfully execute their business models through changing economic environments, competitive challenges and other factors. Because of the degree of uncertainty and susceptibility of these factors to change, our actual losses may vary from our current estimates.
Based on our review of the above-mentioned factors, we recorded a provision for loan losses of $4.3 million for the year ended December 31, 2007 and acquired $4.5 million in allowance for loan losses from the Factory Point Bancorp acquisition to bring our allowance for loan losses at year-end 2007 to $22.1 million, which was 1.14% of total loans. State and federal regulators, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs, net of recoveries. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations.
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Operating
A downturnContinuing Downturn in the local economyLocal Economy or a decline in real estate values could hurt our profits.Local Real Estate Values Could Hurt Our Profits.
Approximately 79% of our loans were secured by real estate as of year-end 2007. A decline in real estate values could expose us to a greater risk of loss. Because the majority of our borrowers and depositors are individuals and businesses located and doing business in our market areas, ourOur success depends to a significant extent upon economic conditions in our market areas. The demand for our products and services, and our ability to maintain satisfactory pricing margins, may be affected by market conditions. Adverse economic conditions in our market areas could reduce our growth rate, affect the ability of our customers to repay their loans and generally effectaffect our financial condition and results of operations. Conditions such as inflation, recession, unemployment, high interest rates, short money supply, scarce natural resources, international disorders, terrorism and other factors beyond our control may adversely affect our profitability. We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in our market areas could adversely affect the value of our assets, revenues, results of operations and financial condition. Moreover, we cannot give any assurance we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur.
Growth
Our geographic expansionGeographic Expansion and growth, if not successful, could negatively impact earnings.
Growth, If Not Successful, Could Negatively Impact Earnings.
We plan to achieve significant growth both organically and through acquisitions. We have recently expanded into new geographic markets and anticipate that we will expand into additional new geographic markets as we transform ourselves intoexpand as a regional bank. The success of this expansion will dependdepends on our ability to continue to maintain and develop an infrastructure appropriate to support such growth. Also, our success will dependdepends on the acceptance by customers of us and our services in these new markets and, in the case of expansion through acquisitions, our success depends on many factors, including the long-term retention of key personnel and acquired customer relationships. The profitability of our expansion strategy also will dependdepends on whether the income we generate in the new markets will offset the increased expenses of operating a larger entity with increased personnel, more branch locations and additional product offerings. We expect that it may take a period of time before certain of our new branches can become profitable, especially in areas in which we do not have an established physical presence. During this period, operating these new branches may negatively impact net income. Additionally, in connection with our expansion, we will need to increase our operational
Competition From Financial Institutions and financial procedures, systemsOther Financial Service Providers May Adversely Affect Our Growth and controls. If we have difficulty in doing so, it could harm our business, results of operations and financial condition.
Competition from financial institutions and other financial service providers may adversely affect our growth and profitability.
Profitability.
The banking business is highly competitive and we experience competition in each of our markets from many other financial institutions. WeDue to the interventions of the federal government, some of the institutions that we compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other super-regional, national and internationalare receiving substantial federal financial institutions that operate offices in our primary market areas and elsewhere.
We compete with these institutions both in attracting deposits and in making loans. This competition has made it more difficult for us to make new loans and has occasionally forced us to offer higher deposit rates. Price competition for loans and deposits might result in our earning less on our loans and paying more on our deposits,support which reduces net interest income. Many of our competitors are larger financial institutions. While we believe we can and do successfully compete with these other financial institutions in our primary markets, we may face a competitive disadvantage as a result of our smaller size, smaller resources and smaller lending limits, lack of geographic diversification and inability to spread our marketing costs across a broader market.
Our continued pace of growth may require us to raise additional capital in the future, but that capital may not be available whento our Company. Many institutions have been allowed to convert to banking charters and to offer insured deposits for the first time. The federal government has guaranteed money market funds which traditionally compete with bank deposits. The federal government has offered significant guarantees of new debt issuances to some of the Company’s competitors to help them fund their operations. Fannie Mae and Freddie Mac are now in federal receivership and may operate directly as a competitor in some lending markets in the future. Emergency measures designed to support some of the Company’s competitors may provide no advantage to the Company or place it at a disadvantage. Emergency changes in deposit insurance, financial market regulation, bank regulation, and policy of the Federal Home Loan Bank system may all affect the competitive environment for the Company and other market participants.
The Terms of Our Capital May Change and Our Access to Capital Markets and Financial Markets May Not Be Available When It Is Needed.
The Company has participated in the U.S. Treasury Capital Purchase Program. The terms of this program are subject to changes by Congress and the burden of the program is needed.
affected by inspections and program management. Congress continues to add new terms to this program and the Treasury’s involvement as a partner is evolving. Uncertainty about the direction of this program and adverse changes in this program could affect the Company’s ability to operate and generate earnings, including the impact of dividend payments and the impact of compensation and operating restrictions. The possible nationalization of portions of the U.S. financial system and/or failures or restructurings of major market participants may create unpredictable and adverse changes in the availability of capital and other financial resources. We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. Regulatory capital requirements and their impact on the Company may change. We may at some point need to raise additional capital to support our operations and continued growth. Our ability to raise capital, if needed, will depend on conditions in the capital markets at that time, which are outside of our control, and on our financial performance. Accordingly, if needed, we cannot assure you of our ability to raise additional capital on terms acceptable to us. If we cannot raise additional capital when needed, it could affect our operations and our ability to execute our strategic plan, which includes further expanding our operations through internal growth and acquisitionsacquisitions.
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We are Subject to Security and Operational Risks Relating to Our Use of Technology that Could Damage Our Reputation and Our Business.
Security breaches in our internet banking activities could be materially impaired.
Interest Rates
Fluctuations in interest rates could reduceexpose us to possible liability and damage our profitability and affect the valuereputation. Any compromise of our assets.
Like other financial institutions, we are subjectsecurity also could deter customers from using our internet banking services that involve the transmission of confidential information. We rely on industry standard internet security systems to interest rate risk. Our primary sourceprovide the security and authentication necessary to effect secure transmission of income is net interest income, which is the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. We expect that we will periodically experience imbalances in the interest rate sensitivitiesdata. These precautions may not protect our systems from compromises or breaches of our assets and liabilities and the relationships of various interest rates to each other. Over any defined period of time, our interest-earning assets may be more sensitive to changessecurity measures that could result in market interest rates than our interest-bearing liabilities, or vice versa. In addition, the individual market interest rates underlying our loan and deposit products (e.g., prime) may not change to the same degree over a given time period. In any event, if market interest rates should move contrarydamage to our position,reputation and our earnings may be negatively affected. In addition, loan volumebusiness. We utilize third part core banking software and quality and deposit volume and mix can be affected by market interest rates. Changesfor some systems we outsource our data processing to a third party. If our third party providers encounter difficulties or if we have difficulty in levels of market interest ratescommunicating with such third parties, it could materially and adversely affect our net interest spread, asset quality, origination volume and overall profitability.
We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially harmed.
Changes in the level of interest rates also may negativelysignificantly affect our ability to originate real estate loans,adequately process and account for customer transactions, which could significantly affect our business operations. Due to the valuerecession, there may be a rising risk of our assetsfraud or illegal acts. Disaster and disaster recovery risks could affect our ability to realize gainsoperate and our reputation.
Conditions in Insurance Markets Could Adversely Affect Our Earnings.
Revenue levels from our insurance segment could be negatively impacted by the salefluctuating premiums in the insurance market caused by capacity constraints and losses due to natural disasters. Premium levels and commission structures may be affected by changes in the financial condition of insurers due to the financial and economic downturn. Other factors that affect our insurance revenue are profitability and growth of our assets, allclients, continued development of which ultimately affectnew products and services, as well as our earnings.access to markets and the impact of state insurance regulations.
Liquidity
Our investment portfolio includes securities that are sensitiveWholesale Funding Sources May Prove Insufficient to interest ratesReplace Deposits at Maturity and variations in interest rates may adversely impact our profitability.
Support Our securities portfolio includes mortgage-backed securities, which are insured or guaranteed by U.S. government agencies or government-sponsored enterprises.. These securities are sensitive to interest rate fluctuations. The unrealized gains or losses in our available-for-sale portfolio are reported as a separate component of stockholders’ equity until realized upon sale. As a result, future interest rate fluctuations may impact stockholders’ equity, causing material fluctuations from quarter to quarter. Failure to hold our securities until maturity or until market conditions are favorable for a sale could adversely affect our financial condition, profitabilityOperations and prospects.
Liquidity
Our wholesale funding sources may prove insufficient to replace deposits at maturity and support our future growth.
Future Growth.
We must maintain sufficient funds to respond to the needs of depositors and borrowers. As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. As we continue to grow, we are likely tomay become more dependent on these sources, which include Federal Home Loan Bank advances, proceeds from the sale of loans, and liquidity resources at the holding company. At December 31, 2007, we had approximately $299 million of FHLB advances outstanding. Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates.costs. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our operating margins and profitability would be adversely affected.
Lack of Consumer Confidence in Financial Institutions May Decrease Our Level of Deposits.
Our abilitylevel of deposits may be affected by lack of consumer confidence in financial institutions, which have caused fewer depositors to service our debt,be willing to maintain deposits that are not insured by the Federal Deposit Insurance Corporation. That may cause depositors to withdraw deposits and place them in other institutions or to invest uninsured funds in investments perceived as being more secure, such as securities issued by the U.S. Treasury. These consumer preferences may cause us to be forced to pay dividendshigher interest rates to retain deposits and otherwise pay our obligationsmay constrain liquidity as they come due is substantially dependentwe seek to meet funding needs caused by reduced deposit levels.
Our Ability to Service Our Debt, Pay Dividends and Otherwise Pay Our Obligations as They Come Due Is Substantially Dependent on capital distributionsCapital Distributions from Berkshire Bank, and these distributions are subjectThese Distributions Are Subject to regulatory limitsRegulatory Limits and other restrictions.Other Restrictions.
AWhile the Company maintained a high level of cash balances at year-end 2008, those balances may decrease due to changes in the Company’s capital structure, possible acquisitions, and possible further investments in the Bank. Over the long term, a substantial source of our income from which we service our debt, pay our obligations and from which we can pay dividends is the receipt of dividends from Berkshire Bank. The availability of dividends from Berkshire Bank is limited by various statutes and regulations. It is possible, depending upon the financial condition of Berkshire Bank, and other factors, that the applicable regulatory authorities could assert that payment of dividends or other payments is an unsafe or unsound practice. If Berkshire Bank is unable to pay dividends to us, we may not be able to service our debt, pay our obligations or pay dividends on our common stock. The inability to receive dividends from Berkshire Bank would adversely affect our business, financial condition, results of operations and prospects.
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Economic Conditions May Adversely Affect Our Liquidity.
OperationalIn the past year, reduced confidence by and between financial institutions, and significant declines in the values of mortgage-backed securities and derivative securities by financial institutions, government sponsored entities, and major commercial and investment banks have led to decreased liquidity in financial markets among borrowers, lenders, and depositors, as well as disruption and extreme volatility in the capital and credit markets and the failure of some entities in the financial sector. As a result, many lenders and institutional investors have reduced or ceased to provide funding to borrowers. Continued turbulence in the capital and credit markets may adversely affect our liquidity and financial condition and the willingness of certain counterparties and customers to do business with us.
Interest Rates
Changes in Interest Rates Could Adversely Affect Our Results of Operations and Financial Condition.
Net interest income is our largest source of income. Changes in interest rates can affect the level of net interest income. The Company’s interest rate sensitivity is discussed in more detail in Item 7A of this report. We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially harmed. Changes in interest rates can also affect the demand for our products and services, and the supply conditions in the U.S. financial and capital markets. Changes in the level of interest rates may negatively affect our ability to originate real estate loans, the value of our assets and our ability to realize gains from the sale of our assets, all of which ultimately affect our earnings.
Securities Market Values
Continued or Further Declines in the Value of Certain Investment Securities Could Require Write-Downs, Which Would Reduce Our Earnings.
The unrealized losses on the investment securities portfolio are due to an increase in credit spreads and liquidity issues in the marketplace. We have concluded these unrealized losses are temporary in nature since they are not related to the underlying credit quality of the issuers, and we have the intent and ability to hold these investments for a time necessary to recover our cost or stated maturity (at which time, full payment is expected). However, a continued decline in the value of these securities or other factors could result in an other-than-temporary impairment write-down which would reduce our earnings. Some of the Bank’s securities are locally originated economic development bonds to nonprofit organizations. These securities could become impaired due to economic and real estate market conditions which also affect loan risk.
If Dividends Paid On Our Investment in the Federal Home Loan Bank of Boston Continue to be Suspended, or If Our Investment is Classified as Other-Than-Temporarily Impaired or as Permanently Impaired, Our Earnings and/or Stockholders’ Equity Could Decrease.
We operateown common stock of the Federal Home Loan Bank of Boston to qualify for membership in the Federal Home Loan Bank System and to be eligible to borrow funds under the FHLBB’s advance program. There is no market for our FHLBB common stock. On February 26, 2009, the FHLBB reported a highly regulated environmentnet annual loss of $73.2 million. The loss was primarily due to a other-than-temporary impairment charge of $339.1 million on its private-label mortgage backed securities portfolio. The FHLBB believes that it will recover a substantial portion of the impairment losses over time and expects to hold the securities until maturity. As a result of the loss, the FHLBB also announced that the dividend paid on its common stock has been suspended indefinitely and that the payment of any dividend in 2009 is unlikely. The continued suspension of the dividend will decrease our income. In an extreme situation, it is possible that the capitalization of a Federal Home Loan Bank, including the FHLBB, could be substantially diminished or reduced to zero. Consequently, we believe that there is a risk that our investment in FHLBB common stock could be deemed other-than-temporarily impaired at some time in the future, and if this occurs, it would cause our earnings and stockholders’ equity to decrease by the after-tax amount of the impairment charge. We have been notified by the FHLBB that future dividend levels may be adversely affected by changes indifferent from past levels, and a reduction or elimination of this dividend would reduce our earnings.
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Regulatory
Recent Legislative and Regulatory Initiatives May Not Stabilize the Banking System.
The potential exists for additional federal or state laws and regulations.
Berkshire Hills Bancorp is subjectregulations regarding lending, funding practices, and liquidity standards, and bank regulatory agencies are expected to extensive regulation, supervisionbe more active in responding to concerns and examination bytrends identified in examinations, including the Officeexpected issuance of Thrift Supervision, its chartering authority,many formal enforcement orders. Actions taken to date, as well as potential actions, may not have the beneficial effects that are intended, particularly with respect to the extreme levels of volatility and Berkshire Bank is subject to extensive supervisionlimited credit availability currently being experienced. In addition, new laws, regulations, and examination by the Massachusetts Division of Banks, its chartering authority, and theother regulatory changes will increase our Federal Deposit Insurance Corporation as insurerinsurance premiums and may also increase our costs of Berkshire Bank’s deposits. Suchregulatory compliance and of doing business, and otherwise affect our operations. New laws, regulations, and supervision governother regulatory changes, along with negative developments in the activitiesfinancial industry and the domestic and international credit markets, may significantly affect the markets in which we do business, the markets for and value of our loans and investments, and our ongoing operations, costs and profitability.
Future Legislative or Regulatory Actions Responding to Perceived Financial and Market Problems Could Impair Our Rights Against Borrowers.
There have been proposals made by members of Congress and others that would reduce the amount distressed borrowers are otherwise contractually obligated to pay under their mortgage loans and limit an institution’s ability to foreclose on mortgage collateral. Were proposals such as these, or other proposals limiting our rights as a creditor, to be implemented, we could experience increased credit losses or increased expense in pursuing our remedies as a creditor.
Our Expenses Will Increase As A Result Of Increases in FDIC Insurance Premiums.
The Federal Deposit Insurance Corporation (“FDIC”) imposes an assessment against financial institutions for deposit insurance. This assessment is based on the risk category of the institution and its holding company may engage, and are intended primarilycurrently ranges from 5 to 43 basis points of the institution’s deposits. On December 22, 2008, the FDIC published a final rule raising the current deposit insurance assessment rates uniformly for all institutions by seven basis points (to a range from 12 to 50 basis points) for the protectionfirst quarter of 2009. The FDIC also expects to issue a final rule early in 2009, to be effective April 1, 2009, to change the way that the FDIC calculates federal deposit insurance assessment rates beginning in the second quarter of 2009. For more information on FDIC assessments, see “Regulation and Supervision—Insurance of Deposit Accounts”.
Changes In Federal Statutes May Adversely Affect the Terms of our Capital Purchase Program Letter Agreement with the U.S. Treasury.
The Treasury may amend any provision of the insurance fund and depositors. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on operations, the classification of assets and determination of the level of allowance for loan losses.Agreement to comply with changes to federal statutes. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action mayAgreement could have a material impact on us and our operations. Berkshire Hills Bancorp primarily depends on Berkshire Bank for dividends as a sourceFuture federal statutory changes may adversely affect the terms of funds to service its indebtedness and to pay dividends to stockholders. Such dividends may be restricted or prohibited by regulatory authorities.
We are subject to security and operational risks relating to our use of technology that could damage our reputationthe Capital Purchase Program and our business.
Security breaches in our internet banking activities could expose us to possible liability and damage our reputation.financial condition. Any compromise of our security also could deter customers from using our internet banking services that involve the transmission of confidential information. We rely on industry standard internet security systems to provide the security and authentication necessary to effect secure transmission of data. These precautionsretroactive restrictions which may not protect our systems from compromises or breaches of our security measures that could result in damage to our reputation and our business. Additionally, we outsource our data processing to a third party. If our third party provider encounters difficulties or if we have difficulty in communicating with such third party, it will significantlyadversely affect our ability to adequately process and account for customer transactions, which would significantly affectcomply with the terms of the Agreement or effectively manage our business operations.or our ability to repay the preferred stock. Current terms of the agreement require approval by bank regulators before the stock may be repaid.
Provisions of our certificate of incorporation, bylaws and Delaware law, as well as state and federal banking regulations, could delay or prevent a takeover of us by a third party.
Provisions in our certificate of incorporation and bylaws, the corporate law of the State of Delaware, and state and federal regulations could delay, defer or prevent a third party from acquiring us, despite the possible benefit to our stockholders, or otherwise adversely affect the price of our common stock. These provisions include: limitations on voting rights of beneficial owners of more than 10% of our common stock, supermajority voting requirements for certain business combinations; the election of directors to staggered terms of three years; and advance notice requirements for nominations for election to our board of directors and for proposing matters that stockholders may act on at stockholder meetings. In addition, we are subject to Delaware laws, including one that prohibits us from engaging in a business combination with any interested stockholder for a period of three years from the date the person became an interested stockholder unless certain conditions are met. These provisions may discourage potential takeover attempts, discourage bids for our common stock at a premium over market price or adversely affect the market price of, and the voting and other rights of the holders of, our common stock. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors other than the candidates nominated by our Board.
Goodwill
Goodwill
Our acquisitions have resultedAcquisitions Have Resulted in significant goodwill, whichSignificant Goodwill, Which if it becomes impaired wouldBecomes Impaired Would be requiredRequired to be written down, which would negatively impact earnings.
Written Down, Which Would Negatively Impact Earnings.
We acquired Factory Point Bancorp, Inc. in 2007 and Woronoco Bancorp in 2005 and have purchased insurance and financial planning businesses in the last two years, including the five insurance agencies we acquired on October 31, 2006. We will pursue additional opportunities for acquisitions in the future, including acquisitions in adjacent states. The success of acquisitions depends on many factors, including the long term retention of key personnel and acquired customer relationships. We recordedThe initial recording and subsequent impairment testing of goodwill and other intangible assets requires subjective judgments about the estimates of the fair value of assets acquired. Factors that may significantly affect the estimates include specific industry or market sector conditions, changes in revenue growth trends, customer behavior, competitive forces, cost structures and changes in discount rates. It is possible that future impairment testing could result in an impairment of the value of goodwill or intangible assets, or both. If we determine impairment exists at a given point in time, our earnings and the book value of the related intangible asset(s) will be reduced by the amount of the impairment. Notwithstanding the foregoing, the results of impairment testing on goodwill and core deposit intangible assets have no impact on our tangible book value or regulatory capital levels. These are non-GAAP financial measures. They are not a substitute for GAAP measures and should only be considered in conjunction with the Factory Point Bancorp acquisition, Woronoco Bancorp acquisition, andCompany’s GAAP financial information.
Trading
The Trading History of Our Common stock is Characterized by Low Trading Volume. The Value of Your Investment May be Subject to Sudden Decreases Due to the acquisitionVolatility of five insurance agencies and such assets may be recorded in future acquisitions. If these assets were to become impaired, we would be required to write them down.
Trading
The trading historythe Price of our common stock is characterized by low trading volume. The value of your investment may be subject to sudden decreases due to the volatility of the price of our common stock.
Common Stock.
Our common stock trades on The NASDAQ Global Select Market. The average daily trading volume of our common stock during 2008 was approximately 62,45054,000 shares. We cannot predict the extent to which investorThe level of interest in us will lead to a more activeand trading market in our common stock or how liquid that market might become. A public trading market having the desired characteristics of depth, liquidity and orderliness depends upon the presence in the marketplace of willing buyers and sellers ofon many factors beyond our common stock at any given time, which presence is dependent upon the individual decisions of investors, over which we have no control.
The market price of our common stock may be highly volatile and subject to wide fluctuations in response to numerous factors, including, but not limited to, the factors discussed in other risk factors and the following:
· actual or anticipated fluctuations in our operating results;
· changes in interest rates;
· changes in the legal or regulatory environment in which we operate;
| ·• | | actual or anticipated fluctuations in our operating results; |
|
| • | | changes in interest rates; |
|
| • | | changes in the legal or regulatory environment in which we operate; |
|
| • | | press releases, announcements or publicity relating to us or our competitors or relating to trends in our industry; |
|
| ·• | | changes in expectations as to our future financial performance, including financial estimates or recommendations by securities analysts and investors; |
|
| ·• | | future sales of our common stock; |
|
| • | | changes in economic conditions in our marketplace, general conditions in the U.S. economy, financial markets or the banking industry; and |
|
| • | | other developments affecting our competitors or us. |
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· changes in economic conditions in our marketplace, general conditions in the U.S. economy, financial markets or the banking industry; and
· other developments affecting our competitors or us.
These factors may adversely affect the trading price of our common stock, regardless of our actual operating performance, and could prevent you from selling your common stock at the price you desire. In addition, the stock markets, from time to time, experience extreme price and volume fluctuations that may be unrelated or disproportionate to the operating performance of companies. These broad fluctuations may adversely affect the market price of our common stock, regardless of our trading performance. In the past, stockholders oftensometimes have brought securities class action litigation against a company following periods of volatility in the market price of their securities. We maycould be the target of similar litigation in the future, which could result in substantial costs and divert management’s attention and resources.
ITEM 1B.1B. UNRESOLVED STAFF COMMENTS None.
The Company’s headquarters are located in an owned facilityand leased facilities located in Pittsfield, Massachusetts. The Company also owns or leases other facilities within its primary market areas: Berkshire County, Massachusetts; Pioneer Valley, Massachusetts; Southern Vermont, and the Capital Region, Northeastern New York. The Company operates 3839 full service banking offices and 10 full service insurance offices and it is in the process of which 21 are premises owned by the Company.combining its banking and insurance offices in several communities. The Company considers its properties to be suitable and adequate for its present and immediately foreseeable needs.
ITEM 3.3. LEGAL PROCEEDINGS At December 31, 2007,2008, neither the Company nor the Bank was involved in any pending legal proceedings believed by management to be material to the Company’s financial condition or results of operations. Periodically, there have been various claims and lawsuits involving the Bank, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Bank’s business. However, neither the Company nor the Bank is a party to any pending legal proceedings that it believes, in the aggregate, would have a material adverse effect on the financial condition or operations of the Company.
ITEM 4. SUBMISSION OFOF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of 2007.2008.
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ITEM 5. MARKET FORFOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Market Information
The common shares of Berkshire Hills trade on the NASDAQ Global Select Market under the symbol “BHLB”. The following table sets forth the quarterly high and low closing sales price information and dividends declared per share of common stock in 20072008 and 2006.2007.
| | | | | | | | | | | | |
| | | | | | | | | | Dividends | |
| | High | | | Low | | | Declared | |
2008 | | | | | | | | | | | | |
First quarter | | $ | 26.29 | | | $ | 19.50 | | | $ | 0.15 | |
Second quarter | | | 27.10 | | | | 22.25 | | | | 0.16 | |
Third quarter | | | 32.00 | | | | 20.67 | | | | 0.16 | |
Fourth quarter | | | 31.01 | | | | 22.48 | | | | 0.16 | |
| | | | | | | | | | | | |
2007 | | | | | | | | | | | | |
First quarter | | $ | 34.71 | | | $ | 32.59 | | | $ | 0.14 | |
Second quarter | | | 33.75 | | | | 31.51 | | | | 0.14 | |
Third quarter | | | 32.52 | | | | 26.10 | | | | 0.15 | |
Fourth quarter | | | 31.31 | | | | 24.27 | | | | 0.15 | |
| | | | | | | | Dividends | |
2007 | | High | | | Low | | | Declared | |
First quarter | | $ | 34.71 | | | $ | 32.59 | | | $ | 0.14 | |
Second quarter | | | 33.75 | | | | 31.51 | | | | 0.14 | |
Third quarter | | | 32.52 | | | | 26.10 | | | | 0.15 | |
Fourth quarter | | | 31.31 | | | | 24.27 | | | | 0.15 | |
2006 | | | | | | | | | | | | |
First quarter | | $ | 36.08 | | | $ | 32.37 | | | $ | 0.14 | |
Second quarter | | | 36.39 | | | | 32.77 | | | | 0.14 | |
Third quarter | | | 38.44 | | | | 33.46 | | | | 0.14 | |
Fourth quarter | | | 39.67 | | | | 33.08 | | | | 0.14 | |
Holders
The Company had approximately 2,2392,217 holders of record of common stock at March 10, 2008.6, 2009.
Dividends
The principal sources ofCompany intends to pay regular cash dividends to common stockholders; however, there can be no assurance as to future dividends because they are dependent on the Company’s cash reserves are dividends receivedfuture earnings, capital requirements, and financial condition. Dividends from the Bank and Berkshire Insurance Group, together with proceeds from stock option exercises. In addition,have been a source of cash used by the Company to pay its dividends, and these dividends from the Bank are dependent on the Bank’s future earnings, capital requirements, and financial condition. Prior to December 19, 2011, unless we have redeemed all the preferred stock issued to the U.S. Treasury on December 19, 2008 under the CPP, or unless the U.S. Treasury has issued subordinated debttransferred all the preferred stock to its wholly owned subsidiary grantor trust. The banking regulators may prohibit banks and holding companies from paying dividends that would constitute an unsafe or unsound banking practice, or which would reducea third party, the amountconsent of its capital below that necessary to comply with minimum applicable regulatory capital requirements. Under applicable regulations, prior regulatory approval isthe U.S. Treasury will be required for us to declare or pay any capitaldividend or make any distribution by the Bank to the Company if the total capitalon common stock other than (i) regular quarterly cash dividends of not more than $0.16 per share, as adjusted for any stock split, stock dividend, reverse stock split, reclassification or similar transaction, (ii) dividends payable solely in shares of common stock and (iii) dividends or distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years. The Companyrights or junior stock in connection with a stockholders’ rights plan. Further information about dividend restrictions is subject to the requirements of Delaware law, which generally limits dividends to an amount equal to the excess of the net assets of the Company (the amount by which total assets exceed total liabilities) over its statutory capital or, if there is no excess, to its net profits for the current and/or immediately preceding fiscal year. See alsoprovided in the Stockholders’ Equity note 13 in the financial statements in Item 8 of this Form 10-K.
Recent Sales of Unregistered Securities; Use of Proceeds From Registered Securities
No unregistered securities were sold by the Company within the last three years. Registered securities were exchanged as part of the consideration for the acquisitions of Factory Point Bancorp and Woronoco Bancorp. Registered securities were issued in 2008 in the Company’s offerings of common stock and preferred stock. The Company issued 1.725 million common shares in a public stock offering. Net proceeds of $38.5 million were primarily deposited by the Company into the Bank, which used the funds to pay off short-term borrowings and to purchase investment securities. The Company also issued 40 thousand shares of preferred stock in the U.S. Department of the Treasury Capital Purchase Program. The offering proceeds were $40 million, of which $30 million was provided to the Bank as additional contributed capital and the remaining balance was deposited into the Bank. The Bank used the funds to purchase investment securities and to purchase short-term investments pending anticipated reinvestment in the expansion of credit through lending activities in 2009. The preferred stock offering included the grant of a warrant to purchase 226 thousand shares of common stock; there was no additional cash consideration received for this grant.
Purchases of Equity Securities by the Issuer and Affiliated Purchases
The following table provides information with respect to any purchaseThere were no purchases of equity securities during the fourth quarter of 2008 made by or on behalf of the Company or any “affiliated purchaser”, as defined by Section 240.10b-18(a)(3) of the Securities and Exchange Act of 1934, of shares of the Company’s common stock.
| | | | | | | | Total number of shares | | | Maximum number of | |
| Total number | | | Average | | | purchased as part of | | | shares that may yet | |
| | of shares | | | price paid | | | publicly announced | | | be purchased under | |
Period | | purchased | | | per share | | | plans or programs | | | the plans or programs | |
October 1-31, 2007 | | | 40,529 | | | $ | 27.96 | | | | 40,529 | | | | 227,393 | |
November 1-30, 2007 | | | 167,500 | | | | 26.52 | | | | 167,500 | | | | 59,893 | |
December 1-31, 2007 | | | 61,900 | | | | 25.69 | | | | 61,900 | | | | 297,993 | |
Total | | | 269,929 | | | $ | 26.55 | | | | 269,929 | | | | 297,993 | |
On February 23, 2006, the Company authorized the purchase of up to 300,000 shares, from time to time, subject to market conditions. The last of the shares under the February 23, 2006 plan were purchased on December 18, 2007. On December 14, 2007, the Company authorized the purchase of up to 300,000 additional shares, from time to time, subject to market conditions. The repurchase plan will continue until it is completed or terminated by the Board of Directors. The Company has no plans that it has electedintentions to terminate this plan or to cease any potential future purchases. However, prior to expirationDecember 19, 2011, unless we have redeemed all the preferred stock issued to the U.S. Treasury on December 19, 2008, or unless the U.S. Treasury has transferred all the preferred stock to a third party, the consent of the U.S. Treasury will be required for us to repurchase any of our shares of common stock. As of year-end 2008, there were 98 thousand maximum shares that may yet be purchased under which it does not intend to make further purchases.this publicly announced plan.
Performance Graph
The performance graph compares the Company’s cumulative stockholder return on its common stock over the last five years to the cumulative return of the NASDAQ Composite Index, and the SNL All Bank and Thrift Index. Total stockholder return is measured by dividing total dividends (assuming dividend reinvestment) for the measurement period plus share price change for a period by the share price at the beginning of the measurement period. The Company’s cumulative stockholder return over a five-year period is based on an initial investment of $100 on December 31, 2002.2003.
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Period Ending | |
Index | | 12/31/03 | | | 12/31/04 | | | 12/31/05 | | | 12/31/06 | | | 12/31/07 | | | 12/31/08 | |
Berkshire Hills Bancorp, Inc. | | | 100.00 | | | | 104.01 | | | | 95.24 | | | | 96.68 | | | | 76.63 | | | | 93.20 | |
NASDAQ Composite | | | 100.00 | | | | 108.59 | | | | 110.08 | | | | 120.56 | | | | 132.39 | | | | 78.72 | |
SNL Bank and Thrift | | | 100.00 | | | | 111.98 | | | | 113.74 | | | | 132.90 | | | | 101.34 | | | | 58.28 | |
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| | Period Ending |
Index | | 12/31/02 | | | 12/31/03 | | | 12/31/04 | | | 12/31/05 | | | 12/31/06 | | | 12/31/07 | |
Berkshire Hills Bancorp Inc. | | $ | 100.00 | | | $ | 156.34 | | | $ | 162.61 | | | $ | 148.90 | | | $ | 151.15 | | | $ | 119.80 | |
NASDAQ Composite | | | 100.00 | | | | 150.01 | | | | 162.89 | | | | 165.13 | | | | 180.85 | | | | 198.60 | |
SNL Bank and Thrift Index | | | 100.00 | | | | 135.57 | | | | 151.82 | | | | 154.20 | | | | 180.17 | | | | 137.40 | |
ITEM 6. SELECTEDSELECTED FINANCIAL DATA The following summary data is based in part on the consolidated financial statements and accompanying notes, and other schedules appearing elsewhere in this Form 10-K. Historical data is also based in part on, and should be read in conjunction with, prior filings with the SEC.
| | | | | | | | | | | | | | | | | | | | |
| | At or For the Years Ended December 31, | |
(In thousands, except per share data) | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
| | | | | | | | | | | | | | | | | | | | |
Selected Financial Data: | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 2,666,729 | | | $ | 2,513,432 | | | $ | 2,149,642 | | | $ | 2,035,553 | | | $ | 1,310,115 | |
Securities | | | 341,516 | | | | 258,497 | | | | 234,174 | | | | 420,320 | | | | 414,363 | |
Loans, net | | | 1,984,244 | | | | 1,921,900 | | | | 1,679,617 | | | | 1,407,229 | | | | 818,842 | |
Goodwill and intangibles | | | 178,830 | | | | 182,452 | | | | 121,341 | | | | 99,616 | | | | 7,254 | |
Deposits | | | 1,829,580 | | | | 1,822,563 | | | | 1,521,938 | | | | 1,371,218 | | | | 845,789 | |
Borrowings and subordinated debentures | | | 374,621 | | | | 349,938 | | | | 360,469 | | | | 412,917 | | | | 327,926 | |
Total stockholders’ equity | | | 408,425 | | | | 326,837 | | | | 258,161 | | | | 246,066 | | | | 131,736 | |
| | | | | | | | | | | | | | | | | | | | |
Selected Operating Data: | | | | | | | | | | | | | | | | | | | | |
Total interest and dividend income | | $ | 133,211 | | | $ | 131,944 | | | $ | 118,051 | | | $ | 87,732 | | | $ | 61,081 | |
Total interest expense | | | 57,471 | | | | 68,019 | | | | 57,811 | | | | 36,115 | | | | 20,724 | |
| | | | | | | | | | | | | | | |
Net interest income | | | 75,740 | | | | 63,925 | | | | 60,240 | | | | 51,617 | | | | 40,357 | |
Service charges and fee income | | | 30,334 | | | | 26,654 | | | | 13,539 | | | | 9,373 | | | | 5,493 | |
All other non-interest income (loss) | | | 1,261 | | | | (2,011 | ) | | | (1,491 | ) | | | 5,550 | | | | 2,271 | |
| | | | | | | | | | | | | | | |
Total net revenue | | | 107,335 | | | | 88,568 | | | | 72,288 | | | | 66,540 | | | | 48,121 | |
Provision for loan losses | | | 4,580 | | | | 4,300 | | | | 7,860 | | | | 1,313 | | | | 1,565 | |
Total non-interest expense | | | 71,699 | | | | 65,494 | | | | 48,868 | | | | 48,998 | | | | 28,977 | |
Provision for income taxes — continuing operations | | | 8,812 | | | | 5,239 | | | | 4,668 | | | | 8,003 | | | | 5,639 | |
Net income (loss) from discontinued operations | | | — | | | | — | | | | 371 | | | | — | | | | (431 | ) |
| | | | | | | | | | | | | | | |
Net income | | $ | 22,244 | | | $ | 13,535 | | | $ | 11,263 | | | $ | 8,226 | | | $ | 11,509 | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Dividends per share | | $ | 0.63 | | | $ | 0.58 | | | $ | 0.56 | | | $ | 0.52 | | | $ | 0.48 | |
Basic earnings per share | | $ | 2.08 | | | $ | 1.47 | | | $ | 1.32 | | | $ | 1.16 | | | $ | 2.18 | |
Diluted earnings per share | | $ | 2.06 | | | $ | 1.44 | | | $ | 1.29 | | | $ | 1.10 | | | $ | 2.01 | |
| | | | | | | | | | | | | | | | | | | | |
Weighted average shares outstanding — basic | | | 10,700 | | | | 9,223 | | | | 8,538 | | | | 7,122 | | | | 5,284 | |
Weighted average shares outstanding — diluted | | | 10,791 | | | | 9,370 | | | | 8,730 | | | | 7,503 | | | | 5,731 | |
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| | | | | | | | | | | | | | | | | | | | |
| | At or For the Years Ended December 31, | |
| | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
| | | | | | | | | | | | | | | | | | | | |
Selected Operating Ratios and Other Data: | | | | | | | | | | | | | | | | | | | | |
Performance Ratios: | | | | | | | | | | | | | | | | | | | | |
Return on average assets | | | 0.87 | % | | | 0.60 | % | | | 0.53 | % | | | 0.47 | % | | | 0.89 | % |
Return on average equity | | | 6.47 | | | | 4.69 | | | | 4.40 | | | | 4.19 | | | | 9.06 | |
Interest rate spread | | | 3.06 | | | | 2.79 | | | | 2.81 | | | | 3.00 | | | | 3.10 | |
Net interest margin | | | 3.44 | | | | 3.26 | | | | 3.24 | | | | 3.33 | | | | 3.37 | |
Non-interest income/total net revenue | | | 29.44 | | | | 27.82 | | | | 16.67 | | | | 22.43 | | | | 16.13 | |
Non-interest expense/average assets | | | 2.81 | | | | 2.90 | | | | 2.31 | | | | 2.81 | | | | 2.25 | |
Dividend payout ratio | | | 30.58 | | | | 40.28 | | | | 42.92 | | | | 45.06 | | | | 22.02 | |
| | | | | | | | | | | | | | | | | | | | |
Capital Ratios: | | | | | | | | | | | | | | | | | | | | |
Tier 1 capital to average assets — bank | | | 9.34 | | | | 7.97 | | | | 7.69 | | | | 7.79 | | | | 8.08 | |
Total capital to risk-weighted assets — bank | | | 12.28 | | | | 10.40 | | | | 10.27 | | | | 11.12 | | | | 12.69 | |
Stockholders’ equity/total assets | | | 15.32 | | | | 13.00 | | | | 12.01 | | | | 12.09 | | | | 10.06 | |
| | | | | | | | | | | | | | | | | | | | |
Asset Quality Ratios: | | | | | | | | | | | | | | | | | | | | |
Nonperforming loans/total loans | | | 0.61 | | | | 0.54 | | | | 0.45 | | | | 0.08 | | | | 0.14 | |
Nonperforming assets/total assets | | | 0.48 | | | | 0.45 | | | | 0.35 | | | | 0.06 | | | | 0.09 | |
Net loans charged-off/average total loans | | | 0.19 | | | | 0.34 | | | | 0.07 | | | | 0.08 | | | | 0.15 | |
Allowance for loan losses/total loans | | | 1.14 | | | | 1.14 | | �� | | 1.14 | | | | 0.92 | | | | 1.13 | |
Allowance for loan losses/nonperforming loans | | | 1.88 | x | | | 2.10 | x | | | 2.55 | x | | | 10.96 | x | | | 8.11 | x |
| | | | | | | | | | | | | | | | | | | | |
Share Data: | | | | | | | | | | | | | | | | | | | | |
Book value per share | | $ | 30.33 | | | $ | 31.15 | | | $ | 29.63 | | | $ | 28.81 | | | $ | 22.43 | |
Market price at year end | | $ | 30.86 | | | $ | 26.00 | | | $ | 33.46 | | | $ | 33.50 | | | $ | 37.15 | |
| | At or For the Years Ended December 31, | |
(Dollars in thousands, except per share data) | | 2007 | | | 2006 | | | 2005 | | | 2004 | | | 2003 | |
| | | | | | | | | | | | | | | |
Selected Financial Data: | | | | | | | | | | | | | | | |
Total assets | | $ | 2,513,432 | | | $ | 2,149,642 | | | $ | 2,035,553 | | | $ | 1,310,115 | | | $ | 1,218,548 | |
Securities | | | 258,497 | | | | 234,174 | | | | 420,320 | | | | 414,363 | | | | 359,294 | |
Loans, net | | | 1,921,900 | | | | 1,679,617 | | | | 1,407,229 | | | | 818,842 | | | | 783,258 | |
Goodwill and intangibles | | | 182,452 | | | | 121,341 | | | | 99,616 | | | | 7,254 | | | | 10,233 | |
Deposits | | | 1,822,563 | | | | 1,521,938 | | | | 1,371,218 | | | | 845,789 | | | | 830,244 | |
Borrowings and subordinated debentures | | | 349,938 | | | | 360,469 | | | | 412,917 | | | | 327,926 | | | | 251,465 | |
Total stockholders’ equity | | | 326,837 | | | | 258,161 | | | | 246,066 | | | | 131,736 | | | | 123,175 | |
| | | | | | | | | | | | | | | | | | | | |
Selected Operating Data: | | | | | | | | | | | | | | | | | | | | |
Total interest and dividend income | | $ | 131,944 | | | $ | 118,051 | | | $ | 87,732 | | | $ | 61,081 | | | $ | 56,308 | |
Total interest expense | | | 68,019 | | | | 57,811 | | | | 36,115 | | | | 20,724 | | | | 18,742 | |
Net interest income | | | 63,925 | | | | 60,240 | | | | 51,617 | | | | 40,357 | | | | 37,566 | |
Provision for loan losses | | | 4,300 | | | | 7,860 | | | | 1,313 | | | | 1,565 | | | | 1,460 | |
Service charges and fee income | | | 26,654 | | | | 13,539 | | | | 9,373 | | | | 5,493 | | | | 5,023 | |
All other non-interest income (loss) | | | (2,011 | ) | | | (1,491 | ) | | | 5,550 | | | | 2,271 | | | | 1,425 | |
Total non-interest expense | | | 65,494 | | | | 48,868 | | | | 48,998 | | | | 28,977 | | | | 28,243 | |
Provision for income taxes - continuing operations | | | 5,239 | | | | 4,668 | | | | 8,003 | | | | 5,639 | | | | 5,161 | |
Net income (loss) from discontinued operations | | | - | | | | 371 | | | | - | | | | (431 | ) | | | (185 | ) |
Net income | | $ | 13,535 | | | $ | 11,263 | | | $ | 8,226 | | | $ | 11,509 | | | $ | 8,965 | |
| | | | | | | | | | | | | | | | | | | | |
Dividends per share | | $ | 0.58 | | | $ | 0.56 | | | $ | 0.52 | | | $ | 0.48 | | | $ | 0.48 | |
Basic earnings per share: | | | | | | | | | | | | | | | | | | | | |
Continuing operations | | $ | 1.47 | | | $ | 1.28 | | | $ | 1.16 | | | $ | 2.26 | | | $ | 1.74 | |
Discontinued operations | | | - | | | | 0.04 | | | | - | | | | (0.08 | ) | | | (0.04 | ) |
Total | | $ | 1.47 | | | $ | 1.32 | | | $ | 1.16 | | | $ | 2.18 | | | $ | 1.70 | |
| | | | | | | | | | | | | | | | | | | | |
Diluted earnings per share: | | | | | | | | | | | | | | | | | | | | |
Continuing operations | | $ | 1.44 | | | $ | 1.25 | | | $ | 1.10 | | | $ | 2.08 | | | $ | 1.60 | |
Discontinued operations | | | - | | | | 0.04 | | | | - | | | | (0.07 | ) | | | (0.03 | ) |
Total | | $ | 1.44 | | | $ | 1.29 | | | $ | 1.10 | | | $ | 2.01 | | | $ | 1.57 | |
| | | | | | | | | | | | | | | | | | | | |
Average shares outstanding: | | | | | | | | | | | | | | | | | | | | |
Basic | | | 9,223 | | | | 8,538 | | | | 7,122 | | | | 5,284 | | | | 5,266 | |
Diluted | | | 9,370 | | | | 8,730 | | | | 7,503 | | | | 5,731 | | | | 5,703 | |
Note: All performance ratios are based on average balance sheet amounts where applicable. | | At or For the Years Ended December 31, | |
| | 2007 | | | 2006 | | | 2005 | | | 2004 | | | 2003 | |
| | | | | | | | | | | | | | | |
Selected Operating Ratios and Other Data: | | | | | | | | | | | | | | | |
Performance Ratios: | | | | | | | | | | | | | | | |
Return on average assets | | | 0.60 | % | | | 0.53 | % | | | 0.47 | % | | | 0.89 | % | | | 0.80 | % |
Return on average equity | | | 4.69 | | | | 4.40 | | | | 4.19 | | | | 9.06 | | | | 7.28 | |
Interest rate spread | | | 2.79 | | | | 2.81 | | | | 3.00 | | | | 3.10 | | | | 3.29 | |
Net interest margin | | | 3.26 | | | | 3.24 | | | | 3.33 | | | | 3.37 | | | | 3.61 | |
Non-interest income/total net revenue | | | 27.82 | | | | 16.67 | | | | 22.43 | | | | 16.13 | | | | 14.65 | |
Non-interest expense/average assets | | | 2.90 | | | | 2.31 | | | | 2.81 | | | | 2.25 | | | | 2.53 | |
Dividend payout ratio | | | 40.28 | | | | 42.92 | | | | 45.06 | | | | 22.02 | | | | 28.24 | |
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Bank Capital Ratios: | | | | | | | | | | | | | | | | | | | | |
Tier 1 capital to average assets | | | 7.97 | | | | 7.69 | | | | 7.79 | | | | 8.08 | | | | 7.87 | |
Total capital to risk-weighted assets | | | 10.40 | | | | 10.27 | | | | 11.12 | | | | 12.69 | | | | 12.55 | |
Stockholders’ equity/total assets | | | 13.00 | | | | 12.01 | | | | 12.09 | | | | 10.06 | | | | 10.11 | |
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Asset Quality Ratios: | | | | | | | | | | | | | | | | | | | | |
Nonperforming loans/total loans | | | 0.54 | | | | 0.45 | | | | 0.08 | | | | 0.14 | | | | 0.40 | |
Nonperforming assets/total assets | | | 0.45 | | | | 0.35 | | | | 0.06 | | | | 0.09 | | | | 0.26 | |
Net loans charged-off/average total loans | | | 0.34 | | | | 0.07 | | | | 0.08 | | | | 0.15 | | | | 0.35 | |
Allowance for loan losses/total loans | | | 1.14 | | | | 1.14 | | | | 0.92 | | | | 1.13 | | | | 1.13 | |
Allowance for loan losses/nonperforming loans | | | 2.10 | x | | | 2.55 | x | | | 10.96 | x | | | 8.11 | x | | | 2.80 | x |
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Share Data: | | | | | | | | | | | | | | | | | | | | |
Book value per share | | $ | 31.15 | | | $ | 29.63 | | | $ | 28.81 | | | $ | 22.43 | | | $ | 20.87 | |
Market price at year end | | $ | 26.00 | | | $ | 33.46 | | | $ | 33.50 | | | $ | 37.15 | | | $ | 36.20 | |
ITEM 7. MANAGEMENT’SMANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL
This discussion is intended to assist in understanding the financial condition and results of operations of the Company. This discussion should be read in conjunction with the consolidated financial statements and accompanying notes contained in this report.
CRITICAL ACCOUNTING POLICIES
The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements. Please see those policies in conjunction with this discussion.
Critical accounting policies are those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. Management believes that our most critical accounting policies, which involve the most complex or subjective decisions or assessments, are as follows:
Allowance for Loan Losses. Arriving at an appropriate level of allowance for loan losses involves a high degree of judgment. The allowance for loan losses provides for probable estimable losses based upon evaluations of known and inherent risks in the loan portfolio. Management uses historical information, as well as current economic data, to assess the adequacy of the allowance for loan losses as it is affected by changing economic conditions and various external factors, which may impact the portfolio in ways currently unforeseen. Although we believe that we use appropriate available information to establish the allowance for loan losses, future additions to the allowance may be necessary if certain future events occur that cause actual results to differ from the assumptions used in making the evaluation. For example, a downturn in the local economy could cause an increase in non-performing loans. Additionally, a decline in real estate values could cause somereduce the collateral protection of our loans to become inadequately collateralized.real estate loans. In either case, this may require us to increase our provisions for loan losses, which would negatively impact earnings. The allowance for loan losses discussion in Item 1 provides additional information about the allowance.
Income Taxes.Management considers accounting for income taxes as a critical accounting policy due to the subjective nature of certain estimates that are involved in the calculation and evaluation of the timing and recognition of resulting tax liabilities and assets. Management uses the asset liability method of accounting for income taxes in which deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of the Company'sCompany’s assets and liabilities. Management must assess the realizability of the deferred tax assets, and to the extent that management believes that recovery is not likely, a valuation allowance is established. Adjustments to increase or decrease the valuation allowance are generally charged or credited, respectively, to income tax expense.
Goodwill and Identifiable Intangible Assets.In conjunction with the acquisitions of Factory Point Bancorp, Inc. in 2007 and Woronoco Bancorp in 2005, goodwill was recorded as an intangible asset equal to the excess of the purchase price over the estimated fair value of the net assets acquired. Other intangible assets were recorded for the fair value of core deposits and non-compete agreements. Goodwill and intangible assets related to insurance contracts were recorded for the purchase of insurance agencies in 2006. The valuation techniques used by management to determine the carrying value of assets acquired in the acquisition and the estimated lives of identifiable intangible assets involve estimates for discount rates, projected future cash flows and time period calculations, all of which are susceptible to change based on changes in economic conditions and other factors. Future events or changes in the estimates which were used to determine the carrying value of goodwill and identifiable intangible assets or which otherwise adversely affects their value or estimated lives could have a material adverse impact on future results of operations.
Determination of Other-Than-Temporary Impairment of Securities.Management evaluates securities for other-than-temporary impairment on at least a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The consideration of the above factors are subjective and involve estimates and assumptions about matters that are inherently uncertain. Should actual factors and conditions differ materially from those used by management, the actual realization of gains or losses on investment securities could differ materially from the amounts recorded in the financial statements.
SUMMARYFair Valuation of Financial Instruments.The Company uses fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. Trading assets, securities available for sale, and derivative instruments are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, or to establish a loss allowance or write-down based on the fair value of impaired assets. Further, the notes to financial statements include information about the extent to which fair value is used to measure assets and liabilities, the valuation methodologies used and its impact to earnings. Additionally, for financial instruments not recorded at fair value, the notes to financial statements disclose the estimate of their fair value. Due to the judgments and uncertainties involved in the estimation process, the estimates could result in materially different results under different assumptions and conditions.
SUMMARY
Net income rose to a record $22.2 million in 2008. Earnings per common share rose to a record $2.06. Financial highlights in 2008 included:
21% increase in total net revenue
3.44% net interest margin, the highest since 2003
8% increase in total commercial loans; 7% increase in total residential mortgage and home equity loans
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61.4% efficiency ratio, improved from 62.9% in 2007
0.48% nonperforming assets to total assets at year-end; accruing delinquent loans were 0.51% of total loans
0.19% charge-offs on average loans
Public issuance of nearly $40 million in common stock and the issuance of $40 million of preferred stock under the U.S. Treasury Capital Purchase Program
Record results in 2008 were the result of positive operating leverage due to the benefit of organic growth and the new Vermont operations. Despite the spreading recession in 2008, Berkshire Hills generated higher year-over-year earnings per share in every quarter of the year. These results were achieved despite the impact of Berkshire Hills’ October common stock offering, which reduced EPS by $0.06 in the fourth quarter and by $0.07 for the year. This successful public offering totaled nearly $40 million and bolstered equity capital, which totaled 15.3% of total assets at year-end. Berkshire Hills also issued $40 million in preferred stock under the Treasury Capital Purchase Program and agreed to expand the flow of credit and support economic vitality in the communities that it serves.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2008 AND 2007
Balance Sheet Summary.Total assets were $2.7 billion at year-end 2008, increasing by $153 million (6%) over year-end 2007 due to growth in loans and investments. Asset growth was primarily funded by common and preferred stock offerings, together with growth in deposits and borrowings. Nonperforming assets did not increase materially. The ratio of equity/assets increased to 15.3% at year-end 2008 from 13.0% at year-end 2007, reflecting the benefit of record earnings and the stock offerings.
Investment Securities.Total investment securities increased by $83 million (32%) in 2008 due primarily to purchases of short duration collateralized mortgage obligations issued by federal agencies. This increase primarily represented the investment of funds provided by capital raises, pending reinvestment in anticipated loan growth in 2009. At year-end 2008, the Company’s securities portfolio consisted primarily of U.S. agency mortgage-backed securities, and municipal and economic development bonds. All debt securities were rated investment grade except for $43 million in unrated local municipal and economic development bonds. The total net unrealized loss on securities available for sale was $3 million at year-end 2008 (1% of the outstanding balance), all of which was deemed to be temporary. During the year, Berkshire Bank entered into an interest rate swap on a $15 million local economic development bond, and as a result this security is carried as a trading security on the balance sheet.
At year-end 2008, the Company owned a total of $342 million in investment securities, including the trading account security. Securities included $175 million in federal agency mortgage-backed securities, $119 million municipal and economic development bonds, $21 million in FHLBB stock, and $27 million in corporate bonds and other securities. The tax equivalent yield on the portfolio in the fourth quarter of 2008 was 5.14%, compared to 5.85% in the fourth quarter of 2007. The duration of the debt securities at year-end 2008 was approximately 3.8 years.
Loans.Total loans increased by $63 million (3%). Excluding targeted run-off of indirect auto loans, total loans increased by 7%, reflecting growth in total commercial loans, along with higher residential mortgage and home equity loans. Growth in commercial real estate loans mostly reflected loan opportunities previously serviced by national providers in the Company’s New England lending areas. Home equity loan growth was due to new lines opened as a result of relationship promotions. Residential and home equity underwriting is based on prime lending standards with 80% maximum loan-to-value. Commercial business loans decreased due to paydowns. The Bank made a decision early in the year to discontinue originations of indirect auto loans and this portfolio is declining as existing balances runoff. The Company has emphasized adherence to strong credit standards and pricing objectives in managing its loan originations. Berkshire Bank introduced commercial loan interest rate swaps as a new offering to larger commercial mortgages in 2008. This allowed the Bank to originate variable rate loans and the customer to swap to a fixed rate. This contributed to loan growth and fee income in 2008. Total loans with repricings over five years declined to $460 million at year-end 2008 from $518 million at the prior year-end. The average yield on loans was 5.79% in the fourth quarter of 2008, compared to 6.68% in the fourth quarter of 2007. This generally reflected declining rates, the lower percentage of fixed-rate loans, and the decrease in indirect auto loans.
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The Company’s problem loan measures at year-end 2008 remained comparatively low and were not significantly changed from the prior year-end. Year-end 2008 nonperforming assets totaled 0.48% of total assets, and accruing delinquent loans were up moderately to 0.51% of total loans. Year-end 2008 nonperforming assets included two real estate secured commercial mortgages in the process of foreclosure totaling approximately $2.5 million each; one loan was related to a recreational income producing property and the other was a condominium construction loan. There were no other nonperforming assets over $1 million at that date.
In addition to nonperforming loans, the Company has identified $73 million in potential problem loans at year-end 2008, compared to $23 million at the prior year-end. Potential problem loans are loans which are currently performing, but where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in disclosure of such in the future as problem loans. Potential problem loans are typically commercial loans that are performing but are classified by the Company’s loan rating system as “substandard.” At year-end 2008, the largest potential problem loans included three commercial mortgages to non-profit organizations totaling $23 million, three residential construction loan projects totaling $17 million, and two commercial mortgages totaling $12 million including a lodging loan and a commercial retail rental property. In several cases, potential problem loans reflect situations in which commercial borrowers increased debt to finance real estate investment and the anticipated cash flow from these investments did not materialize at the projected levels. Economic conditions and other factors may cause these or other loans to become nonaccruing or restructured or to require charge-offs in the future.
Loan Loss Allowance. The determination of the allowance for loan losses is a critical accounting estimate. The Company’s methodologies for determining the loan loss allowance are discussed in Item I of this report. The Company considers the allowance for loan losses of $23 million appropriate to cover losses inherent in the loan portfolio as of December 31, 2008. Actual future losses may be higher than this estimate and will depend on future economic and financial conditions and regulatory requirements. At year-end 2008, there were significant challenges and uncertainties in the Company’s environment as described in the Economic Events section of Item I. The impact of these future events and events in the Company’s real estate markets is very uncertain. The Company believes that its regional economies generally did not enter the recession until the fourth quarter of 2008. While the Company has seen an adverse trend in its commercial loan risk ratings, loan performance in 2008 remained relatively strong and the Company did not believe that inherent losses at year-end 2008 were outside of the range contemplated by its current loan loss allowance methodology. The ratio of the loan loss allowance to total loans remained unchanged at 1.14% of total loans at year-end 2008, compared to the prior year-end. The Company’s net loan charge-offs decreased to $3.8 million in 2008 from $6.0 million in 2007 due to one large loan charged-off in 2007. Total non-accruing loans were $12.2 million at year-end 2008, which was up modestly from $10.5 million at the prior year-end. The portion of the allowance assigned to specific reserves on impaired loans was $1.0 million at year-end 2008 and $1.2 million at year-end 2007. The total amount of loans deemed impaired was $28.6 million at year-end 2008, compared to $14.8 million at year-end. 2007. Performing loans included troubled debt restructurings totaling $7.5 million at year-end 2008.
Cash Surrender Value of Life Insurance.Berkshire Bank owns various life insurance policies which were written as part of the benefits program provided to certain officers in prior years, including policies relating to officers of acquired banks. The cash surrender value of these policies did not change significantly during 2008, and totaled $36 million at year-end. The year-end total included approximately $16 million in general account policies written with an AAA rated insurance company and $9 million written with an AA rated company. There were no material exposures to carriers below investment grade ratings at year-end 2008.
Other Assets.All other assets increased by $9 million to $44 million at year-end 2008 primarily due to an increase in the net deferred tax asset as a result of tax benefits related to unrealized losses on certain investment securities and derivative financial instruments.
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Deposits.Total deposits increased by $7 million to $1.83 billion in 2008. Deposit activity included approximately $45 million in targeted run-off of higher cost municipal and commercial deposits, and brokered time deposit accounts, primarily in the second quarter. Deposit growth excluding this run-off was 3%. Growth in money market and time deposit balances offset a decline in NOW account balances, and demand deposit and savings balances did not change significantly. Most of Berkshire Bank’s retail deposit and loan promotions are linked to companion checking accounts. At the beginning of the year, the Bank promoted money market accounts due to their lower cost and stronger relationship cross sales. The Company also promotes time deposit account specials when they enhance balance sheet management strategies or when the Company feels that the pricing is advantageous. When rates declined in the fourth quarter, and subsequent to raising nearly $80 million from capital offerings, the Company reduced its promotions of interest-bearing deposit accounts. Throughout the year, the Company carefully hewed to its pricing disciplines in order to support an expansion of the net interest margin and to mitigate the impact of the decision to discontinue originations of indirect auto loans. Most brokered deposits were prepaid, and the total declined to $3 million at year-end 2008 compared to $21 million at the prior year-end. The Bank’s deposit growth primarily was in time deposits over $100 thousand, in part reflecting the benefit of the 100% deposit insurance protection offered by the Bank.
Deposit markets were turbulent in the last several months of the year. Due to the failures and takeovers of investment banks and prominent national banks and mortgage agencies, there was a flight to quality and short-term treasury rates were at times negative. There were several federal interventions in the credit markets, including a federal guarantee of money market funds. Berkshire Bank provides 100% insurance on all deposits due to a combination of FDIC insurance and the Massachusetts Depositors Insurance Fund. Berkshire Bank initially received inflows of deposits and benefited from demand for this comprehensive insurance. The FDIC increased deposit insurance on all deposit accounts and optionally made available unlimited insurance on demand deposit balances, which Berkshire Bank elected to participate in. Federal banking regulators also allowed numerous national financial institutions to convert to bank charters in order to be able to issue FDIC guaranteed deposits to replace liquidity sources which became unavailable as national wholesale funding markets contracted. Accordingly, many national institutions offered comparatively high-rate time deposits which competed with Berkshire Bank’s deposit accounts. The FDIC also began guaranteeing wholesale debt offerings by participating banks, and these offerings also competed with traditional bank deposits. Due to these factors and the extraordinarily low level of interest rates, total deposits declined by $8 million in the fourth quarter.
Borrowings and Debentures. Total borrowings and debentures increased by $25 million in 2008. Total short-term debt decreased by $70 million, and longer term FHLBB advances increased by $97 million. This was the result of the Company’s strategy to bolster its liquidity and to eliminate its liability sensitivity in its interest rate risk profile. The Company entered into $135 million in adjustable rate term advances from the FHLBB and used interest rate swaps to fix the cost of these advances for periods in the range of 3 — 10 years, achieving a 3.9% fixed interest cost for a total average duration of 6 years on these advances. Berkshire Hills Bancorp reduced its holding company lines of credit from $30 million to $15 million in 2008 due to higher credit costs.
Derivative Financial Instruments.The Company established relationships with several national banks in 2008 in order to be able to enter into interest rate swaps. At year-end 2008, the Company had $243 million outstanding in gross notional balances of interest rate swaps. In addition to swaps related to Federal Home Loan Bank borrowings, the Company has also entered into swaps related to a trading investment security, to the Company’s trust preferred debenture, and to back-to-back swaps arranged with commercial borrowers. At year-end, the Company had swaps with gross unrealized losses totaling $24 million and gross unrealized gains totaling $4 million. The unrealized losses related primarily to swaps used to fix the interest rates on Federal Home Loan Bank borrowings, which were valued at a discount at year-end due to the low rates resulting from government interventions to respond to the economic crisis. If the Company had instead fixed these rates directly with the Federal Home Loan Bank as it previously did, there would have been no market value adjustment recorded to the Company’s balance sheet. The increase in Other Liabilities was primarily due to the swap unrealized losses, together with a clearing balance due to broker.
Equity.Stockholders’ equity increased by $82 million, including the benefit of $79 million in proceeds from common stock and preferred stock offerings. The contribution of earnings was mostly offset by dividends, stock repurchases, and unrealized losses on securities and derivative financial instruments. The ratio of total equity to assets increased to 15.3% at year-end 2008, compared to 13.0% at the prior year-end. Reflecting the additional shares outstanding, book value per common share was $30.33 at year-end 2008, compared to $31.15 at the prior year-end.
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In October 2008, Berkshire Hills issued 1.725 million shares of common stock, including an over-allotment amount which was issued early in November. These shares were publicly issued under the Company’s universal securities shelf registration with the SEC. The Company received cash proceeds of $39 million from this stock issuance, net of underwriting discounts and expenses. The shares were sold at an average gross price of $24 per share. Berkshire Hills deposited the cash proceeds into a deposit account at the Bank and maintained these cash balances at year-end 2008 to support future growth opportunities and potential further investment in the Bank.
In December 2008, Berkshire Hills issued 40 thousand shares of preferred stock to the United States Department of the Treasury under its Capital Purchase Program in exchange for cash proceeds of $40 million. Under the related agreement, Berkshire Hills also issued a ten year warrant for 226,330 common shares exercisable at $26.51 per share. The Company amended its SEC shelf registration and issued these securities under that registration. The preferred stock will pay cumulative dividends at the rate of 5% per year for the first five years, and 9% thereafter. The agreement included significant restrictions on repayment of the preferred stock, on common stock repurchases and dividends, on executive compensation, and other aspects of corporate governance. Under the agreement, the Company pledged to expand the flow of credit to U.S. consumers and businesses on competitive terms to promote the sustained growth and vitality of the U.S. economy and to work diligently under existing programs to modify the terms of residential mortgages as appropriate to strengthen the health of the U.S. housing market. Please see additional related discussion in the Stockholders’ Equity note to the financial statements in Item 8 of this report. The agreement allows Congress to unilaterally modify and/or add terms to the agreement. New terms were added in February 2009 and additional changes continue to be proposed in Congress. The Company is evaluating the benefits of continuing to participate in this program and its options to repurchase this preferred stock. Berkshire Hills contributed $30 million of the cash proceeds as additional capital to the Bank, and held the remainder as deposits in the Bank to be used as potential future capital contributions to the Bank or to service dividend payments on the preferred stock. At year-end 2008, there were approximately 46,000 shares remaining available to be issued under the Company’s universal shelf registration, which expires in October, 2009.
The Bank met all regulatory capital requirements at year-end 2008 and continued to satisfy the conditions necessary to be classified as “Well Capitalized” in accordance with federal regulatory standards. The Bank’s risk-based capital was 12.3% at year-end 2008 compared to 10.4% at year-end 2007. During 2008, the Bank paid $17 million in dividends to the holding company, and proceeds were generally used to reduce outstanding debt of Berkshire Hills.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Net Income.Total net income increased by 64% to a record $22.2 million in 2008 from $13.5 million in 2007. Most categories of income and expense increased in the first nine months of 2008, including the benefit of Vermont operations acquired in September 2007. Earnings in 2007 were reduced by charges relating to the completion of the Vermont acquisition and an associated balance sheet restructuring. All earnings per share references in this report are to diluted earnings per share unless otherwise noted.
Earnings per share increased by 43% to a record $2.06 in 2008 from $1.44 in 2007. Earnings per share increased by 8% in 2008 compared to the $1.90 result in 2007 before the above mentioned acquisition and restructuring charges. This 8% increase included accretion from the Factory Point acquisition, the benefit of the balance sheet restructuring, and the benefit of organic growth and an improved net interest margin in 2008.
The return on assets increased to 0.87% in 2008 from 0.60% in 2007, and the return on equity increased to 6.5% from 4.7%. These returns in 2008 were the highest level reported by the Company since 2004. The 3.44% net interest margin was the highest since 2003. These results show the benefit resulting from acquisitions and organic growth in recent years which allowed Berkshire Hills to develop its management, infrastructure, and integration with the goal of achieving higher franchise and stockholder value. Additionally, the Bank’s ten-branch de novo expansion into the New York Albany region continued to mature, reaching $165 million in total deposits, and with four branches operating at or above the breakeven level at year-end.
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Berkshire Hills’ common and preferred stock placements in the fourth quarter of 2008 decreased the Company’s leverage, and this was expected to initially result in annualized earnings per share dilution of $0.24 related to the common stock and $0.17 related to the preferred stock. Because these stock offerings were late in the year, the impact on 2008 earnings per share was $0.07 for the common stock, and there was no impact for the preferred stock. Actual dilution in 2009 will depend primarily on the pace of loan growth and any increase in leverage that the Company may produce.
Total Revenue.Total revenue consists of net interest income and non-interest income. Total revenue increased by 21% in 2008 to $107 million from $89 million primarily due to the benefit of acquired Vermont operations. Revenue in 2008 was 4% higher than the pro forma combined 2007 revenue including Vermont operations and excluding balance sheet restructuring charges. This 4% increase was due primarily to organic growth, improved pricing, and the benefit of the 2007 balance sheet restructure. On a per share basis, revenues increased by 1% to $9.95 over 2007 revenues per share excluding restructuring charges. Revenues per share increased by 5% over 2007 revenues including restructuring charges. Fee income declined slightly to 28% of total revenue in 2008 compared to 30% in 2007, reflecting soft pricing conditions in insurance and wealth management, as well as the improvement in the net interest margin. Berkshire Hills continues to focus on long-term growth of this ratio to diversify revenue and to increase franchise value reflecting higher wallet share achieved through improved cross sales.
Net Interest Income.Net interest income increased by 18% in 2008 primarily due to the benefit of acquired Vermont operations. Net interest income increased by 4% compared to the pro forma combined net interest income of Berkshire Hills and Factory Point in 2007. This increase included the benefit of the 2007 balance sheet restructuring, adherence to loan and deposit pricing disciplines, and organic loan and deposit growth in 2008. Net interest income increased sequentially in each quarter of the year. Net interest income was up 7% in the fourth quarter of 2008 compared to 2007. The impacts of the Vermont operations and balance sheet restructuring were included in results beginning in the fourth quarter of 2007.
Average interest bearing assets and liabilities were each up approximately 11% due to the Vermont operations and organic growth. Average earning assets increased sequentially in each quarter in 2008, with the 2008 fourth quarter average exceeding the 2007 fourth quarter average by 6%. This was primarily driven by continuous loan growth, despite the impact of targeted runoff in the indirect auto loan portfolio.
The net interest margin increased to 3.44% in 2008 from 3.26% in 2007, reflecting the benefit of higher-margin Vermont operations, the balance sheet restructuring, and improved pricing spreads in 2008. The fourth quarter net interest margin was 3.41% in 2008 compared to 3.38% in 2007. The margin increased sequentially in the first three quarters of 2008, reaching 3.48% in the third quarter. This was achieved despite the decision to fix the rates on more than $100 million in Federal Home Loan Bank advances to reduce the sensitivity of earnings to anticipated future interest rate hikes. These fixed rates were achieved through interest rate swaps, and the Company accepted the higher current period interest costs to improve expected future earnings.
In the fourth quarter, the net interest margin decreased to 3.41% and it is expected to decrease further in 2009. Due to the global financial crisis and extraordinary federal interventions, short-term treasury rates at times dipped below zero in the fourth quarter. Due to usual market floors for deposit rates in its regional markets, and due to competition from distressed national financial institutions, the Company was unable to fully offset the decline in loan interest income by reducing deposit costs. The effective cost of deposits also increased due to higher FDIC insurance premiums, which are included in non-interest expense.
The yield on interest bearing assets and the cost of interest bearing liabilities decreased sequentially in each quarter of the year, primarily reflecting the reduction in short term interest rates during the year. The yield on earning assets also decreased due to the targeted run-off of higher yielding indirect auto loans and promotions of lower yielding home equity lines of credit. The cost of interest bearing liabilities reflected the benefit of targeted run-off of higher cost deposit accounts.
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Provision for Loan Losses.The provision for loan losses is a charge to earnings in an amount sufficient to maintain the allowance for loan losses at a level deemed adequate by the Company. The level of the allowance is a critical accounting estimate, which is subject to uncertainty. The level of the allowance was included in the discussion of financial condition. The loan loss provision totaled $4.6 million in 2008 compared to $4.3 million in 2007, and the year-end level of the loan loss allowance remained unchanged at 1.14% of total loans. Net loan charge-offs declined to $3.8 million from $6.0 million for these periods; charge-offs in 2007 included $4.0 million in losses recorded on one commercial credit with borrower fraud. The Company anticipates that the amount of net loan charge-offs and the loan loss provision will increase in the coming year due to the increase in potential problem loans and an expected deepening of the recession in the economy and real estate markets. While the national and global financial outlook is considered by many to be a crisis, the impact of the downturn in the Company’s lending markets is uncertain and may not be as severe as in other regions of the country. These markets generally did not experience the level of speculative development and subprime pricing that were prevalent in growth markets elsewhere in the U.S. Berkshire Bank does not participate in shared national credits and substantially all of its loan portfolio is to relationships in and around the Company’s lending areas in New England and New York.
Non-Interest Income.Non-interest income increased by 28% to $32 million in 2008 from $25 million in 2007. primarily due to the benefit of the acquired Vermont operations. Non-interest income increased by 2% over the pro forma combined 2007 non-interest income of Berkshire Hills and Factory Point, excluding restructuring charges. Deposit service fees increased by 7% over the pro forma combined 2007 deposit service fees, reflecting organic volume growth in 2008. Wealth management fees increased by 8% over this pro forma combined base, reflecting both organic growth and the benefit of the acquisition of the Center for Financial Planning in Albany in January 2008. This fee growth was achieved despite the stock market downturn, which caused a 21% reduction in fourth quarter wealth management revenues in 2008. Wealth management new business bookings in 2008 totaled $116 million, which was 15% of the starting balance. Total assets under management decreased from $781 million to $670 million due to the impact of the stock market downturn. Insurance revenues decreased by 1% in 2008. The negative impact of softer commercial renewal premiums was partially offset by organic growth in commercial insurance policies. The 59% increase in loan and swap fee revenues was mostly attributable to Berkshire Bank’s introduction of commercial loan interest rate swaps in 2008.
Non-Interest Expense.Non-interest expense increased by 9% in 2008 to $72 million from $65 million including the impact of acquired Vermont operations. Non-interest expense included $0.7 million of nonrecurring charges in 2008 and $3.0 million in 2007 related to merger, integration, and restructuring charges. Excluding these charges, and adjusting for the $2.5 million in targeted expense savings in Vermont, total non-interest expense increased by 2% in 2008 over the adjusted combined pro forma total including Berkshire Hills and Factory Point in 2007. Higher expenses included a $0.8 million increase in intangible amortization, a $0.5 million increase in loan collections expense, and a $0.6 million increase in deposit insurance premiums. The Company expects a significant increase in deposit insurance expense in 2009 due to higher ongoing and one-time FDIC premium assessments. The Company’s efficiency increased in 2008, reflecting the positive operating leverage generated by the 4% revenue growth compared to the 2% expense growth over the adjusted combined pro forma 2007 total.
Income Tax Expense.The effective tax rate was 28.4% in 2008 compared to 27.9% in 2007. The tax rate in 2008 included a rate benefit of 2.6% related to the elimination of a state tax valuation allowance as a result of growth in the Bank’s taxable income.
Results of Segment and Parent Operations.Net income of the banking segment increased to $22 million from $13 million due primarily to the same factors that affected consolidated earnings growth which were previously discussed. Net income of the insurance segment decreased by 23% to $1.9 million from $2.5 million due to the impact of soft renewal premiums and additional integration and restructuring charges in 2008. Net income of the parent increased due to earnings in the Bank. Dividends from subsidiaries were used to pay down debt, which reduced interest expense.
Comprehensive Income.Comprehensive income is a component of total stockholders’ equity on the balance sheet. Comprehensive income includes changes in accumulated other comprehensive income, which consist of changes (after-tax) in the unrealized market gains and losses on securities available for sale and the net gain (loss) on derivative instruments used as cash flow hedges. The Company recorded comprehensive income of $9.5 million in 2008 compared to $14.7 million in 2007. This decrease was primarily due to unrealized losses recorded on derivative financial instruments as a result of a sharp decline in interest rates following federal interventions in the financial markets in the fourth quarter.
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COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006
Summary.Net income increased by 20% to $13.5 million in 2007, compared to $11.3 million in the prior year. Net income per diluted share increased by 12% to $1.44 in 2007 from $1.29 in 2006. Earnings growth was driven primarily by a $3.7 million increase in net interest income, a $3.6 million decrease in provision for loan losses and a $12.6 million increase in non-interest income offset by a $16.6 million increase in non-interest expense. The increases in non-interest income and non-interest expense were due primarily to the acquisition of the five insurance agencies in the fourth quarter of 2006 and Factory Point in the third quarter of 2007. All earnings per share references are to diluted shares, and also reflect the additional shares issued in the Factory Point acquisition.
Financial highlights in 2007 included:
$10.0 million increase in insurance commissions and fees (from first full year of operations from acquired insurance agencies)
| · | $10.0 million increase in insurance commissions and fees (from first full year of operations from acquired insurance agencies) |
33% increase in deposit service fees
| · | 33% increase in deposit service fees |
34% increase in wealth management fees
| · | 34% increase in wealth management fees |
14% increase in loans (primarily from the Factory Point acquisition)
| · | 14% increase in loans (primarily from the Factory Point acquisition) |
32% non-maturity deposit growth (23% from the Factory Point acquisition and 9% from organic growth)
| · | 32% non-maturity deposit growth (23% from the Factory Point acquisition and 9% from organic growth) |
Other highlights in 2007 included:
Acquired Factory Point Bancorp, contributing to a 17% increase in total assets
| · | Acquired Factory Point Bancorp, contributing to a 17% increase in total assets |
Opened four new branches in New York increasing our presence to ten branches in the New York Capital region
| · | Opened four new branches in New York increasing our presence to ten branches in the New York Capital region |
Introduced a new brand identity to improve our overall competitive positioning
| · | Introduced a new brand identity to improve our overall competitive positioning |
First full year of operations for the expanded Berkshire Insurance Group — contributed $2.5 million in net income
| · | First full year of operations for the expanded Berkshire Insurance Group – contributed $2.5 million in net income |
| · | Net interest margin of 3.38% for the fourth quarter of 2007 – highest level in fourteen quarters |
| · | Solid asset quality with nonperforming assets at 0.45% of total assets at December 31, 2007 |
Results in 2007 included a third quarter after-tax loss of $2.4 million ($0.25 per share) due to a $3.8 million loss from a balance sheet restructuring, $1.7 million in expenses from the Factory Point acquisition ($1.1 million after-tax or $0.11 per share), $1.3 million in other restructuring expenses ($0.8 million after-tax or $0.08 per share), and a $2.5 million provision for loan losses ($1.5 million after-tax or $0.16 per share) related to a $2.5 million charge-off for one commercial loan that was impacted by borrower fraud. Collectively, these charges lowered 2007 net income by $5.6 million or $0.61 per share. Results in 2006 included a third quarter loss of $2.1 million ($0.25 per share) due to a $5.3 million securities loss related to a securities portfolio restructuring and deleveraging. Third quarter results in 2006 also included a $6.2 million loan loss provision due to an adjustment of the loan loss allowance.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2007 AND 2006
Balance Sheet Summary. Total assets were $2.51 billion at year-end 2007, increasing by $364 million (17%). Most categories of assets and liabilities increased due to the acquisition of Factory Point and organic growth. In conjunction with the acquisition, the Company restructured its balance sheet in the third quarter by selling $32 million in securities and $50 million in residential mortgage loans. Total loans increased by $245 million, including acquired Factory Point loans. Organic loan growth in 2007 totaled $58 million (3%) primarily due to growth of $40 million (7%) in commercial mortgages.
Total deposits increased by $301 million in 2007, including acquired Factory Point deposits. Organic deposit growth in 2007 totaled $25 million (2%) due to growth of $49 million (6%) in core non-maturity deposit balances. The Company allowed expensive time deposits to decrease as loan growth declined, and the Company promoted non-time accounts to take advantage of more favorable cost and cross sale characteristics. Total borrowings decreased by $11 million in 2007, with the increase relating to the Factory Point acquisition being more than offset by the third quarter balance sheet deleveraging. Stockholders’ equity increased in 2007 primarily due to $63 million recorded in conjunction with the Factory Point acquisition, including the issuance of 1.91 million common shares. Goodwill increased by $57 million, primarily due to the Factory Point acquisition. Total book value per share increased to $31.15. The ratio of total equity to assets increased to 13.0% reflecting the benefit of the new shares issued and the balance sheet deleveraging. Net income of $14 million in 2007 was primarily used for dividends of $5 million and treasury stock buybacks of $8 million. In the fourth quarter, the Company repurchased 270,000 shares at an average price of $26.55 per share.
Investment Securities. Total investment securities increased $24.3 million at year-end 2007 compared to year-end 2006. The Factory Point acquisition increased investment securities by $68 million. This increase was offset primarily by the sale of securities in connection with the deleveraging program, which totaled $32 million and the sale of $25 million of securities from Factory Point sold shortly after the merger date. The sale of $25 million of Factory Point securities was comprised mainly of municipal securities and other debt securities. These securities were marked to market as of the acquisition date, and they were sold for an amount that approximated this value. The Company reinvested approximately $34 million of the proceeds in agency mortgage-backed securities and municipal bonds with average lives of 2-3 years. The remaining securities from Factory Point were comprised mainly of conventional government agency and mortgage-backed securities, and municipal bonds. The loss from the securities sold in connection with the deleveraging program was $0.6 million. These securities had an estimated average life of approximately 4 years and a book yield of 4.75%. As a result of the actions noted above, the Company’s investment portfolio estimated average life was reduced by approximately three quarters of a year.
At year-end 2007, the total investment securities portfolio of $258 million included $112 million of municipal bonds and obligations, $107 million of mortgage backed securities, Federal Home Loan Bank stock of $21 million, and $18 million of other securities which consisted primarily of trust preferred securities. The fully taxable equivalent yield on investment securities remained unchanged at 5.6% in the fourth quarter of 2007 compared to the same period— highest level in 2006. This reflected the benefit of deleveraging in the third quarter of 2007.
Loans. Total loans increased by $245 million (14%) in 2007. The Factory Point acquisition accounted for $237 million of the increase. Excluding the impact of the $50 million residential mortgage loan sale, organic loan growth totaled $58 million (3%) due primarily to growth in commercial mortgages of $40 million, residential construction loans of $10 million and home equity loan growth of $6 million. The Company slowed the pace of loan growth in 2007 in order to maintain adherence to strong credit standards and pricing objectives in order to strengthen its net interest margin.
Residential mortgages increased $58 million in 2007 including $69 million from the Factory Point acquisition. As mentioned previously, the Company sold $50 million in residential mortgages in the third quarter of 2007 as part of a deleverage program to improve the Company’s interest rate risk profile. The Company has no subprime lending programs and does not offer Alt-A or other non-conforming loan documentation programs. The growth in residential construction lending of $10 million was driven primarily by the Company’s expansion in the Albany, NY market. The Company will focus on selling long-term fixed rate residential mortgages and maintaining adjustable rate products in its portfolio in 2008.
Commercial loans and mortgages increased $151 million (20%) in 2007 including $136 million from the Factory Point acquisition. Excluding the increase from the Factory Point acquisition, commercial mortgages increased $40 million organically, primarily in the Berkshire and Pioneer Valley markets. Commercial loans decreased by $25 million, primarily from the outplacement of a large credit in 2007. The Company forecasts solid growth in the commercial loan and mortgage portfolio for 2008, given the opportunity to book larger commercial real estate and commercial loans in Vermont as a result of the Factory Point acquisition, penetration in the expanding Albany market and our dominant position in the Berkshire and Pioneer Valley region.
Consumer loans increased $36 million (10%) in 2007 including $32 million from the Factory Point acquisition. Indirect automobile lending growth remained relatively flat and home equity lines of credit experienced moderate growth from pricing promotions. Loans with repricings over five years totaled $518 million at year-end 2007, which was an increase of $17 million over the $501 million total at year-end 2006. The average yield on loans remained unchanged at 6.7% in the fourth quarter of 2007 compared to the same period in 2006.
Asset Quality. The Company’sSolid asset quality measures remained solidwith nonperforming assets at year-end 2007, despite softening economic conditions taking hold in the second half of 2007. Nonperforming loans increased to $10.5 million at year-end 2007 (0.54%0.45% of total loans) compared to $7.6 millionassets at year-end 2006 (0.45% of total loans). Nonaccruing commercial business loans decreased from $7.2 million at year-end 2006 to $4.2 million at year-end 2007, primarily due to charge-offs of $4.0 million related to one commercial loan stemming from borrower fraud. Offsetting this decrease in nonaccruing commercial business loans was a $4.9 million increase in nonaccruing commercial mortgages. The increase in nonaccruing commercial mortgages resulted mainly from the classification of one large commercial mortgage totaling $2.6 million in the third quarter of 2007 and several smaller credits placed on nonaccrual during the year.
In addition to the nonperforming loans discussed above, the Company has identified approximately $23.1 million in potential problem loans at year-end 2007 as compared to $16.2 million at year-end 2006. Potential problem loans are loans that are currently performing, but where known information about possible credit problems of the related borrowers causes management to have doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in disclosure of such loans as nonperforming at some time in the future. Potential problem loans are typically loans that are performing but are classified by the Company’s loan rating system as “substandard.” At December 31, 2007 and 2006, potential problem loans primarily consisted of commercial business loans and commercial mortgages. At year-end 2007, there were six potential problem loans that exceeded $1.0 million, totaling $14.2 million in aggregate compared to six potential problem loans exceeding $1.0 million, totaling $10.0 million at year-end 2006. Management cannot predict the extent to which economic conditions may worsen or other factors which may impact borrowers and the potential problem loans. Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on nonaccrual, become restructured, or require increased allowance coverage and provision for loan losses.
As a result of the softening economic conditions in 2007, the Company did experience a modest increase in nonaccruing residential mortgages and consumer loans (mostly home equity loans). Nonaccruing residential mortgages totaled $0.7 million and nonaccruing consumer loans totaled $0.4 million at year-end 2007. Other real estate owned totaled $0.9 million at year-end 2007 and was comprised of two residential mortgage properties.
Loan Loss Allowance. The determination of the allowance for loan losses is a critical accounting estimate. The Company’s methodologies for determining and allocating the allowance for loan losses focus on ongoing reviews of larger individual loans, historical net charge-offs, delinquencies in the loan portfolio, the level of impaired and non-performing assets, values of underlying loan collateral, the overall risk characteristics of the portfolios, changes in composition or size of the portfolio, geographic location, prevailing economic conditions and other relevant factors. The various factors used in the methodologies are reviewed on a periodic basis.
The Company considers the allowance for loan losses of $22.1 million appropriate to cover losses inherent in the loan portfolio as of December 31, 2007. However, no assurance can be given that the Company will not, in any particular period, sustain loan losses that are sizable in relation to the amount reserved, or that subsequent evaluations of the loan portfolio, in light of factors then prevailing, including economic conditions, the Company’s ongoing credit review process or regulatory requirements, will not require significant changes in the allowance for loan losses. Among other factors, a protracted economic slowdown and/or a decline in commercial or residential real estate values in the Company’s markets may have an adverse impact on the current adequacy of the allowance for loan losses by increasing credit risk and the risk of potential loss. The ratio of the loan loss allowance to total loans was 1.14% at year-end 2007 and year-end 2006.
The total allowance for loan losses is generally available to absorb losses from any segment of the portfolio. The allocation of the Company’s allowance for loan losses disclosed in a table on page 12 of this document is subject to change based on the changes in criteria used to evaluate the allowance and is not necessarily indicative of the trend of future losses in any particular portfolio.
In 2006, the Company refined its allowance for loan losses allocation methodology. In addition, management determined in the third quarter of 2006, loan losses would increase above negligible levels of recent years due to signs of an economic slowdown and increasing risk factors in the commercial and real estate loan portfolios. These changes resulted in a third quarter 2006 provision for loan losses of $5.5 million to increase general pool reserve levels due to a higher percentage of inherent losses in the loan portfolio.
Other Assets. The net book value of premises increased $9.7 million due primarily to the Factory Point acquisition and the de-novo branching program in the Company’s New York market. Goodwill and other intangible assets increased $61.1 million mainly from the acquisition of Factory Point. All other assets increased primarily due to equity investments in community and historic development entities which provide transferable tax credits utilized by the Company and an increase in current income tax receivable and net deferred tax assets.
Deposits and Borrowings. Total deposits increased by $300.6 million (20%) in 2007. The Factory Point acquisition resulted in $274 million of this increase. Organic non-maturity deposit growth was $72 million and time deposits decreased $45 million. Deposit growth was centered in higher yielding money market accounts and demand deposits. Time deposits continued to decrease in 2007, as the Company has shifted its focus, generating growth in demand deposits, NOW accounts and money market accounts. The Bank’s strategy is to promote lower cost transaction accounts, along with money market accounts which can be tied to other relationship banking. With this strategy, the Bank has also enhanced its commercial payment services and municipal account solicitation in order to broaden its footprint and improve cross sales with loan and insurance products. In 2007, the Bank unveiled its “I’m so excited” branding initiative and implemented new goals and incentives for increasing the pool of customers and products. The de novo branch program in New York generated $29 million in deposit growth, with total New York deposits increasing to $131 million at year-end 2007.
Total borrowings decreased by $11 million during 2007 due to the reduction of FHLBB borrowings with $82 million in funds provided from the deleveraging at the end of the third quarter offset by the assumption of $34 million in borrowings from Factory Point and a $20 million increase in borrowings at the holding company to fund the cash portion of the Factory Point acquisition and stock repurchases. During 2007, the Bank borrowed $65 million in FHLBB term advances over one year. The average maturity of these term borrowings was 4.8 years and they were used to fund growth of intermediate term loans. Most of these advances were bullet advances without optional calls. Total year-end borrowings with maturities over three years increased to $80 million from $68 million. FHLBB Borrowings maturing under a year increased slightly to $124 million at year-end 2007 from $122 million at the prior year-end. Borrowings in 2007 also included $35 million in short term note payables at the holding company which were used to provide funding for the Factory Point acquisition and stock repurchases mentioned previously. The cost of borrowings increased to 4.7%
in the fourth quarter of 2007 from 4.4% in the same quarter of 2006. This cost rose primarily due to extending term borrowings and the cost of holding company short-term note payables.
Equity. Stockholders’ equity increased in 2007 primarily due to $63 million recorded in conjunction with the Factory Point acquisition, including the issuance of 1.91 million common shares. Total book value per share increased to $31.15. The ratio of total equity to assets increased to 13.0% reflecting the benefit of the new shares issued and the balance sheet deleveraging. Net income of $14 million in 2007 was primarily used for dividends of $5 million and treasury stock buybacks of $8 million. There were 272,600 shares of treasury stock repurchased at a total cost of $7.8 million ($26.52 per share on average), and there were 138,548 shares issued for option exercises and stock grants.
The Bank met all regulatory capital requirements and continued to satisfy the conditions necessary to be classified as “Well Capitalized” in accordance with federal regulatory standards. The Bank’s risk based capital was 10.4% at year-end 2007 compared to 10.3% at year-end 2006 Because the Bank’s dividends exceeded retained earnings from recent operations in accordance with certain regulatory measurements in 2006, the Bank’s dividends to the Company required specific regulatory approval. Such dividends in the immediate future would also require specific regulatory approval. The Bank received regulatory approval to pay $10 million in dividends to the Company in 2007. For 2008, the Bank can declare aggregate additional dividends of $9 million without obtaining regulatory approval.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2007 AND 2006
Net Income.Net income increased by 20% to $13.5 million in 2007, compared to $11.3 million in the prior year. Net income in 2007 included a third quarter after-tax charge of $2.4 million ($0.25 per share) due to a $3.8 million charge from a balance sheet restructuring, $1.7 million in expenses from the Factory Point acquisition ($1.1 million after-tax), $1.3 million in other restructuring expenses ($0.8 million after-tax), and a $2.5 million provision for loan losses ($1.5 million after-tax) related to a $2.5 million charge-off for one commercial loan that was impacted by borrower fraud. Collectively, these charges lowered 2007 net income by $5.6 million.Net income in 2007 also included total costs of $4.2 million for the New York de novo branch program and the costs of the Company’s branding program, which the Company views as an investment in franchise expansion and brand awareness. The above charges arewere not viewed as related to usual operations. The return on average assets for the year 2007 was 0.60% and the return on average equity was 4.69% for the year. Results in 2006 included a third quarter loss of $2.1 million ($0.25 per share) due to a $5.3 million securities loss related to a securities portfolio restructuring and deleveraging. Third quarter results in 2006 also included a $6.2 million loan loss provision due to an adjustment of the loan loss allowance.
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Total Revenue.Total revenue consists of net interest income and non-interest income. Total revenue increased by $16.3 million (23%) in 2007. This increase was due primarily to a full year of insurance commissions and fees from Berkshire Insurance Group, acquisitions, de novo expansion, and organic growth.
Net Interest Income.Net interest income increased by $3.7 million (6%) to $63.9 million in 2007 compared to 2006. The increase in net interest income resulted primarily from an increase in average earning assets of 6% due to higher loan balances (primarily from the Factory Point acquisition and organic loan growth). The net interest margin improved by 2 basis points (“bp”) to 3.26% for 2007 compared to 3.24% in 2006. The Company improved its net interest margin during the second half of 2007 despite the difficult market conditions. As previously mentioned, the Company restructured the balance sheet in the third quarter of 2007 by selling $32 million in investment securities and $50 million in residential mortgages and paid down $82 million in borrowings. In addition, the Company acquired Factory Point which had a net interest margin in excess of 4% and implemented new pricing strategies. These actions led to the improvement in the net interest margin increasing to 3.38% in the fourth quarter of 2007 from 3.15% for the second quarter of 2007.
The yield on earning assets increased 36 bp to 6.61% in 2007 compared to 2006. This increase was due primarily to the deleveraging transactions in 2006 and 2007 as well as an increase in yield on loan originations and purchases of new securities during an increasing rate environment that was prevalent for 2006 and most of 2007. The average rate paid for interest bearing liabilities increased 38 bp to 3.82% in 2007 compared to 2006. The increase in the rate paid on interest bearing liabilities can be attributed to a higher average federal funds rate in 2007 compared to 2006. The increase in average balances on interest earning assets and interest bearing liabilities was impacted by the Factory Point acquisition and offset somewhat by the third quarter balance sheet restructuring.
Provision for Loan Losses.The provision for loan losses is a charge to earnings in an amount sufficient to maintain the allowance for loan losses at a level deemed adequate by the Company. The level of the allowance is a critical accounting estimate, which is subject to uncertainty. The level of the allowance was included in the discussion of
financial condition. The loan loss provision totaled $4.3 million for the year 2007, compared to $7.9 million in 2006. The provision for loan losses for 2007 reflected a $2.5 million charge-off related to a commercial credit with borrower fraud. The total charge-offs in 2007 related to this commercial credit with borrower fraud totaled $4.0 million. Total net loan charge-offs were $6.0 million in 2007. Excluding the $4.0 million charge-off mentioned above, all other net charge-offs totaled $2.0 million (0.11% of average loans), compared to net charge-offs of $1.1 million (0.07% of average loans) in 2006. The decrease in the provision for loan losses in 2007 from 2006 was due primarily to the previously mentioned $5.5 million charge in 2006 for increases in general pool reserve levels due to management’s evaluation of a higher percentage of inherent losses in the loan portfolio at that time.
Non-Interest Income.Non-interest income increased $12.6 million in 2007 to $24.6 million from $12.0 million in 2006. The increase was driven primarily by a $10.0 million increase in insurance commissions and fees from a full year of activity of Berkshire Insurance Group as well as increases in deposit service fees and wealth management. Deposit service fees increased $1.9 million (33%) in 2007 from growth in core deposit accounts, pricing increases and the Factory Point acquisition. Wealth management fees increased $1.1 million (34%) in 2007 from organic growth and the Factory Point acquisition. The Company will continue to focus on diversifying and expanding its sources of non-interest income. Non-interest income included $3.8 million in losses for the previously mentioned deleveraging in the third quarter of 2007 and $3.1 million in losses from a balance sheet restructuring in the third quarter of 2006.
Non-Interest Expense.Non-interest expense increased by $16.6 million (34%) in 2007 compared to 2006. For 2007, additional expense from the acquired insurance agencies totaled $6.5 million, merger, integration and restructuring expenses increased $1.4 million, marketing expenses increased $1.1 million from the branding campaign and acquisitions, amortization of intangible assets increased $1.0 million from acquisitions, and expenses related to the de novo branch program increased by $1.5 million to $3.4 million in 2007, compared to $1.9 million in 2006. Berkshire views the de novo branch costs as an investment in franchise expansion in the attractive Albany and Tech Valley, New York area.million. The remaining $5.1 million increase (10%) in total non-interest expense was in all other non-interest expense related to higher overhead for the Company’s transition into a regional bank, together with initiatives to develop sales and products which resulted in increases in personnel, data processing and professional fees.
Income Tax Expense.The effective tax rate for 2007 was 27.9%. The effective tax rate in 2006 was 30.3%. The decrease in the effective tax rate resulted mainly from increases in tax credits and tax-exempt income in 2007.
Results of Segment Operations. The Company acquired five affiliated insurance agencies in the fourth quarter of 2006. The Company had not previously established operating segments for the purposes of financial statement disclosure. Due to the change in the composition of the Company’s business as a result of the insurance agency acquisitions, the Company has designated two operating segments for financial statement disclosure: banking and insurance. Additional information about the Company’s accounting for segment operations is contained in Note 17 to the financial statements contained in Item 8 of this 10-K.
One of the Company's strategies is to emphasize non-depository products and increase fee income to diversify revenues, enhance customer benefit, and reduce reliance on net interest income. The Company's acquisition of insurance agencies in the fourth quarter of 2006 was a significant step in implementing this strategy. Net income of the insurance segment for 2007 increased by $2.2 million due to the impact of the acquired insurance agencies and earnings due to the impact of annual contingency revenues which are receivedagency acquisitions in the first half of the year.2006. Net income for the banking segment for 2007 increased $1.1 million due to increases in net interest income (primarily due to growth in earning assets and the Factory Point acquisition) and non-interest income (increases in deposit service and wealth management fees) as well as a decrease in the provision for loan losses offset by an increase in non-interest expense (driven by the de novo branches, marketing costs and the Factory Point merger costs).
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Comprehensive Income.Comprehensive income is a component of total stockholders’ equity on the balance sheet. Comprehensive income includes changes in accumulated other comprehensive income, which consist of changes (after-tax) in the unrealized market gains and losses of investment securities available for sale and the net gain/(loss) on derivative instruments used as cash flow hedges. The Company recorded comprehensive income of $14.7 million in 2007 compared to $13.6 million in 2006.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005
Net Income. Net income increased by 37% to $11.3 million in 2006, compared to $8.2 million in the prior year. Net income in 2006 included third quarter charges related to a $5.3 million loss on the securities portfolio restructuring and a $5.5 million adjustment of loan loss allowance pool reserve levels. Net income in 2006 also included total costs of $1.8 million for the New York de novo branch program, which the Company views as an investment in franchise expansion. The return on average assets for the year 2006 was 0.53%. Before the above charges, which total $12.6 million in the aggregate ($8.2 million after adjusting for taxes at a 35% tax rate), income was $19.5 million which represented a return of approximately 0.92% on assets. The return on average equity was 4.4% for the year, and the return before the above charges was approximately 7.6%. Results in 2006 also included non-cash charges of $2.0 million for the amortization of intangible assets. Before these additional charges, the return on equity was approximately 8.1%, which the Company regards as a measure of its ongoing cash return on invested capital before its investment in franchise expansion. Most major categories of income and expense increased in 2006 compared to 2005 due to the full year benefit of the Woronoco acquisition, along with expansion and organic growth.
Total Net Revenue. Total net revenue consists of net interest income and non-interest income. Total net revenue increased by $5.7 million (9%) in 2006. Excluding net securities losses of $3.1 million in 2006 and gains of $4.3 million in 2005, total net revenue increased by $13.2 million (21%) due to acquisitions, de novo expansion, and organic growth. Excluding securities gains and losses, total net revenue per diluted share was $8.64 in 2006, increasing by 4% from $8.30 in the prior year. Including securities gains and losses, this measure was $8.28 and $8.87 in 2006 and 2005, respectively.
Net Interest Income. Net interest income increased by $8.6 million (17%) to $60.2 million in 2006 compared to 2005. Average earning assets increased by 21% due to higher loan balances. This favorable volume variance was offset by an unfavorable rate variance, as the net interest margin decreased to 3.24% in 2006 from 3.33% in 2005 due to the impact of the flat yield curve and deposit balance shifts towards higher cost accounts. This margin tightening produced an unfavorable rate variance of approximately $2.9 million, which was offset by the benefit of the strong increase in average loans which produced a positive volume variance of approximately $12.0 million to fully taxable equivalent net interest income.
The Federal Reserve Bank completed the final interest rate hike in a series of seventeen sequential interest rate hikes over a two year period ending at mid-year 2006. Short term interest rates increased by 1% during the first half of the year and then remained constant through year-end. The year-end federal funds rate was 5.25% and the prime rate was 8.25%. The ten year treasury rate increased by approximately 0.30% to 4.70% over the course of the year, peaking around 5.25% at mid-year. The yield curve was inverted for much of the year, with short-term rates exceeding long-term rates. The Company had modest liability sensitivity at the end of 2005 which was expected to produce a 0.02% decrease in the net interest margin based on a 1% increase in rates, but the margin decreased by 0.09% due to the aforementioned flat yield curve and deposit mix shifts.
The net interest margin decreased from 3.36% in the fourth quarter of 2005 to 3.16% in the second quarter of 2006 and then rebounded to 3.31% in the fourth quarter of 2006. Fourth quarter net interest income included some of the benefit of the securities restructuring. This was partially offset by borrowings to fund the insurance agency acquisitions. Seasonal time account repricings, narrower commercial loan spreads, and a continuing negative yield curve were expected to push thereduction in other net interest margin towards 3.20% in 2007. In order to combat these margin pressures, the Bank intended to promote low cost transaction accounts and to continue to emphasize commercial loan originations which are its highest yielding assets.comprehensive income.
AVERAGE BALANCES, INTEREST AND AVERAGE YIELDS/COST
Balance sheet average balances reflected the full year benefit of the Woronoco Bancorp acquisition in June 2005. The average balances of the major loan categories generally increased throughout 2006, increasing by 31% for the year 2006 compared to 2005. Securities average balances decreased gradually during the year and then fell sharply in the fourth quarter due to the portfolio restructuring. For the year, the average balance declined by 10%. Deposit balances increased throughout the year, with the yearly average increasing by 29% over 2005. NOW and savings account balances trended downward during the year due to the migration of balances into higher yield and faster growing money market and time deposit accounts. Average demand deposit accounts declined in the first two quarters but then increased at an 8% annualized rate in the second half of 2006, producing yearly growth of 17% compared to 2005. Average borrowings declined in the first half of the year, increased in the third quarter due to the strong loan growth in
the second quarter, and then declined in the fourth quarter due to the deleveraging related to the securities portfolio restructuring. Average borrowings decreased by 4% for the year. Average equity increased by 30% for the year due primarily to the full year impact of the equity issued in conjunction with the Woronoco acquisition.
All major categories of interest-earning assets and interest-bearing liabilities produced higher yields and costs in 2006 due to the cumulative impact of increasing interest rates over the last two years except for savings costs which were flat year-to-year. Several categories have contracted future repricings which will produce additional increases based on current interest rate levels. Commercial business loans, money market deposit accounts, and time deposits have the most sensitivity to rate changes and the quarterly average rates in these three categories increased in the range of 0.9% - 1.0% due to the 1.0% increase in short term rates in 2006. Residential mortgages and savings accounts showed the least sensitivity, with quarterly average rates increasing by less than 0.30%. The average interest spread decreased by approximately 0.19% to 2.81% in 2006 from 3.00% in 2005. The decrease in the net interest margin was less than the decrease in the spread due to the benefit from growth in non-interest bearing demand deposits and stockholders’ equity.
Provision for Loan Losses. The loan loss provision totaled $7.9 million for the year 2006, compared to $1.3 million in 2005. The year’s provision included approximately $5.5 million related to the third quarter increase in the pool reserves as a result of the higher inherent losses due to economic changes. The year’s provision also increased due to loan growth and higher impairment reserves. Net loan charge-offs were $1.1 million (0.07% of average loans) in 2006, compared to $1.0 million (0.08% of average loans) in the prior year.
Non-Interest Income. Non-interest income decreased by $2.9 million (19%) to $12.0 million in 2006 compared to $14.9 million in 2005. This was due to a $7.4 million swing from securities gains to securities losses, which the Company does not view as part of its basic operating income. All other non-interest income increased by $4.5 million (43%). This increase primarily reflected the benefit of fee income from acquisitions and organic growth. Deposit fee income increased by $1.3 million (28%), insurance fee income increased by $2.5 million (199%), and wealth management fee income increased by $0.5 million (16%). Fourth quarter insurance fee income increased by $1.0 million in 2006 compared to 2005 due to two months’ revenues from insurance agencies acquired at the end of October 2006. On a pro forma basis, assuming that the agencies had been acquired at the beginning of 2006 and excluding securities gains and losses, pro forma non-interest income measured 29% of total 2006 pro forma net revenue, compared to an historic ratio of 17% in 2005. Including securities gains and losses, this measure was 26% and 22% in 2006 and 2005, respectively.
The Company is strategically emphasizing growth of fee income sources both to enhance cross sales in its pool of customers and products, and to reduce its reliance on net interest income which may continue to be impacted by tighter margins based on competitive industry conditions.
The Company recorded gross securities losses of $5.6 million in 2006 due primarily to the securities portfolio restructuring in the third quarter. Gross losses of $1.9 million were recorded in 2005 in relation to a deleveraging in the first half, in connection with the Woronoco Bancorp acquisition. The Company recorded gross securities gains of $2.4 million in 2006 which were primarily related to the sale of equity securities. The Company had recorded $6.1 million in securities gains in 2005 which were also mostly related to equity securities sales. As of the end of 2006, the Company had substantially liquidated its portfolio of equity securities and no further significant equity securities gains were expected to be recorded. All other non-interest income increased to $1.6 million in 2006 from $1.3 million in 2005. This income was primarily related to increases in cash surrender value of life insurance, and the increase in 2006 was primarily related to life insurance death benefits received.
Non-Interest Expense. Total non-interest expense was essentially unchanged in 2006 compared to 2005, with increases related to growth, branch expansion, and acquisitions offset by the impact of the one-time non-cash $8.8 million charge for the ESOP termination in 2005. Excluding the ESOP termination charge, total non-interest expense increased by $8.7 million (22%) in 2006. This increase included approximately $1.2 million in higher New York expansion charges, which totaled $1.8 million for the de novo branch program for 2006. These charges are viewed by the Company as an investment in franchise expansion. All other non-interest expenses increased by $7.5 million (19%) in 2006 compared to 2005. The $0.6 million decrease in non-recurring expense was due to the Woronoco indirect acquisition related charges in 2005. Nonrecurring expenses in 2006 were primarily related to insurance agency integration expenses and severance costs. All other categories of expense increased due to the acquisitions, de novo branching, and organic growth. Total full time equivalent staff increased by 31% to 522 at year-end 2006 from 399 at the prior year-end,
primarily due to the staff of the insurance agencies acquired in the fourth quarter. While the Company has significantly expanded its loan origination activities, much of the impact on expenses has been offset by higher deferrals of loan origination related expenses; these deferrals increased by $3.9 million in 2006 compared to 2005. The Company’s strategy continues to emphasize the realization of efficiencies from expanded operations, targeted programs developed in the Company’s Six Sigma process improvement discipline, and ongoing expense controls. Amortization of intangible assets increased to $2.0 million in 2006 from $1.1 million in 2005 and is scheduled to increase to $2.7 million in 2007 due to the insurance agency acquisitions. The Company evaluates its profitability both including and excluding this non-cash charge which is related to acquisitions of relationships which are expected to provide ongoing value beyond the period of the related deposit and insurance contracts which comprise the majority of intangible assets and related amortization. The ratio of non-interest expense to total average assets decreased to 2.31% in 2006 from 2.81% in the prior year.
Income Tax Expense and Income from Discontinued Operations. The effective tax rate for 2006 was 30.3%. The effective tax rate in 2005 was 49.3% due to the non-deductibility of most of the ESOP termination charge. Excluding this charge, the effective tax rate was approximately 32% in 2005. The improvement in the effective tax rate included a benefit of approximately 2.7% compared to pre-tax income which was related to a higher average balance of municipal securities in 2006. Results for the second and third quarters of 2006 also included income from discontinued operations from the sale of the Company’s data processing subsidiary in June 2004. The Company does not expect to record additional income or expense from these discontinued operations.
Comprehensive Income. Comprehensive income is a component of total stockholders’ equity on the balance sheet. Comprehensive income includes changes in accumulated other comprehensive income, which consist primarily of changes (after-tax) in the unrealized market gains and losses of investment securities available for sale. The Company recorded comprehensive income of $13.6 million in 2006 compared to $1.8 million in 2005. Results in 2005 included the impact of a $10.2 million unrealized loss on available for sale investment securities due to higher interest rates. Results in 2006 included a $3.9 million unrealized gain which remained after the realization of $3.1 million in net securities losses through the income statement.
Average Balances, Interest and Average Yields/Cost
The following table presents an analysis of average rates and yields on a fully taxable equivalent basis for the years presented. Tax exempt interest revenue is shown on a tax-equivalent basis for proper comparison using a statutory federal income tax rate of 35%.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2008 | | | 2007 | | | 2006 | |
| | | | | | | | | | Average | | | | | | | | | | | Average | | | | | | | | | | | Average | |
| | Average | | | | | | | Yield/ | | | Average | | | | | | | Yield/ | | | Average | | | | | | | Yield/ | |
(Dollars in millions) | | Balance | | | Interest | | | Rate | | | Balance | | | Interest | | | Rate | | | Balance | | | Interest | | | Rate | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Loans (1) | | $ | 1,980.1 | | | $ | 120.6 | | | | 6.09 | % | | $ | 1,789.0 | | | $ | 120.1 | | | | 6.71 | % | | $ | 1,547.3 | | | $ | 100.8 | | | | 6.51 | % |
Investment securities (2) | | | 271.2 | | | | 14.5 | | | | 5.37 | | | | 235.2 | | | | 13.9 | | | | 5.91 | | | | 370.8 | | | | 19.1 | | | | 5.15 | |
Short-term investments | | | 12.2 | | | | 0.2 | | | | 1.64 | | | | 4.7 | | | | 0.1 | | | | 3.02 | | | | 4.9 | | | | 0.3 | | | | 6.12 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-earning assets | | | 2,263.5 | | | | 135.3 | | | | 5.98 | | | | 2,028.9 | | | | 134.1 | | | | 6.61 | | | | 1,923.0 | | | | 120.2 | | | | 6.25 | |
Intangible assets | | | 180.3 | | | | | | | | | | | | 138.3 | | | | | | | | | | | | 103.2 | | | | | | | | | |
Other non-interest earning assets | | | 107.0 | | | | | | | | | | | | 95.2 | | | | | | | | | | | | 90.1 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 2,550.8 | | | | | | | | | | | $ | 2,262.4 | | | | | | | | | | | $ | 2,116.3 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Deposits: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
NOW accounts | | $ | 200.1 | | | | 1.5 | | | | 0.75 | % | | $ | 157.9 | | | | 2.3 | | | | 1.46 | % | | $ | 137.8 | | | | 1.5 | | | | 1.09 | % |
Money market accounts | | | 464.9 | | | | 10.0 | | | | 2.15 | | | | 339.2 | | | | 12.2 | | | | 3.60 | | | | 284.4 | | | | 9.7 | | | | 3.41 | |
Savings accounts | | | 216.4 | | | | 1.6 | | | | 0.74 | | | | 201.6 | | | | 2.2 | | | | 1.09 | | | | 210.6 | | | | 1.9 | | | | 0.90 | |
Certificates of deposit | | | 725.4 | | | | 28.6 | | | | 3.94 | | | | 714.1 | | | | 33.9 | | | | 4.75 | | | | 651.7 | | | | 27.9 | | | | 4.28 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-bearing deposits | | | 1,606.8 | | | | 41.7 | | | | 2.60 | | | | 1,412.8 | | | | 50.6 | | | | 3.58 | | | | 1,284.5 | | | | 41.0 | | | | 3.19 | |
Borrowings | | | 363.8 | | | | 15.8 | | | | 4.34 | | | | 365.8 | | | | 17.4 | | | | 4.76 | | | | 394.4 | | | | 16.8 | | | | 4.26 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-bearing liabilities | | | 1,970.6 | | | | 57.5 | | | | 2.92 | | | | 1,778.6 | | | | 68.0 | | | | 3.82 | | | | 1,678.9 | | | | 57.8 | | | | 3.44 | |
Non-interest-bearing demand deposits | | | 225.2 | | | | | | | | | | | | 190.4 | | | | | | | | | | | | 174.5 | | | | | | | | | |
Other non-interest-bearing liabilities | | | 11.0 | | | | | | | | | | | | 5.4 | | | | | | | | | | | | 7.2 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities | | | 2,206.8 | | | | | | | | | | | | 1,974.4 | | | | | | | | | | | | 1,860.6 | | | | | | | | | |
Equity | | | 344.0 | | | | | | | | | | | | 288.0 | | | | | | | | | | | | 255.7 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities and equity | | $ | 2,550.8 | | | | | | | | | | | $ | 2,262.4 | | | | | | | | | | | $ | 2,116.3 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
Net interest-earning assets | | $ | 292.9 | | | | | | | | | | | $ | 250.3 | | | | | | | | | | | $ | 244.1 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income | | | | | | $ | 77.8 | | | | | | | | | | | $ | 66.1 | | | | | | | | | | | $ | 62.4 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest rate spread | | | | | | | | | | | 3.06 | % | | | | | | | | | | | 2.79 | % | | | | | | | | | | | 2.81 | % |
Net interest margin | | | | | | | | | | | 3.44 | % | | | | | | | | | | | 3.26 | % | | | | | | | | | | | 3.24 | % |
Interest-earning assets/interest-bearing liabilities | | | | | | | | | | | 114.86 | % | | | | | | | | | | | 114.07 | % | | | | | | | | | | | 114.54 | % |
Fully taxable equivalent adjustment | | | | | | $ | 2.1 | | | | | | | | | | | $ | 2.2 | | | | | | | | | | | $ | 2.1 | | | | | |
| | 2007 | | 2006 | | 2005 |
| | | | | | | | Average | | | | | | | | Average | | | | | | | | Average |
| | Average | | | | | | Yield/ | | Average | | | | | | Yield/ | | Average | | | | | | Yield/ |
(Dollars in millions) | | Balance | | | Interest | | | Rate | | Balance | | | Interest | | | Rate | | Balance | | | Interest | | | Rate |
| | | |
Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Loans (1) | | $ | 1,789.0 | | | $ | 120.1 | | | | 6.71 | % | | $ | 1,547.3 | | | $ | 100.8 | | | | 6.51 | % | | $ | 1,182.3 | | | $ | 70.1 | | | | 5.93 | % |
Investment securities (2) | | | 235.2 | | | | 13.9 | | | | 5.91 | | | | 370.8 | | | | 19.1 | | | | 5.15 | | | | 413.0 | | | | 19.2 | | | | 4.64 | |
Short-term investments | | | 4.7 | | | | 0.1 | | | | 3.02 | | | | 4.9 | | | | 0.3 | | | | 6.12 | | | | 2.8 | | | | 0.1 | | | | 3.30 | |
Total interest-earning assets | | | 2,028.9 | | | | 134.1 | | | | 6.61 | | | | 1,923.0 | | | | 120.2 | | | | 6.25 | | | | 1,598.1 | | | | 89.4 | | | | 5.59 | |
Intangible assets | | | 138.3 | | | | | | | | | | | | 103.2 | | | | | | | | | | | | 62.0 | | | | | | | | | |
Other non-interest earning assets | | | 95.2 | | | | | | | | | | | | 90.1 | | | | | | | | | | | | 85.1 | | | | | | | | | |
Total assets | | $ | 2,262.4 | | | | | | | | | | | $ | 2,116.3 | | | | | | | | | | | $ | 1,745.2 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Deposits: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
NOW accounts | | $ | 157.9 | | | | 2.3 | | | | 1.46 | % | | $ | 137.8 | | | | 1.5 | | | | 1.09 | % | | $ | 121.7 | | | | 0.5 | | | | 0.39 | % |
Money market accounts | | | 339.2 | | | | 12.2 | | | | 3.60 | | | | 284.4 | | | | 9.7 | | | | 3.41 | | | | 209.0 | | | | 4.4 | | | | 2.13 | |
Savings accounts | | | 201.6 | | | | 2.2 | | | | 1.09 | | | | 210.6 | | | | 1.9 | | | | 0.90 | | | | 205.8 | | | | 1.8 | | | | 0.90 | |
Certificates of deposit | | | 714.1 | | | | 33.9 | | | | 4.75 | | | | 651.7 | | | | 27.9 | | | | 4.28 | | | | 445.2 | | | | 14.3 | | | | 3.20 | |
Total interest-bearing deposits | | | 1,412.8 | | | | 50.6 | | | | 3.58 | | | | 1,284.5 | | | | 41.0 | | | | 3.19 | | | | 981.7 | | | | 21.0 | | | | 2.14 | |
Borrowings | | | 365.8 | | | | 17.4 | | | | 4.76 | | | | 394.4 | | | | 16.8 | | | | 4.26 | | | | 410.8 | | | | 15.1 | | | | 3.67 | |
Total interest-bearing liabilities | | | 1,778.6 | | | | 68.0 | | | | 3.82 | | | | 1,678.9 | | | | 57.8 | | | | 3.44 | | | | 1,392.5 | | | | 36.1 | | | | 2.59 | |
Non-interest-bearing demand | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
deposits | | | 190.4 | | | | | | | | | | | | 174.5 | | | | | | | | | | | | 149.6 | | | | | | | | | |
Other non-interest-bearing | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
liabilities | | | 5.4 | | | | | | | | | | | | 7.2 | | | | | | | | | | | | 6.6 | | | | | | | | | |
Total liabilities | | | 1,974.4 | | | | | | | | | | | | 1,860.6 | | | | | | | | | | | | 1,548.7 | | | | | | | | | |
Equity | | | 288.0 | | | | | | | | | | | | 255.7 | | | | | | | | | | | | 196.5 | | | | | | | | | |
Total liabilities and equity | | $ | 2,262.4 | | | | | | | | | | | $ | 2,116.3 | | | | | | | | | | | $ | 1,745.2 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net interest-earning assets | | $ | 250.3 | | | | | | | | | | | $ | 244.1 | | | | | | | | | | | $ | 205.6 | | | | | | | | | |
Net interest income | | | | | | $ | 66.1 | | | | | | | | | | | $ | 62.4 | | | | | | | | | | | $ | 53.3 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest rate spread | | | | | | | | | | | 2.79 | % | | | | | | | | | | | 2.81 | % | | | | | | | | | | | 3.00 | % |
Net interest margin | | | | | | | | | | | 3.26 | % | | | | | | | | | | | 3.24 | % | | | | | | | | | | | 3.33 | % |
Interest-earning assets/interest-bearing liabilities | | | | | | | | 114.07 | % | | | | | | | | | | | 114.54 | % | | | | | | | | | | | 114.76 | % |
Fully taxable equivalent adjustment | | | | | | $ | 2.2 | | | | | | | | | | | $ | 2.1 | | | | | | | | | | | $ | 1.6 | | | | | |
| | |
(1) | | | | | | | | | | | | | | |
(1) The average balances of loans includes nonaccrual loans, loans held for sale, and deferred fees and costs. | | | | | |
|
(2) | | The average balance of investment securities is based on amortized cost. | | | | | | | | | | | | |
- 44 -
RATE/VOLUME ANALYSIS
The following table presents the effects of changing rates and volumes on the fully taxable equivalent net interest income. Tax exempt interest revenue is shown on a tax-equivalent basis for proper comparison using a statutory, federal income tax rate of 35%. Changes attributable to changes in both rate and volume have been allocated proportionately based on the absolute value of the change due to rate and the change due to volume.
| | | | | | | | | | | | | | | | | | | | | | | | |
| | 2008 Compared with 2007 | | | 2007 Compared with 2006 | |
| | Increase (Decrease) Due to | | | Increase (Decrease) Due to | |
(In thousands) | | Rate | | | Volume | | | Net | | | Rate | | | Volume | | | Net | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Interest income: | | | | | | | | | | | | | | | | | | | | | | | | |
Loans | | $ | (11,686 | ) | | $ | 12,194 | | | $ | 508 | | | $ | 2,944 | | | $ | 16,280 | | | $ | 19,224 | |
Investment securities | | | (1,362 | ) | | | 1,979 | | | | 617 | | | | 2,548 | | | | (7,714 | ) | | | (5,166 | ) |
Short-term investments | | | (92 | ) | | | 134 | | | | 42 | | | | (103 | ) | | | (11 | ) | | | (114 | ) |
| | | | | | | | | | | | | | | | | | |
Total interest income | | | (13,140 | ) | | | 14,307 | | | | 1,167 | | | | 5,389 | | | | 8,555 | | | | 13,944 | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Interest expense: | | | | | | | | | | | | | | | | | | | | | | | | |
NOW accounts | | | (1,318 | ) | | | 506 | | | | (812 | ) | | | 616 | | | | 235 | | | | 851 | |
Money market accounts | | | (5,874 | ) | | | 3,654 | | | | (2,220 | ) | | | 601 | | | | 1,953 | | | | 2,554 | |
Savings accounts | | | (783 | ) | | | 146 | | | | (637 | ) | | | 442 | | | | (77 | ) | | | 365 | |
Certificates of deposit | | | (5,728 | ) | | | 533 | | | | (5,195 | ) | | | 2,996 | | | | 2,812 | | | | 5,808 | |
| | | | | | | | | | | | | | | | | | |
Total deposits | | | (13,703 | ) | | | 4,839 | | | | (8,864 | ) | | | 4,655 | | | | 4,923 | | | | 9,578 | |
Borrowings | | | (1,587 | ) | | | (97 | ) | | | (1,684 | ) | | | 1,926 | | | | (1,273 | ) | | | 653 | |
| | | | | | | | | | | | | | | | | | |
Total interest expense | | | (15,290 | ) | | | 4,742 | | | | (10,548 | ) | | | 6,581 | | | | 3,650 | | | | 10,231 | |
| | | | | | | | | | | | | | | | | | |
Change in net interest income | | $ | 2,150 | | | $ | 9,565 | | | $ | 11,715 | | | $ | (1,192 | ) | | $ | 4,905 | | | $ | 3,713 | |
| | | | | | | | | | | | | | | | | | |
| | 2007 Compared with 2006 | | | 2006 Compared with 2005 | |
| | Increase (Decrease) Due to | | | Increase (Decrease) Due to | |
(In thousands) | | Rate | | | Volume | | | Net | | | Rate | | | Volume | | | Net | |
| | | | | | | | | | | | | | | | | | |
Interest income: | | | | | | | | | | | | | | | | | | |
Loans | | $ | 2,944 | | | $ | 16,280 | | | $ | 19,224 | | | $ | 7,355 | | | $ | 23,378 | | | $ | 30,733 | |
Investment securities | | | 2,548 | | | | (7,714 | ) | | | (5,166 | ) | | | 1,970 | | | | (2,062 | ) | | | (92 | ) |
Short-term investments | | | (103 | ) | | | (11 | ) | | | (114 | ) | | | 40 | | | | 106 | | | | 146 | |
Total interest income | | | 5,389 | | | | 8,555 | | | | 13,944 | | | | 9,365 | | | | 21,422 | | | | 30,787 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Interest expense: | | | | | | | | | | | | | | | | | | | | | | | | |
NOW accounts | | | 616 | | | | 235 | | | | 851 | | | | 924 | | | | 70 | | | | 994 | |
Money market accounts | | | 601 | | | | 1,953 | | | | 2,554 | | | | 3,272 | | | | 1,970 | | | | 5,242 | |
Savings accounts | | | 442 | | | | (77 | ) | | | 365 | | | | (29 | ) | | | 42 | | | | 13 | |
Certificates of deposit | | | 2,996 | | | | 2,812 | | | | 5,808 | | | | 5,813 | | | | 7,934 | | | | 13,747 | |
Total deposits | | | 4,655 | | | | 4,923 | | | | 9,578 | | | | 9,980 | | | | 10,016 | | | | 19,996 | |
Borrowings | | | 1,926 | | | | (1,273 | ) | | | 653 | | | | 2,319 | | | | (619 | ) | | | 1,700 | |
Total interest expense | | | 6,581 | | | | 3,650 | | | | 10,231 | | | | 12,299 | | | | 9,397 | | | | 21,696 | |
Change in net interest income | | $ | (1,192 | ) | | $ | 4,905 | | | $ | 3,713 | | | $ | (2,934 | ) | | $ | 12,025 | | | $ | 9,091 | |
LIQUIDITY AND CAPITAL RESOURCES
Liquidity is the ability to meet cash needs at all times with available cash or by conversion of other assets to cash at a reasonable price and in a timely manner. At year-end 2008, the Company had $45 million in cash and equivalents due primarily to its $40 million common stock offering in the fourth quarter. The primary ongoing source of funding for the Company is dividend payments from the Bank and from Berkshire Insurance Group. Additional sources of liquidity are proceeds from borrowings and capital offerings, and from stock option exercises. The main uses of liquidity are the payment of common and preferred stockholder dividends, purchases of treasury stock, debt service on outstanding borrowings and debentures, and business acquisitions. There are certain restrictions on the payment of dividends as discussed in the Stockholders’ Equity note to the consolidated financial statements.
The Bank’s primary source of liquidity is customer deposits. Additional sources are borrowings, repayments of loans and investment securities, and the sale and repayments of investment securities. The Bank closely monitors its liquidity position on a daily basis. Sources of borrowings include advances from the FHLBB and a repurchase agreement lineborrowings at the Federal Reserve Bank of creditBoston. As of year-end 2008, based on its arrangements and collateral amounts, the Bank had potential borrowing capacity totaling $270 million with a nationally recognized broker-dealer. the Federal Home Loan Bank of Boston.
The greatest sources of uncertainty affecting liquidity are deposit withdrawals and usage of loan commitments, which are influenced by interest rates, economic conditions, and competition. The Bank offers 100% insurance on all deposit balances as a result of the combination of FDIC insurance and the Massachusetts Depositors Insurance Fund. The Bank also relies on competitive rates, customer service, and long-standing relationships with customers to manage deposit and loan liquidity. Based on its historical experience, management believes that it has adequately provided for deposit and loan liquidity needs. Both liquidity and capital resources are managed according to policies approved by the Board of Directors.
The Bank must satisfy various regulatory capital requirements, which are discussed in the Regulation and Supervision section of Item 1 and in the Stockholders’ Equity note to the consolidated financial statements. At year-end 2006, the Company was engaged in its eighth stock repurchase program as further described in Item 12. Please see the Equity section of the discussion of financial condition for additional information about liquidity and capital at year-end 2007.2008. In September 2006, the Company filed a universal shelf registration with the Securities and Exchange Commission for the issuance of up to $125 million in debt securities, common stock, or preferred stock. There were noAt year-end 2008, approximately $46 million in securities issued pursuant toremained issuable under this registration at year-end 2007.statement.
Contractual Obligations.The year-end 20072008 contractual obligations were as follows:
| | | | | | | | | | | | | | | | | | | | |
| | | | | | Less than One | | | One to Three | | | Three to Five | | | After Five | |
(In thousands) | | Total | | | Year | | | Years | | | Years | | | Years | |
| | | | | | | | | | | | | | | | | | | | |
FHLBB borrowings (1) | | $ | 342,332 | | | $ | 77,686 | | | $ | 95,610 | | | $ | 78,000 | | | $ | 91,036 | |
Junior subordinated debentures | | | 15,464 | | | | — | | | | — | | | | — | | | | 15,464 | |
Operating lease obligations (2) | | | 42,180 | | | | 2,558 | | | | 4,925 | | | | 4,667 | | | | 30,030 | |
Note payable | | | 17,000 | | | | 625 | | | | 16,375 | | | | — | | | | — | |
Purchase obligations (3) | | | 4,777 | | | | 2,945 | | | | 968 | | | | 864 | | | | — | |
| | | | | | | | | | | | | | | |
Total Contractual Obligations | | $ | 421,753 | | | $ | 83,814 | | | $ | 117,878 | | | $ | 83,531 | | | $ | 136,530 | |
| | | | | | | | | | | | | | | |
| | | | | Less than One | | | One to Three | | | Three to Five | | | After Five | |
(In thousands) | | Total | | | Year | | | Years | | | Years | | | Years | |
| | | | | | | | | | | | | | | |
FHLBB borrowings (1) | | $ | 299,664 | | | $ | 124,364 | | | $ | 95,525 | | | $ | 55,610 | | | $ | 24,165 | |
Junior subordinated debentures | | | 15,464 | | | | - | | | | - | | | | - | | | | 15,464 | |
Operating lease obligations (2) | | | 32,286 | | | | 2,454 | | | | 4,692 | | | | 4,515 | | | | 20,625 | |
Note payable | | | 35,000 | | | | 15,000 | | | | 20,000 | | | | - | | | | - | |
Purchase obligations (3) | | | 4,036 | | | | 1,441 | | | | 1,743 | | | | 852 | | | | - | |
Total Contractual Obligations | | $ | 386,450 | | | $ | 143,259 | | | $ | 121,960 | | | $ | 60,977 | | | $ | 60,254 | |
| | |
(1) | | Consists of borrowings from the Federal Home Loan Bank. The maturities extend through 20222027 and the rates vary by borrowing. |
|
(2) | | Consists of leases, of four Bank officesbank branches and ATMs through 2030.2031. |
|
(3) | | Consists of obligations with multiple vendors to purchase a broad range of services and contractual estimates of capital |
renovations to Bank buildings.services. |
Further information about borrowings and lease obligations is contained in Notes 10the Borrowings and 12Commitment notes to the consolidated financial statements. Equity contribution commitments are primarily related to community and historic development entities with transferable tax credits.
Off-Balance Sheet Arrangements.In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with accounting principles generally accepted accounting principlesin the United States are not recorded in the Company’s financial instruments.statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. In JanuaryFor 2008 the Company entered into interest rate swaps related to $60 million of FHLBB borrowings. The interest rate swaps are for terms up to 10 years and require the Company to receive a floating rate of interest tied to 3 month LIBOR and pay a fixed rate at 4.53% based on the $60 million notional amount. A further presentation of the Company’s off-balance sheet arrangements presented is in note 12, “Commitments, Contingencies, and Off-Balance Sheet Activities” in the notes to the financial statements.
For 2007, the Company did not engage in any off-balance sheet transactions reasonably likely to have a material effect on the Company’s financial condition, results of operations or cash flows.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related financial data presented in this Form 10-K have been prepared in conformity with accounting principles generally accepted in the United States of America, 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 many industrial companies, substantially all of the assets and liabilities of Berkshire Bank are monetary in nature. As a result, interest rates have a more significant impact on Berkshire Bank’s performance than the general level of inflation. Interest rates may be affected by inflation, but the direction and magnitude of the impact may vary. A sudden change in inflation (or expectations about inflation), with a related change in interest rates, would have a significant impact on our operations.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
Please refer to the note on Recent Accounting Pronouncements in Note 1 to the consolidated financial statements for a detailed discussion of new accounting pronouncements.
ITEM 7A. QUANTITATIVE AND QUALITATIVEQUALITATIVE DISCLOSURES ABOUT MARKET RISK MANAGEMENT OF INTEREST RATE RISK AND MARKET RISK ANALYSIS
Qualitative Aspects of Market Risk.Risk. The Bank’s most significant form of market risk is interest rate risk. The Bank seeks to avoid fluctuations in its net interest income and to maximize net interest income within acceptable levels of risk through periods of changing interest rates. Berkshire Bank maintains an Asset/Liability Committee that is responsible for reviewing its asset/liability policies and interest rate risk position. This Committee meets at least quarterlymonthly and reports trends and interest rate risk position to the Risk Management Committee and Board of Directors on a quarterly basis. The extent of the movement of interest rates is an uncertainty that could have a negative impact on the Company’s earnings. The Bank has managed interest rate risk by emphasizing assets with shorter-term repricing durations, periodically selling long term fixed-rate assets, promoting low cost core deposits, and using FHLBB advances to structure its liability repricing durations. Berkshire Bank also has used off-balance sheet derivative instruments in the past and may do so in the futureuses interest rate swaps in order to enhance its interest rate risk position and manage its balance sheet.
Quantitative Aspects of Market Risk. Berkshire HillsThe Company uses a simulation model to measure the potential change in net interest income that would result from both an instantaneous or ramped increase or decrease ofchange in market interest rates assuming a parallel shift along the entire yield curve. While emphasis has previously been placed onThe chart below shows the shocked model, in recent years, the Company has come to stress the importanceanalysis of a ramped change. The range of the rampedramp was shifted up at year-end 2008 in the chart due to the very low interest rate scenario as management believes this more accurately reflects actionsrates prevailing at that will be taken by the Federal Reserve Bank and the path of interest rates.date. Loans, deposits and borrowings were expected to reprice at the repricing or maturity date. The Company uses prepayment guidelines set forth by market sources as well as Company generated data where applicable. Cash flows from loans and securities are assumed to be reinvested based on current operating conditions and strategies. Other assumptions about balance sheet mix are generally held constant. No material changes have been made to the methodologies used in the model.
| | | | | | | | | | | | | | | | |
Change in | | | | | | |
Interest Rates-Basis |
Points (Rate Ramp) | | 1 – 12 Months | | | 13 – 24 Months | |
(Dollars in thousands) | | $ Change | | | % Change | | | $ Change | | | % Change | |
| | | | | | | | | | | | | | | | |
At December 31, 2008 | | | | | | | | | | | | | | | | |
+ 300 | | $ | 2,207 | | | | 3.07 | % | | $ | 7,065 | | | | 10.24 | % |
+ 200 | | | 1,587 | | | | 2.21 | | | | 5,283 | | | | 7.66 | |
+ 100 | | | 869 | | | | 1.21 | | | | 2,778 | | | | 4.03 | |
- 100 | | | (1,977 | ) | | | (2.75 | ) | | | (5,779 | ) | | | (8.38 | ) |
| | | | | | | | | | | | | | | | |
At December 31, 2007 | | | | | | | | | | | | | | | | |
+ 200 | | $ | (1,373 | ) | | | (1.88 | )% | | $ | (1,704 | ) | | | (2.31 | )% |
+ 100 | | | (732 | ) | | | (1.00 | ) | | | (649 | ) | | | (0.88 | ) |
- 100 | | | 428 | | | | 0.59 | | | | (119 | ) | | | (0.16 | ) |
- 200 | | | 101 | | | | 0.14 | | | | (1,971 | ) | | | (2.67 | ) |
- 47 -
Change in | | | | | | | | | | | | | | | | |
Interest Rates-Basis | | | Net Interest | | | 1 - 12 Months | | 13 - 24 Months |
Points (Rate Ramp) | | | Amount | | | $ Change | | | % Change | | $ Change | | | % Change |
(Dollars in thousands) | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
At December 31, 2007 | | | | | | | | | | | | | | | | |
+ 200 | | | $ | 56,317 | | | $ | (1,373 | ) | | | (1.88 | ) % | | $ | (1,704 | ) | | | (2.31 | ) % |
+ 100 | | | | 58,430 | | | | (732 | ) | | | (1.00 | ) | | | (649 | ) | | | (0.88 | ) |
- 100 | | | | 60,944 | | | | 428 | | | | 0.59 | | | | (119 | ) | | | (0.16 | ) |
- 200 | | | | 59,078 | | | | 101 | | | | 0.14 | | | | (1,971 | ) | | | (2.67 | ) |
| | | | | | | | | | | | | | | | | | | | | |
At December 31, 2006 | | | | | | | | | | | | | | | | | | | | | |
+ 200 | | | $ | 60,226 | | | $ | (1,402 | ) | | | (2.26 | ) % | | $ | (3,380 | ) | | | (5.31 | ) % |
+ 100 | | | | 60,982 | | | | (415 | ) | | | (0.67 | ) | | | (1,255 | ) | | | (1.97 | ) |
- 100 | | | | 62,765 | | | | 238 | | | | 0.38 | | | | 453 | | | | 0.71 | |
- 200 | | | | 60,057 | | | | (3 | ) | | | (0.01 | ) | | | (1,188 | ) | | | (1.87 | ) |
At year-end 2007,During 2008, the Company displayed an improved, but stillshifted from a moderately liability sensitive profile to a moderately asset sensitive profile. This shift reflects the Company’s general preference to be modestly negative income sensitivity to higherasset sensitive and also reflects management’s expectations that inflation and interest rates (liability sensitivity) than it did atwill rise from recent low levels. Factors contributing to this shift included the end of 2006. The primary factors for the decreaseshift in liability sensitivity hasconsumer lending from fixed rate indirect auto loans to do with the mortgage and securities deleverage that took place at the end of the third quarter and the execution of $60 million pay fixed- receive floating swaps that the Bank committed to on the last day of 2007. These transactions were able to offset items suchprime based home equity lines, as well as the acquisition of Factory Point National Bankstock common and the emphasis on growing money market type core accounts that would have increased the Bank’s liability sensitive position. Berkshire believes that growing money market deposit accounts is an effective strategy to grow customer relationshipspreferred stock offerings which were reinvested in short term investments and increase fee revenue and as such has reduced the emphasis on short-term high rate certificates of deposit.low duration mortgage backed securities at year-end. Berkshire Bank also realizes that these money market accounts could potentially be even more rate sensitive than the certificates and management will closely monitor this potential impact to the Bank’s interest rate risk position and may use longer term FHLBB advances andentered into $135 million in cash flow interest rate swaps to hedge this risk.fix the rate on adjustable-rate Federal Home Loan Bank advances to match the rate duration on existing residential and commercial mortgage loans. The Company also entered into swaps to convert a $15 million fixed rate economic development bond to variable rate and to fix the interest rate on the Company’s $15 million in trust preferred debentures. Additionally, the Company also began offering back-to-back interest rate swaps to certain commercial borrowers, and thereby was able to originate adjustable rate commercial loans which the customers swapped into fixed interest rates. This allowed Berkshire Bank to fund these loans with short term deposits, including money market accounts which help the Company grow its core transaction based customer deposit franchise.
Due to the limitations and uncertainties relating to model assumptions, thesethe above computations should not be relied on as projections of income. Further, the computations do not reflect any actions that management may undertake in response to changes in interest rates. The most significant assumption relates to expectations for the interest sensitivity of non-maturity deposit accounts in a rising rate environment. The model assumes that deposit rate sensitivity will be a percentage of the market interest rate change as follows: NOW accounts–accounts—ranging between 0 and 40% depending on product type; money market accounts–accounts—ranging between 50 and 75% depending on the balance and product type; and savings accounts–accounts—65%. One of the significant limitations of the simulation is that it assumes parallel shifts in the yield curve. Actual interest rate risks are often more complex than this scenario. A key interest rate change in 2007 was the steepening of the yield curve in the second half of the year. Assumption changes in 2007 were based on a review of past performance and future expectations and were not viewed as material.
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ITEM 8. FINANCIAL STATEMENTSSTATEMENTS AND SUPPLEMENTARY DATA
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control process has been designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America.
Management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007,2008, utilizing the framework established inInternal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 20072008 is effective.
Our internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect in reasonable detail,the transactions and dispositions of assets; andthe assets of the company; (2) provide reasonable assurances that: (1)assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, generally accepted in the United States; (2)and that receipts and expenditures of the company are being made only in accordance with authorizations of management and the directors of the Company;company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’scompany’s assets that could have a material effect on the Company’s financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The effectiveness of the Company’s internal control over financial reporting as of December 31, 20072008 has been audited by Wolf & Company, P.C., an independent registered public accounting firm, as stated in their report, which follows. This report expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2007.2008.
| | | | |
/s/ Michael P. DalyMichael P. Daly | | /s/ Kevin P. RileyKevin P. Riley | | |
President and Chief Executive Officer | | Executive Vice President and Chief Financial Officer | | |
March 13, 2009 | | March 13, 2009 | | |
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Berkshire Hills Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of Berkshire Hills Bancorp, Inc. and subsidiaries as of December 31, 20072008 and 2006,2007, and the related consolidated statements of income, changes in stockholders'stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2007.2008. We also have audited Berkshire Hills Bancorp, Inc.’s internal control over financial reporting as of December 31, 2007,2008, based on criteria established inInternal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Berkshire Hills Bancorp, Inc.'s’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on these financial statements and an opinion on the Company'sCompany’s internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company'scompany’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company'scompany’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company'scompany’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Berkshire Hills Bancorp, Inc. and subsidiaries as of December 31, 20072008 and 2006,2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2007,2008, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, Berkshire Hills Bancorp, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007,2008, based on criteria established inInternal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
/s/ Wolf & Company, P.C.
Boston, Massachusetts
March 12, 200816, 2009
BERKSHIRE HILLS BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
| | | | | | | | |
| | December 31, | |
(In thousands, except share data) | | 2008 | | | 2007 | |
Assets | | | | | | | | |
Cash and due from banks | | $ | 26,582 | | | $ | 33,259 | |
Short-term investments | | | 18,216 | | | | 7,883 | |
| | | | | | |
Total cash and cash equivalents | | | 44,798 | | | | 41,142 | |
Trading security | | | 18,144 | | | | — | |
Securities available for sale, at fair value | | | 274,380 | | | | 195,921 | |
Securities held to maturity (fair values of $26,729 and $39,689) | | | 25,872 | | | | 39,456 | |
Restricted equity securities | | | 23,120 | | | | 23,120 | |
|
Residential mortgages | | | 677,254 | | | | 657,045 | |
Commercial mortgages | | | 805,456 | | | | 704,764 | |
Commercial business loans | | | 178,934 | | | | 203,564 | |
Consumer loans | | | 345,508 | | | | 378,643 | |
| | | | | | |
Total loans | | | 2,007,152 | | | | 1,944,016 | |
Less: Allowance for loan losses | | | (22,908 | ) | | | (22,116 | ) |
| | | | | | |
Net loans | | | 1,984,244 | | | | 1,921,900 | |
| | | | | | | | |
Premises and equipment, net | | | 37,448 | | | | 38,806 | |
Goodwill | | | 161,178 | | | | 161,632 | |
Other intangible assets | | | 17,652 | | | | 20,820 | |
Cash surrender value of life insurance | | | 35,668 | | | | 35,316 | |
Other assets | | | 44,225 | | | | 35,319 | |
| | | | | | |
Total assets | | $ | 2,666,729 | | | $ | 2,513,432 | |
| | | | | | |
| | | | | | | | |
Liabilities | | | | | | | | |
Demand deposits | | $ | 233,040 | | | $ | 231,994 | |
NOW deposits | | | 190,828 | | | | 213,150 | |
Money market deposits | | | 448,238 | | | | 439,341 | |
Savings deposits | | | 211,156 | | | | 210,186 | |
Time deposits | | | 746,318 | | | | 727,892 | |
| | | | | | |
Total deposits | | | 1,829,580 | | | | 1,822,563 | |
Short-term debt | | | 23,200 | | | | 92,800 | |
Long term Federal Home Loan Bank advances | | | 318,957 | | | | 221,674 | |
Other long-term debt | | | 17,000 | | | | 20,000 | |
Junior subordinated debentures | | | 15,464 | | | | 15,464 | |
Other liabilities | | | 54,103 | | | | 14,094 | |
| | | | | | |
Total liabilities | | | 2,258,304 | | | | 2,186,595 | |
Commitments and contingencies (See note 15) | | | | | | | | |
| | | | | | | | |
Stockholders’ equity | | | | | | | | |
Preferred stock ($.01 par value; 1,000,000 shares authorized; 40,000 shares with $1,000 liquidation value in 2008 and no shares issued in 2007) | | | 36,822 | | | | — | |
Common stock ($.01 par value; 26,000,000 shares authorized; 14,238,825 shares issued in 2008 and 12,513,825 in 2007) | | | 142 | | | | 125 | |
Additional paid-in capital | | | 307,620 | | | | 266,134 | |
Unearned compensation | | | (1,905 | ) | | | (2,009 | ) |
Retained earnings | | | 127,773 | | | | 113,387 | |
Accumulated other comprehensive (loss) income | | | (11,574 | ) | | | 1,217 | |
Treasury stock (1,985,381 shares in 2008 and 2,021,120 shares in 2007) | | | (50,453 | ) | | | (52,017 | ) |
| | | | | | |
Total stockholders’ equity | | | 408,425 | | | | 326,837 | |
| | | | | | |
Total liabilities and stockholders’ equity | | $ | 2,666,729 | | | $ | 2,513,432 | |
| | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.
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| | December 31, | |
(In thousands, except share data) | | 2007 | | | 2006 | |
Assets | | | | | | |
Total cash and cash equivalents | | $ | 41,142 | | | $ | 30,985 | |
| | | | | | | | |
Securities available for sale, at fair value | | | 219,041 | | | | 194,206 | |
Securities held to maturity (fair values of $39,689 and $39,686) | | | 39,456 | | | | 39,968 | |
| | | | | | | | |
Residential mortgages | | | 657,045 | | | | 599,273 | |
Commercial mortgages | | | 704,764 | | | | 566,339 | |
Commercial business loans | | | 203,564 | | | | 190,493 | |
Consumer loans | | | 378,643 | | | | 342,882 | |
Total loans | | | 1,944,016 | | | | 1,698,987 | |
Less: Allowance for loan losses | | | (22,116 | ) | | | (19,370 | ) |
Net loans | | | 1,921,900 | | | | 1,679,617 | |
| | | | | | | | |
Premises and equipment, net | | | 38,806 | | | | 29,130 | |
Goodwill | | | 161,632 | | | | 104,531 | |
Other intangible assets | | | 20,820 | | | | 16,810 | |
Cash surrender value of life insurance | | | 35,316 | | | | 30,338 | |
Other assets | | | 35,319 | | | | 24,057 | |
Total assets | | $ | 2,513,432 | | | $ | 2,149,642 | |
| | | | | | | | |
Liabilities and stockholders’ equity | | | | | | | | |
Liabilities | | | | | | | | |
Demand deposits | | $ | 231,994 | | | $ | 178,109 | |
NOW deposits | | | 213,150 | | | | 153,087 | |
Money market deposits | | | 439,341 | | | | 297,155 | |
Savings deposits | | | 210,186 | | | | 202,213 | |
Total non-maturity deposits | | | 1,094,671 | | | | 830,564 | |
Brokered time deposits | | | 21,497 | | | | 41,742 | |
Other time deposits | | | 706,395 | | | | 649,632 | |
Total time deposits | | | 727,892 | | | | 691,374 | |
Total deposits | | | 1,822,563 | | | | 1,521,938 | |
Borrowings | | | 334,474 | | | | 345,005 | |
Junior subordinated debentures | | | 15,464 | | | | 15,464 | |
Other liabilities | | | 14,094 | | | | 9,074 | |
Total liabilities | | | 2,186,595 | | | | 1,891,481 | |
| | | | | | | | |
Commitments and contingencies (Note 12) | | | | | | | | |
| | | | | | | | |
Stockholders’ equity | | | | �� | | | | |
Preferred stock ($.01 par value; 1,000,000 shares authorized; none issued) | | | - | | | | - | |
Common stock ($.01 par value; 26,000,000 shares authorized; | | | | | | | | |
12,513,825 shares issued in 2007 and 10,600,472 in 2006) | | | 125 | | | | 106 | |
Additional paid-in capital | | | 266,134 | | | | 200,975 | |
Unearned compensation | | | (2,009 | ) | | | (1,896 | ) |
Retained earnings | | | 113,387 | | | | 105,731 | |
Accumulated other comprehensive income | | | 1,217 | | | | 92 | |
Treasury stock, at cost (2,021,120 shares in 2007 and 1,887,068 shares in 2006) | | | (52,017 | ) | | | (46,847 | ) |
Total stockholders' equity | | | 326,837 | | | | 258,161 | |
Total liabilities and stockholders' equity | | $ | 2,513,432 | | | $ | 2,149,642 | |
| | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements. | | | | | |
BERKSHIRE HILLS BANCORP, INC.
CONSOLIDATED STATEMENTS OF INCOME
| | | | | | | | | | | | |
| | Years Ended December 31, | |
(In thousands, except per share data) | | 2008 | | | 2007 | | | 2006 | |
Interest and dividend income | | | | | | | | | | | | |
Loans | | $ | 120,567 | | | $ | 120,059 | | | $ | 100,836 | |
Securities | | | 12,460 | | | | 11,743 | | | | 16,957 | |
Other | | | 184 | | | | 142 | | | | 258 | |
| | | | | | | | | |
Total interest and dividend income | | | 133,211 | | | | 131,944 | | | | 118,051 | |
Interest expense | | | | | | | | | | | | |
Deposits | | | 41,733 | | | | 50,597 | | | | 41,044 | |
Borrowings and junior subordinated debentures | | | 15,738 | | | | 17,422 | | | | 16,767 | |
| | | | | | | | | |
Total interest expense | | | 57,471 | | | | 68,019 | | | | 57,811 | |
| | | | | | | | | |
Net interest income | | | 75,740 | | | | 63,925 | | | | 60,240 | |
Non-interest income | | | | | | | | | | | | |
Deposit service fees | | | 9,782 | | | | 7,747 | | | | 5,803 | |
Wealth management fees | | | 5,704 | | | | 4,407 | | | | 3,287 | |
Insurance commissions and fees | | | 13,619 | | | | 13,728 | | | | 3,757 | |
Loan and swap fees | | | 1,229 | | | | 772 | | | | 692 | |
| | | | | | | | | |
Total fee income | | | 30,334 | | | | 26,654 | | | | 13,539 | |
Loss on sales of securities, net | | | (22 | ) | | | (591 | ) | | | (3,130 | ) |
Loss on sale of loans and prepayment of borrowings | | | — | | | | (3,130 | ) | | | — | |
Other | | | 1,283 | | | | 1,710 | | | | 1,639 | |
| | | | | | | | | |
Total non-interest income | | | 31,595 | | | | 24,643 | | | | 12,048 | |
| | | | | | | | | |
Total net revenue | | | 107,335 | | | | 88,568 | | | | 72,288 | |
Provision for loan losses | | | 4,580 | | | | 4,300 | | | | 7,860 | |
Non-interest expense | | | | | | | | | | | | |
Salaries and employee benefits | | | 38,282 | | | | 34,018 | | | | 24,708 | |
Occupancy and equipment | | | 11,238 | | | | 9,945 | | | | 7,699 | |
Marketing, data processing, and professional services | | | 8,761 | | | | 8,598 | | | | 6,648 | |
Merger, integration and restructuring | | | 683 | | | | 2,956 | | | | 1,510 | |
Amortization of intangible assets | | | 3,830 | | | | 3,058 | | | | 2,035 | |
Other | | | 8,905 | | | | 6,919 | | | | 6,268 | |
| | | | | | | | | |
Total non-interest expense | | | 71,699 | | | | 65,494 | | | | 48,868 | |
| | | | | | | | | |
Income from continuing operations before income taxes | | | 31,056 | | | | 18,774 | | | | 15,560 | |
Income tax expense | | | 8,812 | | | | 5,239 | | | | 4,668 | |
| | | | | | | | | |
Net income from continuing operations | | | 22,244 | | | | 13,535 | | | | 10,892 | |
Income from discontinued operations before income taxes | | | — | | | | — | | | | 606 | |
Income tax expense | | | — | | | | — | | | | 235 | |
| | | | | | | | | |
Net income from discontinued operations | | | — | | | | — | | | | 371 | |
| | | | | | | | | |
Net income | | $ | 22,244 | | | $ | 13,535 | | | $ | 11,263 | |
| | | | | | | | | |
| | | | | | | | | | | | |
Basic earnings per share | | | | | | | | | | | | |
Continuing operations | | $ | 2.08 | | | $ | 1.47 | | | $ | 1.28 | |
Discontinued operations | | | — | | | | — | | | | 0.04 | |
| | | | | | | | | |
Total | | $ | 2.08 | | | $ | 1.47 | | | $ | 1.32 | |
| | | | | | | | | |
| | | | | | | | | | | | |
Diluted earnings per share | | | | | | | | | | | | |
Continuing operations | | $ | 2.06 | | | $ | 1.44 | | | $ | 1.25 | |
Discontinued operations | | | — | | | | — | | | | 0.04 | |
| | | | | | | | | |
Total | | $ | 2.06 | | | $ | 1.44 | | | $ | 1.29 | |
| | | | | | | | | |
| | | | | | | | | | | | |
Weighted average shares outstanding | | | | | | | | | | | | |
Basic | | | 10,700 | | | | 9,223 | | | | 8,538 | |
Diluted | | | 10,791 | | | | 9,370 | | | | 8,730 | |
The accompanying notes are an integral part of these consolidated financial statements.
- 53 -
| | Years Ended December 31, |
(In thousands, except per share data) | | 2007 | | | 2006 | | | 2005 | |
Interest and dividend income | | | | | | | | | |
Loans | | $ | 120,059 | | | $ | 100,836 | | | $ | 70,103 | |
Securities | | | 11,743 | | | | 16,957 | | | | 17,517 | |
Short-term investments | | | 142 | | | | 258 | | | | 112 | |
Total interest and dividend income | | | 131,944 | | | | 118,051 | | | | 87,732 | |
Interest expense | | | | | | | | | | | | |
Deposits | | | 50,597 | | | | 41,044 | | | | 21,048 | |
Borrowings and junior subordinated debentures | | | 17,422 | | | | 16,767 | | | | 15,067 | |
Total interest expense | | | 68,019 | | | | 57,811 | | | | 36,115 | |
Net interest income | | | 63,925 | | | | 60,240 | | | | 51,617 | |
Non-interest income | | | | | | | | | | | | |
Deposit service fees | | | 7,747 | | | | 5,803 | | | | 4,539 | |
Wealth management fees | | | 4,407 | | | | 3,287 | | | | 2,742 | |
Insurance commissions and fees | | | 13,728 | | | | 3,757 | | | | 1,343 | |
Loan service fees | | | 772 | | | | 692 | | | | 749 | |
(Loss) gain on sales of securities, net | | | (591 | ) | | | (3,130 | ) | | | 4,283 | |
Loss on sale of loans | | | (1,950 | ) | | | - | | | | - | |
Loss on prepayment of borrowings | | | (1,180 | ) | | | - | | | | - | |
Other | | | 1,710 | | | �� | 1,639 | | | | 1,267 | |
Total non-interest income | | | 24,643 | | | | 12,048 | | | | 14,923 | |
Total revenue | | | 88,568 | | | | 72,288 | | | | 66,540 | |
Provision for loan losses | | | 4,300 | | | | 7,860 | | | | 1,313 | |
Non-interest expense | | | | | | | | | | | | |
Salaries and employee benefits | | | 34,018 | | | | 24,708 | | | | 20,281 | |
Termination of employee stock ownership plan | | | - | | | | - | | | | 8,836 | |
Occupancy and equipment | | | 9,945 | | | | 7,699 | | | | 5,798 | |
Marketing, data processing, and professional services | | | 8,598 | | | | 6,648 | | | | 4,881 | |
Merger, integration and restructuring | | | 2,956 | | | | 1,510 | | | | 2,142 | |
Amortization of intangible assets | | | 3,058 | | | | 2,035 | | | | 1,140 | |
Other | | | 6,919 | | | | 6,268 | | | | 5,920 | |
Total non-interest expense | | | 65,494 | | | | 48,868 | | | | 48,998 | |
Income from continuing operations before income taxes | | | 18,774 | | | | 15,560 | | | | 16,229 | |
Income tax expense | | | 5,239 | | | | 4,668 | | | | 8,003 | |
Net income from continuing operations | | | 13,535 | | | | 10,892 | | | | 8,226 | |
Income from discontinued operations before income taxes | | | - | | | | 606 | | | | - | |
Income tax expense | | | - | | | | 235 | | | | - | |
Net income from discontinued operations | | | - | | | | 371 | | | | - | |
Net income | | $ | 13,535 | | | $ | 11,263 | | | $ | 8,226 | |
| | | | | | | | | | | | |
Basic earnings per share | | | | | | | | | | | | |
Continuing operations | | $ | 1.47 | | | $ | 1.28 | | | $ | 1.16 | |
Discontinued operations | | | - | | | | 0.04 | | | | - | |
Total | | $ | 1.47 | | | $ | 1.32 | | | $ | 1.16 | |
| | | | | | | | | | | | |
Diluted earnings per share | | | | | | | | | | | | |
Continuing operations | | $ | 1.44 | | | $ | 1.25 | | | $ | 1.10 | |
Discontinued operations | | | - | | | | 0.04 | | | | - | |
Total | | $ | 1.44 | | | $ | 1.29 | | | $ | 1.10 | |
| | | | | | | | | | | | |
Weighted average shares outstanding | | | | | | | | | | | | |
Basic | | | 9,223 | | | | 8,538 | | | | 7,122 | |
Diluted | | | 9,370 | | | | 8,730 | | | | 7,503 | |
| | | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements. | | | | | | | | | |
BERKSHIRE HILLS BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Years Ended December 31, 2008, 2007 2006 and 20052006
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | Accumulated | | | | | | | |
| | | | | | | | | | | | | | Additional | | | Unearned | | | | | | | other comp- | | | | | | | |
| | Common stock | | | Preferred | | | paid-in | | | compen- | | | Retained | | | rehensive | | | Treasury | | | | |
(In thousands) | | Shares | | | Amount | | | stock | | | capital | | | sation | | | earnings | | | income (loss) | | | stock | | | Total | |
Balance at December 31, 2005 | | | 8,540 | | | $ | 106 | | | $ | — | | | $ | 198,667 | | | $ | (1,435 | ) | | $ | 99,429 | | | $ | (2,239 | ) | | $ | (48,462 | ) | | $ | 246,066 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
|
Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | | — | | | | — | | | | — | | | | — | | | | — | | | | 11,263 | | | | — | | | | — | | | | 11,263 | |
Other net comprehensive income | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 2,331 | | | | — | | | | 2,331 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 13,594 | |
Cash dividends declared ($0.56 per share) | | | — | | | | — | | | | — | | | | — | | | | — | | | | (4,834 | ) | | | — | | | | — | | | | (4,834 | ) |
Treasury stock purchased/transferred | | | (76 | ) | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (2,876 | ) | | | (2,876 | ) |
Exercise of stock options | | | 197 | | | | — | | | | — | | | | — | | | | — | | | | (127 | ) | | | — | | | | 3,556 | | | | 3,429 | |
Reissuance of treasury stock — other | | | 53 | | | | — | | | | — | | | | 853 | | | | — | | | | — | | | | — | | | | 935 | | | | 1,788 | |
Stock-based compensation | | | — | | | | — | | | | — | | | | 195 | | | | — | | | | — | | | | — | | | | — | | | | 195 | |
Tax benefit from stock compensation | | | — | | | | — | | | | — | | | | 1,260 | | | | — | | | | — | | | | — | | | | — | | | | 1,260 | |
Change in unearned compensation | | | — | | | | — | | | | — | | | | — | | | | (461 | ) | | | — | | | | — | | | | — | | | | (461 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance at December 31, 2006 | | | 8,713 | | | | 106 | | | | — | | | | 200,975 | | | | (1,896 | ) | | | 105,731 | | | | 92 | | | | (46,847 | ) | | | 258,161 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | | — | | | | — | | | | — | | | | — | | | | — | | | | 13,535 | | | | — | | | | — | | | | 13,535 | |
Other net comprehensive income | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 1,125 | | | | — | | | | 1,125 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 14,660 | |
Acquisition of Factory Point Bancorp, Inc. | | | 1,913 | | | | 19 | | | | — | | | | 63,331 | | | | — | | | | — | | | | — | | | | — | | | | 63,350 | |
Cash dividends declared ($0.58 per share) | | | — | | | | — | | | | — | | | | — | | | | — | | | | (5,398 | ) | | | — | | | | — | | | | (5,398 | ) |
Treasury stock purchased | | | (290 | ) | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (7,822 | ) | | | (7,822 | ) |
Forfeited shares | | | (41 | ) | | | — | | | | — | | | | (36 | ) | | | — | | | | — | | | | — | | | | (1,112 | ) | | | (1,148 | ) |
Exercise of stock options | | | 132 | | | | — | | | | — | | | | — | | | | — | | | | (481 | ) | | | — | | | | 2,598 | | | | 2,117 | |
Reissuance of treasury stock — other | | | 66 | | | | — | | | | — | | | | 1,001 | | | | — | | | | — | | | | — | | | | 1,166 | | | | 2,167 | |
Stock-based compensation | | | — | | | | — | | | | — | | | | 187 | | | | — | | | | — | | | | — | | | | — | | | | 187 | |
Tax benefit from stock compensation | | | — | | | | — | | | | — | | | | 676 | | | | — | | | | — | | | | — | | | | — | | | | 676 | |
Change in unearned compensation | | | — | | | | — | | | | — | | | | — | | | | (113 | ) | | | — | | | | — | | | | — | | | | (113 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance at December 31, 2007 | | | 10,493 | | | | 125 | | | | — | | | | 266,134 | | | | (2,009 | ) | | | 113,387 | | | | 1,217 | | | | (52,017 | ) | | | 326,837 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | | — | | | | — | | | | — | | | | — | | | | — | | | | 22,244 | | | | — | | | | — | | | | 22,244 | |
Other net comprehensive loss | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (12,791 | ) | | | — | | | | (12,791 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 9,453 | |
Issuance of preferred stock | | | — | | | | — | | | | 36,802 | | | | — | | | | — | | | | — | | | | — | | | | — | | | | 36,802 | |
Fair value of warrant issued with preferred stock | | | — | | | | — | | | | — | | | | 3,198 | | | | — | | | | — | | | | — | | | | — | | | | 3,198 | |
Issuance of common stock | | | 1,725 | | | | 17 | | | | — | | | | 38,504 | | | | — | | | | — | | | | — | | | | — | | | | 38,521 | |
Cash dividends declared ($0.63 per share) | | | — | | | | — | | | | — | | | | — | | | | — | | | | (6,837 | ) | | | — | | | | — | | | | (6,837 | ) |
Treasury stock purchased | | | (200 | ) | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | | | | (4,880 | ) | | | (4,880 | ) |
Forfeited shares | | | (3 | ) | | | — | | | | — | | | | (5 | ) | | | 70 | | | | — | | | | — | | | | (65 | ) | | | — | |
Exercise of stock options | | | 185 | | | | — | | | | — | | | | — | | | | — | | | | (1,206 | ) | | | — | | | | 4,714 | | | | 3,508 | |
Reissuance of treasury stock — other | | | 53 | | | | — | | | | 20 | | | | (193 | ) | | | — | | | | 185 | | | | — | | | | 1,795 | | | | 1,807 | |
Stock-based compensation | | | — | | | | — | | | | — | | | | 55 | | | | — | | | | — | | | | — | | | | — | | | | 55 | |
Tax loss from stock compensation | | | — | | | | — | | | | — | | | | (73 | ) | | | — | | | | — | | | | — | | | | — | | | | (73 | ) |
Change in unearned compensation | | | — | | | | — | | | | — | | | | — | | | | 34 | | | | — | | | | — | | | | — | | | | 34 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
Balance at December 31, 2008 | | | 12,253 | | | | $142 | | | | $36,822 | | | | $307,620 | | | | $(1,905 | ) | | | $127,773 | | | | $(11,574 | ) | | | $(50,453 | ) | | | $408,425 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | Accumulated | | | | | | | |
| | | | | | | | Additional | | | Unearned | | | | | | other comp- | | | | | | | |
| | Common stock | | | paid-in | | | compen- | | | Retained | | | rehensive | | | Treasury | | | | |
(In thousands) | | Shares | | | Amount | | | capital | | | sation | | | earnings | | | income (loss) | | | stock | | | Total | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Balance at December 31, 2004 | | | 5,874 | | | $ | 77 | | | $ | 77,588 | | | $ | (7,414 | ) | | $ | 94,996 | | | $ | 4,214 | | | $ | (37,725 | ) | | $ | 131,736 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | | - | | | | - | | | | - | | | | - | | | | 8,226 | | | | - | | | | - | | | | 8,226 | |
Other net comprehensive loss | | | - | | | | - | | | | - | | | | - | | | | - | | | | (6,453 | ) | | | - | | | | (6,453 | ) |
Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 1,773 | |
Acquisition of Woronoco Bancorp | | | 2,927 | | | | 29 | | | | 111,810 | | | | - | | | | - | | | | - | | | | - | | | | 111,839 | |
Termination of Employee Stock | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Ownership Plan | | | - | | | | - | | | | 8,459 | | | | 5,105 | | | | - | | | | - | | | | - | | | | 13,564 | |
Cash dividends declared ($0.52 per share) | | | - | | | | - | | | | - | | | | - | | | | (3,707 | ) | | | - | | | | - | | | | (3,707 | ) |
Treasury stock purchased/transferred | | | (382 | ) | | | - | | | | - | | | | - | | | | - | | | | - | | | | (12,837 | ) | | | (12,837 | ) |
Exercise of stock options | | | 103 | | | | - | | | | - | | | | - | | | | (86 | ) | | | - | | | | 1,777 | | | | 1,691 | |
Reissuance of treasury stock - other | | | 18 | | | | - | | | | 315 | | | | - | | | | - | | | | - | | | | 323 | | | | 638 | |
Tax benefit from stock compensation | | | - | | | | - | | | | 279 | | | | - | | | | - | | | | - | | | | - | | | | 279 | |
Change in unearned compensation | | | - | | | | - | | | | 216 | | | | 874 | | | | - | | | | - | | | | - | | | | 1,090 | |
Balance at December 31, 2005 | | | 8,540 | | | | 106 | | | | 198,667 | | | | (1,435 | ) | | | 99,429 | | | | (2,239 | ) | | | (48,462 | ) | | | 246,066 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | | - | | | | - | | | | - | | | | - | | | | 11,263 | | | | - | | | | - | | | | 11,263 | |
Other net comprehensive income | | | - | | | | - | | | | - | | | | - | | | | - | | | | 2,331 | | | | - | | | | 2,331 | |
Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 13,594 | |
Cash dividends declared ($0.56 per share) | | | - | | | | - | | | | - | | | | - | | | | (4,834 | ) | | | - | | | | - | | | | (4,834 | ) |
Treasury stock purchased/transferred | | | (76 | ) | | | - | | | | - | | | | - | | | | - | | | | - | | | | (2,876 | ) | | | (2,876 | ) |
Exercise of stock options | | | 197 | | | | - | | | | - | | | | - | | | | (127 | ) | | | - | | | | 3,556 | | | | 3,429 | |
Reissuance of treasury stock - other | | | 53 | | | | - | | | | 853 | | | | - | | | | - | | | | - | | | | 935 | | | | 1,788 | |
Stock-based compensation | | | - | | | | - | | | | 195 | | | | - | | | | - | | | | - | | | | - | | | | 195 | |
Tax benefit from stock compensation | | | - | | | | - | | | | 1,260 | | | | - | | | | - | | | | - | | | | - | | | | 1,260 | |
Change in unearned compensation | | | - | | | | - | | | | - | | | | (461 | ) | | | - | | | | - | | | | - | | | | (461 | ) |
Balance at December 31, 2006 | | | 8,713 | | | | 106 | | | | 200,975 | | | | (1,896 | ) | | | 105,731 | | | | 92 | | | | (46,847 | ) | | | 258,161 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | | - | | | | - | | | | - | | | | - | | | | 13,535 | | | | - | | | | - | | | | 13,535 | |
Other net comprehensive income | | | - | | | | - | | | | - | | | | - | | | | - | | | | 1,125 | | | | - | | | | 1,125 | |
Total comprehensive income | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | 14,660 | |
Acquisition of Factory Point Bancorp, Inc. | | | 1,913 | | | | 19 | | | | 63,331 | | | | - | | | | - | | | | - | | | | - | | | | 63,350 | |
Cash dividends declared ($0.58 per share) | | | - | | | | - | | | | - | | | | - | | | | (5,398 | ) | | | - | | | | - | | | | (5,398 | ) |
Treasury stock purchased | | | (290 | ) | | | - | | | | - | | | | - | | | | - | | | | - | | | | (7,822 | ) | | | (7,822 | ) |
Forfeited shares | | | (41 | ) | | | - | | | | (36 | ) | | | - | | | | - | | | | - | | | | (1,112 | ) | | | (1,148 | ) |
Exercise of stock options | | | 132 | | | | - | | | | - | | | | - | | | | (481 | ) | | | - | | | | 2,598 | | | | 2,117 | |
Reissuance of treasury stock - other | | | 66 | | | | - | | | | 1,001 | | | | - | | | | - | | | | - | | | | 1,166 | | | | 2,167 | |
Stock-based compensation | | | - | | | | - | | | | 187 | | | | - | | | | - | | | | - | | | | - | | | | 187 | |
Tax benefit from stock compensation | | | - | | | | - | | | | 676 | | | | - | | | | - | | | | - | | | | - | | | | 676 | |
Change in unearned compensation | | | - | | | | - | | | | - | | | | (113 | ) | | | - | | | | - | | | | - | | | | (113 | ) |
Balance at December 31, 2007 | | | 10,493 | | | $ | 125 | | | $ | 266,134 | | | $ | (2,009 | ) | | $ | 113,387 | | | $ | 1,217 | | | $ | (52,017 | ) | | $ | 326,837 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements. | | | | | | | | | | | | | | | | | |
The accompanying notes are an integral part of these consolidated financial statements.BERKSHIRE HILLS BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2008, 2007 2006 and 20052006
| | | | | | | | | | | | |
(In thousands) | | 2008 | | | 2007 | | | 2006 | |
Cash flows from operating activities: | | | | | | | | | | | | |
Continuing operations: | | | | | | | | | | | | |
Net income | | $ | 22,244 | | | $ | 13,535 | | | $ | 10,892 | |
Adjustments to reconcile net income to net cash provided by continuing operating activities: | | | | | | | | | | | | |
Provision for loan losses | | | 4,580 | | | | 4,300 | | | | 7,860 | |
Net amortization of securities | | | 173 | | | | 250 | | | | 943 | |
Net loan amortization and deferrals | | | 2,949 | | | | 3,767 | | | | 2,981 | |
Premises depreciation and amortization expense | | | 3,835 | | | | 3,404 | | | | 2,831 | |
Stock-based compensation expense | | | 1,635 | | | | 1,604 | | | | 1,338 | |
Excess tax loss (benefit) from stock-based payment arrangements | | | 73 | | | | (676 | ) | | | (1,260 | ) |
Amortization of other intangibles | | | 3,830 | | | | 3,058 | | | | 2,035 | |
Increase in cash surrender value of bank owned life insurance | | | (352 | ) | | | (1,078 | ) | | | (1,034 | ) |
Loss on sales of securities, net | | | 22 | | | | 591 | | | | 3,130 | |
Loss on sale of loans | | | — | | | | 1,950 | | | | — | |
Loss on prepayment of borrowings | | | — | | | | 1,180 | | | | — | |
Deferred income tax provision (benefit), net | | | 905 | | | | 986 | | | | (1,762 | ) |
Net change in other | | | (704 | ) | | | (9,440 | ) | | | (3,540 | ) |
| | | | | | | | | |
Net cash provided by continuing operating activities | | | 39,190 | | | | 23,431 | | | | 24,414 | |
| | | | | | | | | |
| | | | | | | | | | | | |
Discontinued operations: | | | | | | | | | | | | |
Pre-tax income | | | — | | | | — | | | | 606 | |
| | | | | | | | | |
Net cash provided by discontinued operations | | | — | | | | — | | | | 606 | |
| | | | | | | | | |
| | | | | | | | | | | | |
Total net cash provided by operating activities: | | | 39,190 | | | | 23,431 | | | | 25,020 | |
| | | | | | | | | |
| | | | | | | | | | | | |
Cash flows from investing activities: | | | | | | | | | | | | |
Trading account security purchased | | | (15,000 | ) | | | — | | | | — | |
Securities available for sale: | | | | | | | | | | | | |
Sales | | | 10,058 | | | | 59,141 | | | | 190,009 | |
Proceeds from maturities, calls, and prepayments | | | 25,307 | | | | 31,152 | | | | 46,138 | |
Purchases | | | (98,918 | ) | | | (45,810 | ) | | | (40,155 | ) |
Securities held to maturity: | | | | | | | | | | | | |
Proceeds from maturities, calls, and prepayments | | | 30,065 | | | | 14,850 | | | | 16,319 | |
Purchases | | | (16,481 | ) | | | (14,344 | ) | | | (26,379 | ) |
(continued)
The accompanying notes are an integral part of these consolidated financial statements.
- 55 -
| | 2007 | | | 2006 | | | 2005 | |
(In thousands) | | | | | | | | | |
Cash flows from operating activities: | | | | | | | | | |
Continuing operations: | | | | | | | | | |
Net income | | $ | 13,535 | | | $ | 10,892 | | | $ | 8,226 | |
Adjustments to reconcile net income to net cash provided | | | | | | | | | | | | |
by continuing operating activities: | | | | | | | | | | | | |
Provision for loan losses | | | 4,300 | | | | 7,860 | | | | 1,313 | |
Net amortizaton of securities | | | 250 | | | | 943 | | | | 1,349 | |
Net loan amortization and deferrals | | | 1,070 | | | | 2,981 | | | | 312 | |
Premises depreciation and amortization expense | | | 3,404 | | | | 2,831 | | | | 2,268 | |
Stock-based compensation and ESOP expense | | | 1,604 | | | | 1,338 | | | | 10,396 | |
Excess tax benefits from stock-based payment arrangements | | | (676 | ) | | | (1,260 | ) | | | (279 | ) |
Amortization of other intangibles | | | 3,058 | | | | 2,035 | | | | 1,140 | |
Increase in cash surrender value of bank owned life insurance | | | (1,078 | ) | | | (1,034 | ) | | | (893 | ) |
Loss (gain) on sales of securities, net | | | 591 | | | | 3,130 | | | | (4,283 | ) |
Loss on sale of loans | | | 1,950 | | | | - | | | | - | |
Loss on prepayment of borrowings | | | 1,180 | | | | - | | | | - | |
Deferred income tax (benefit) provision, net | | | 986 | | | | (1,762 | ) | | | 1,689 | |
Other, net | | | (6,743 | ) | | | (3,540 | ) | | | (1,532 | ) |
Net cash provided by continuing operating activities | | | 23,431 | | | | 24,414 | | | | 19,706 | |
| | | | | | | | | | | | |
Discontinued operations: | | | | | | | | | | | | |
Pre-tax income | | | - | | | | 606 | | | | - | |
Net cash (used) provided by discontinued operations | | | - | | | | 606 | | | | - | |
| | | | | | | | | | | | |
Total net cash provided by operating activities: | | | 23,431 | | | | 25,020 | | | | 19,706 | |
| | | | | | | | | | | | |
Cash flows from investing activities: | | | | | | | | | | | | |
Securities available for sale: | | | | | | | | | | | | |
Sales | | | 59,141 | | | | 190,009 | | | | 134,195 | |
Proceeds from maturities, calls, and prepayments | | | 31,152 | | | | 46,138 | | | | 80,816 | |
Purchases | | | (45,810 | ) | | | (40,155 | ) | | | (46,523 | ) |
Securities held to maturity: | | | | | | | | | | | | |
Proceeds from maturities, calls, and prepayments | | | 14,850 | | | | 16,319 | | | | 22,858 | |
Purchases | | | (14,344 | ) | | | (26,379 | ) | | | (22,843 | ) |
| | | | | | | | | | | | |
(continued) |
The accompanying notes are an integral part of these consolidated financial statements. |
BERKSHIRE HILLS BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONCLUDED)
Years Ended December 31, 2008, 2007 2006 and 20052006
| | | | | | | | | | | | |
(In thousands) | | 2008 | | | 2007 | | | 2006 | |
|
Increase in loans, net | | | (70,744 | ) | | | (77,679 | ) | | | (279,458 | ) |
Proceeds from sales of loans | | | — | | | | 55,612 | | | | — | |
Additions to premises and equipment, net | | | (2,477 | ) | | | (5,571 | ) | | | (6,095 | ) |
Net cash paid for business acquisitions | | | (1,090 | ) | | | (8,050 | ) | | | (22,541 | ) |
| | | | | | | | | |
Net cash (used) provided by continuing investing activities | | | (139,280 | ) | | | 9,301 | | | | (122,162 | ) |
| | | | | | | | | |
| | | | | | | | | | | | |
Cash flows from financing activities: | | | | | | | | | | | | |
Net increase in deposits | | | 7,017 | | | | 31,598 | | | | 150,720 | |
Proceeds from Federal Home Loan Bank advances | | | 145,000 | | | | 150,214 | | | | 257,014 | |
Repayments of Federal Home Loan Bank advances | | | (102,317 | ) | | | (216,127 | ) | | | (324,462 | ) |
Proceeds from notes payable | | | — | | | | 35,000 | | | | 15,000 | |
Repayments of notes payable | | | (18,000 | ) | | | (15,000 | ) | | | — | |
Proceeds from issuance of preferred stock and warrant | | | 40,000 | | | | — | | | | — | |
Proceeds from common stock issuance | | | 38,521 | | | | — | | | | — | |
Payments to acquire treasury stock | | | (4,880 | ) | | | (7,822 | ) | | | (2,876 | ) |
Proceeds from reissuance of treasury stock | | | 5,315 | | | | 4,284 | | | | 5,218 | |
Excess tax loss (benefit) from stock-based payment arrangements | | | (73 | ) | | | 676 | | | | 1,260 | |
Cash dividends paid | | | (6,837 | ) | | | (5,398 | ) | | | (4,834 | ) |
| | | | | | | | | |
Net cash provided (used) by financing activities | | | 103,746 | | | | (22,575 | ) | | | 97,040 | |
| | | | | | | | | |
| | | | | | | | | | | | |
Net change in cash and cash equivalents | | | 3,656 | | | | 10,157 | | | | (102 | ) |
| | | | | | | | | | | | |
Cash and cash equivalents at beginning of year | | | 41,142 | | | | 30,985 | | | | 31,087 | |
| | | | | | | | | |
| | | | | | | | | | | | |
Cash and cash equivalents at end of year | | $ | 44,798 | | | $ | 41,142 | | | $ | 30,985 | |
| | | | | | | | | |
| | | | | | | | | | | | |
Supplemental cash flow information: | | | | | | | | | | | | |
Interest paid on deposits | | $ | 42,089 | | | $ | 50,759 | | | $ | 40,992 | |
Interest paid on borrowed funds | | | 14,902 | | | | 17,686 | | | | 16,760 | |
Income taxes paid, net | | | 6,043 | | | | 5,405 | | | | 931 | |
Fair value of non-cash assets acquired | | | 837 | | | | 376,656 | | | | 9,835 | |
Fair value of liabilities assumed | | | — | | | | 305,592 | | | | 3,492 | |
Fair value of common stock issued in acquisition | | | — | | | | 63,350 | | | | — | |
Due to broker, investment purchase | | | 19,895 | | | | — | | | | — | |
| | 2007 | | | 2006 | | | 2005 | |
(In thousands) | | | | | | | | | |
| | | | | | | | | |
Increase in loans, net | | | (77,679 | ) | | | (279,458 | ) | | | (63,458 | ) |
Proceeds from sales of loans | | | 55,612 | | | | - | | | | 3,635 | |
Additions to premises and equipment | | | (5,571 | ) | | | (6,095 | ) | | | (4,133 | ) |
Net cash paid for business acquisitions | | | (8,050 | ) | | | (22,541 | ) | | | (26,640 | ) |
Net cash provided (used) by investing activities | | | 9,301 | | | | (122,162 | ) | | | 77,907 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
Cash flows from financing activities: | | | | | | | | | | | | |
Net increase in deposits | | | 31,598 | | | | 150,720 | | | | 82,755 | |
Proceeds from Federal Home Loan Bank advances | | | 150,214 | | | | 257,014 | | | | 889,653 | |
Repayments of Federal Home Loan Bank advances | | | (216,127 | ) | | | (324,462 | ) | | | (1,063,248 | ) |
Proceeds from junior subordinated debentures | | | - | | | | - | | | | 15,464 | |
Proceeds from notes payable | | | 35,000 | | | | 15,000 | | | | - | |
Repayments of notes payable | | | (15,000 | ) | | | - | | | | - | |
Payments to acquire treasury stock | | | (7,822 | ) | | | (2,876 | ) | | | (7,953 | ) |
Proceeds from reissuance of treasury stock | | | 4,284 | | | | 5,218 | | | | 2,329 | |
Excess tax benefits from stock-based payment arrangements | | | 676 | | | | 1,260 | | | | 279 | |
Cash dividends paid | | | (5,398 | ) | | | (4,834 | ) | | | (3,707 | ) |
Net cash provided (used) by financing activities | | | (22,575 | ) | | | 97,040 | | | | (84,428 | ) |
| | | | | | | | | | | | |
Net change in cash and cash equivalents | | | 10,157 | | | | (102 | ) | | | 13,185 | |
| | | | | | | | | | | | |
Cash and cash equivalents at beginning of year | | | 30,985 | | | | 31,087 | | | | 17,902 | |
| | | | | | | | | | | | |
Cash and cash equivalents at end of year | | $ | 41,142 | | | $ | 30,985 | | | $ | 31,087 | |
| | | | | | | | | | | | |
Supplemental cash flow information: | | | | | | | | | | | | |
Interest paid on deposits | | $ | 50,759 | | | $ | 40,992 | | | $ | 20,356 | |
Interest paid on borrowed funds | | | 17,686 | | | | 16,760 | | | | 14,283 | |
Income taxes paid, net | | | 5,405 | | | | 931 | | | | 3,310 | |
Non-cash transfer treasury shares to pay off ESOP loan | | | - | | | | - | | | | 4,897 | |
Fair value of non-cash assets acquired | | | 376,656 | | | | 9,835 | | | | 827,780 | |
Fair value of liabilities assumed | | | 305,592 | | | | 3,492 | | | | 702,622 | |
Fair value of common stock issued | | | 63,350 | | | | - | | | | 108,318 | |
The accompanying notes are an integral part of these consolidated financial statements.- 56 -
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2008, 2007 2006 and 20052006
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
Basis of presentation and consolidation
The consolidated financial statements (the “financial statements”) of Berkshire Hills Bancorp, Inc. (the “Company”) have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The Company is a Delaware corporation and the holding company for Berkshire Bank (the “Bank”), a Massachusetts-chartered savings bank headquartered in Pittsfield, Massachusetts. These consolidated financial statements include the accounts of Berkshire Hills Bancorp, Inc. and its wholly-owned subsidiaries, Berkshire BankInsurance Group and Berkshire Insurance Group,Bank, together with the Bank’s consolidated subsidiaries. One of the Bank’s consolidated subsidiaries is Berkshire Bank Municipal Bank, a New York chartered limited-purpose commercial bank. All significant inter-company balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to prior year balances to conform to the current year presentation.
Business
Through its wholly-owned subsidiaries, the Company provides a variety of financial services to individuals, municipalitiesbusinesses, not-for-profit organizations, and businessesmunicipalities through its offices in western Massachusetts, southern Vermont and northeastern New York. Its primary deposit products are checking, NOW, money market, savings, and time deposit accounts. Its primary lending products are residential mortgages, commercial mortgages, commercial business loans and consumer loans. The Company offers electronic banking, cash management, and other transaction and reporting services.services; it also offers interest rate swap contracts to commercial customers. The Company offers wealth management services including trust, financial planning, and investment services. The Company is an agent for complete lines of property and casualty, life, disability, and health insurance.
Business segments
An operating segment is a component of a business for which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and evaluate performance. The Company has two reportable operating segments, Banking and Insurance, which are delineated by the consolidated subsidiaries of Berkshire Hills Bancorp.Bancorp, Inc. Banking includes the activities of Berkshire Bank and its subsidiaries, which provide commercial and consumer banking services. Insurance includes the activities of Berkshire Insurance Group, which provides commercial and consumer insurance services. The only other consolidated financial activity of the Company is the Parent, which consists of the transactions of Berkshire Hills Bancorp.Bancorp Inc.
Use of estimates
In preparing consolidatedthe financial statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated balance sheets and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses; the measurementvaluation of deferred tax related assets and liabilities; andassets; the estimates related to the initial measurement of goodwill and intangible assets and subsequent impairment analyses.analyses; the determination of other than temporary impairment of investment securities; and the determination of fair value of financial instruments.
Cash and cash equivalents
Cash and cash equivalents include cash, balances due from banks, and short-term investments, all of which mature within ninety days. Cash and cash equivalents are carried at cost.
-53-The Company elected the fair value option permitted by Statement of Financial Accounting Standards (“SFAS”) No. 159,“The Fair Value Option for Financial Assets and Financial Liabilities”, on an economic bond originated in 2008. The bond has been designated as a trading account security and is recorded at fair value, with unrealized gains and losses recorded through earnings each period as part of non-interest income.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Securities
Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. The Company has no trading securities. All other securities, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. The Company’s investmentRestricted equity securities are reflected at cost and consist of $21.1 million of stock in the stock of the Federal Home Loan Bank of Boston (“FHLBB”) and $2.0 million of stock in the Savings Bank Life Insurance Company of Massachusetts. The Bank is included witha member of the FHLBB, which requires that members maintain an investment in FHLBB stock, which may be redeemed based on certain conditions. There are no quoted market prices for restricted equity securities available for sale. The fair value of thissecurities. FHLBB stock equals book value.
redemptions may be delayed in the future. Please see the note on Subsequent Events.
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Loans Heldheld for Salesale / Gainsgains and Losseslosses on Salessales of Mortgage Loans
mortgage loans
Residential mortgage loans originated and held for sale are carried at the lower of aggregate cost or market value and are included with other assets on the balance sheet. Gains and losses on sales of mortgage loans are recognized in non-interest income at the time of the sale. Market value is based on committed secondary market prices.
Loans
The Bank originates residential mortgage, commercial mortgage, commercial business, and consumer loans to customers. A substantial portion of the loan portfolio is secured by real estate in western Massachusetts, southern Vermont, and northeastern New York.York, and in the Bank’s New England lending areas. The ability of many of the Bank’s debtors to honor their contracts is dependent, among other things, on the local economyeconomies and the local real estate market.markets in these areas.
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, any deferred fees or costs on originated loans, and any premiums or discounts on loans purchased or acquired through mergers. Interest income is accrued on the unpaid principal balance. LoanDirect loan originations costs, net of any origination fees, net of certain direct origination costs in addition to premiums and discounts on loans, are deferred and recognized as an adjustment of the related loan yield using the interest method. Interest on loans, excluding automobile loans, is generally not accrued on loans which are ninety days or more past due unless the loan is well-secured and in the process of collection. Past due status is based on contractual terms of the loan. Automobile loans generally continue accruing to one hundred and twenty days delinquent at which time they are charged off. All interest accrued but not collected for loans that are placed on non-accrual or charged-off is reversed against interest income except for certain loans designated as well-secured. The interest on non-accrual loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Allowance for loan losses
The allowance for loan losses is established through a provision for loan losses charged to earnings to account for inherent losses that are probable at the financial statement date and which can be reasonably estimated. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the composition and volume of the loan portfolio, adverse situations that may affect the borrower’sborrowers’ ability to repay, the estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of impaired, pool, and poolunallocated components. For loans that are classified as impaired, an allowance is established based on the methodology discussed below. The pool component covers pools of non-impaired loans segregated by loan type and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimated impaired and pool losses in the portfolio.
A loan is considered impaired when, based on current information and events, it is probable that a creditorthe Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if the loan is collateral dependent. Substantially all of the Company’s loans that have been identified as impaired have been measured by the fair value of existing collateral. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer loans or residential mortgage loans for impairment disclosures.
Foreclosed and repossessed assets
Assets acquired through, or in lieu of, loan foreclosure or repossession are held for sale and are initially recorded at the lower of the investment in the loan or fair value less estimated costs to sell at the date of foreclosure or repossession, establishing a new cost basis. Subsequently, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated costs to sell. Revenue and expenses from operations and changes in the valuation allowance are included in other non-interest expense.
- 59 -
Mortgage servicing rights
Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. For sales of mortgage loans, a portion of the cost of originating the loan is allocated to the servicing right based on relative fair value. Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying rights into tranches based on predominant characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the capitalized amount for the tranches. If the Company later determines that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the allowance may be recorded as an increase to income. Capitalized servicing rights are reported in other assets and are amortized into noninterestnon-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Premises and equipment
Land is carried at cost. Buildings and improvements and equipment are carried at cost, less accumulated depreciation and amortization computed on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the initial term of the lease, plus optional terms if certain conditions are met.
Goodwill and other intangibles
The tangible assets, identifiable intangible assets, and liabilities acquired in a business combination are recorded at fair value at the date of acquisition. The fair values of tangible assets and liabilities are established based on specific guidance set forth in SFAS No. 141, “"Business Combinations”. Identifiable intangible assets arise from contractual or other legal rights. The fair values of these assets are generally determined based on appraisals. Deferred tax liabilities or assets are recognized for differences between the assigned value and the tax basis of the recognized assets and acquired liabilities. Premiums and discounts recorded on interest-bearing assets and liabilities are recognized as an adjustment of interest yield or cost using the interest method, or based on a straight-line amortization over an estimated average life if that is the most practicable estimate. Identifiable intangible assets are subsequently amortized on a straight-line basis or an accelerated basis over their estimated lives. Management assesses the recoverability of intangible assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable. If carrying amount exceeds fair value, an impairment charge is recorded to income.
Goodwill is recognized for the excess of the acquisition cost over the fair values of the net assets acquired and is not subsequently amortized. Goodwill includes direct costs of the business combination. Contingently payable costs are recorded to goodwill at the time that it is determined that the contingency will be satisfied. Goodwill may be adjusted for a reasonable period of time after acquisition based on additional information that is received about the fair values of acquired net assets. Management evaluates each material component of goodwill for impairment annually, with the test being performed in the same period of each year. The impairment test compares the fair value of a reportable business unit to its carrying value, including goodwill. The fair value is based on observable market prices, when practicable. Other valuation techniques may be used when market prices are unavailable. If the fair value exceeds the carrying value, then there is no impairment. If there is impairment, the fair value of the assets and liabilities of the unit are evaluated as they would be in a contemporaneous purchase. If the resulting net fair value is less than the carrying value, an impairment charge is recorded to net income to reduce the carrying value to net fair value.
Transfers of financial assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
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Income taxes
The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes” (SFAS 109)(“SFAS No.109”), which results in two components of income tax expense: current and deferred. Current income tax expense approximates taxes to be paid or refunded for the current period. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. Valuation allowances are then recorded as necessary to reduce deferred tax assets to the amounts management concludes are more likely than not to be realized. As changes in tax laws or rates are enacted, deferred tax assets and liabilities, and the related valuation allowance, are adjusted accordingly through the provision for income taxes. The Bank’s base amount of its federal income tax reserve for loan losses is a permanent difference for which there is no recognition of a deferred tax liability. However, the loan loss allowance maintained for financial reporting purposes is a temporary difference with allowable recognition of a related deferred tax asset, if it is deemed realizable.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company estimates its income taxes for each of the jurisdictions in which it operates to determine the appropriate components of income tax expense. Significant management judgment is required in determining income tax expense, deferred tax assets and liabilities, and any valuation allowances. Management calculates and discloses the reasons for the differences between the statutory federal income tax rate and the effective tax rates. Management also calculates and discloses the significant components of year-end tax assets and liabilities. Management annually reviews the final tax returns for accuracy and adjusts its current assumptions and estimates based on the completed tax returns. The Company uses the deferral method of accounting for income tax credits.
FASB Interpretation No. 48,“Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109”(“FIN No.48”) prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Management reviews the inventory of tax positions taken at each reporting period to assess the more-likely-than-not recognition threshold proposed by FIN 48. Previously recognized tax positions that no longer meet the more-likely-than not recognition threshold are derecognized in the first subsequent financial reporting period in which that threshold is no longer met.
Insurance commissions
Most commission revenue is recognized as of the effective date of the insurance policy or the date the customer is billed, whichever is later, net of return commissions related to policy cancellations. In addition, the Company may receive additional performance commissions based on achieving certain sales and loss experience measures. Such commissions are recognized when determinable, which is generally when such commissions are received or when the Company receives data from the insurance companies that allows the reasonable estimation of these amounts.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Stock-based compensation
Prior to January 1, 2006, employee compensation expense under stock option plans was reported only if options were granted below market price at the grant date inIn accordance with SFAS No. 123R, “Share Based Payment”, the intrinsicfair value method of Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees,”restricted stock and related interpretations. Because the exercise price of the Company’s employee stock options always equaled the market price of the underlying stockis determined on the date of grant, no compensation expense was recognized on options granted. The Company adopted the provisions of SFAS No. 123, “Stock-based Payment (Revised 2004),” on January 1, 2006. There was no material impact on the financial statements from the adoption of SFAS 123R. SFAS 123R eliminates the ability to account for stock-based compensation using APB 25 and requires that such transactions be recognized as compensation cost in the income statement based on their fair values on the measurement date, which, for the Company, is the date of the grant. The Company transitioned to fair-value based accounting for stock-based compensation using a modified version of prospective application (“modified prospective application”). Under modified prospective application, as it is applicable to the Company, SFAS 123R applies to new awards and to awards modified, repurchased, or cancelled after January 1, 2006. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered (generally referring to non-vested awards) that were outstanding as of January 1, 2006 is being recognized as the remaining requisite service is rendered during the period of and/or the periods after the adoption of SFAS 123R. The attribution of compensation cost for those earlier awards is based on the same method and on the same grant-date fair values previously determined for the pro forma disclosures required for companies that did not previously adopt the fair value accounting method for stock-based employee compensation. Compensation expense for non-vested stock awards is based on the fair value of the awards, on the date of grant, and is recognized ratably over the service period of the award.
SFAS No. 123R requires pro forma disclosures of net income and earnings per share for all periods prior to the adoption of the fair value accounting method for stock-based employee compensation. The pro forma disclosures presented in Note 15 - Stock-Based Compensation Plans and Employee Stock Ownership Plan, use the fair value method of SFAS 123 to measure compensation expense for stock-based employee compensation plans for years prior to 2006.
The fair market value ofrestricted stock grants, based on the market price at date of grant, is recorded as unearned compensation. Unearned compensationThe deferred expense is amortized to compensation expense ratably over the vestinglonger of the required service period or performance period. VestedFor performance-based restricted stock awardawards, the Company estimates the degree to which performance conditions will be met to determine the number of shares are considered outstanding for basic earnings per share. Stock award shares not vested are consideredthat will vest and the related compensation expense. Compensation expense is adjusted in the calculationperiod such estimates change.
Income tax benefits related to stock compensation in excess of diluted earnings per share.
Employee stock ownership plan (“ESOP”)
The Company’s ESOP was terminatedgrant date fair value less any proceeds on June 30, 2005. Prior to this, compensation expense wasexercise are recognized as ESOP shares were committedan increase to additional paid-in capital upon vesting or exercising and delivery of the stock. Any income tax effects related to stock compensation that is less than grant date fair value less any proceeds on exercise would be released. Allocated and committed to be released ESOP shares were considered outstanding for earnings per share calculations. Other ESOP shares were excluded from earnings per share calculations. Dividends declared on allocated ESOP shares were charged to retained earnings. Dividends declared on unallocated ESOP shares were used to satisfy debt service. The value of unearned shares to be allocated to ESOP participants for future services not yet performed was reflectedrecognized as a reduction of stockholders’ equity.additional paid in capital to the extent of previously recognized income tax benefits and then as compensation expense for the remaining amount.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Earnings per common share
Earnings per common share have been computed based on the following (average diluted shares outstanding is calculated using the treasury stock method):
| | | | | | | | | | | | |
| | Years Ended December 31, | |
(In thousands, except per share data) | | 2008 | | | 2007 | | | 2006 | |
| | | | | | | | | | | | |
Net income applicable to common stock | | $ | 22,244 | | | $ | 13,535 | | | $ | 11,263 | |
| | | | | | | | | | | | |
Average number of common shares issued | | | 12,869 | | | | 11,135 | | | | 10,600 | |
Less: average number of treasury shares | | | (2,046 | ) | | | (1,812 | ) | | | (1,963 | ) |
Less: average number of unvested stock award shares | | | (123 | ) | | | (100 | ) | | | (99 | ) |
| | | | | | | | | |
Average number of basic shares outstanding | | | 10,700 | | | | 9,223 | | | | 8,538 | |
Plus: dilutive effect of unvested stock award shares | | | 123 | | | | 100 | | | | 78 | |
Plus: dilutive effect of stock options outstanding | | | (32 | ) | | | 47 | | | | 114 | |
| | | | | | | | | |
Average number of diluted shares outstanding | | | 10,791 | | | | 9,370 | | | | 8,730 | |
| | | | | | | | | |
| | | | | | | | | | | | |
Earnings per average basic share | | $ | 2.08 | | | $ | 1.47 | | | $ | 1.32 | |
Earnings per average diluted share | | $ | 2.06 | | | $ | 1.44 | | | $ | 1.29 | |
For the year 2008, 115 thousand shares of restricted stock were anti-dilutive and therefore excluded from the earnings per share calculations. At year-end 2008, the warrant to purchase 226 thousand shares of common stock that was granted to the U.S. Treasury on December 19, 2008 was not dilutive to earnings per share. See note on Stockholders’ Equity. | | Years Ended December 31, | |
(In thousands, except per share data) | | 2007 | | | 2006 | | | 2005 | |
| | | | | | | | | |
Net income applicable to common stock | | $ | 13,535 | | | $ | 11,263 | | | $ | 8,226 | |
| | | | | | | | | | | | |
Average number of common shares issued | | | 11,135 | | | | 10,600 | | | | 9,390 | |
Less: average number of treasury shares | | | (1,812 | ) | | | (1,963 | ) | | | (1,935 | ) |
Less: average number of unallocated ESOP shares | | | - | | | | (2 | ) | | | (200 | ) |
Less: average number of unvested stock award shares | | | (100 | ) | | | (97 | ) | | | (133 | ) |
Average number of basic shares outstanding | | | 9,223 | | | | 8,538 | | | | 7,122 | |
Plus: average number of unvested stock award shares | | | 100 | | | | 78 | | | | 133 | |
Plus: net dilutive effect of stock options outstanding | | | 47 | | | | 114 | | | | 248 | |
Average number of diluted shares outstanding | | | 9,370 | | | | 8,730 | | | | 7,503 | |
| | | | | | | | | | | | |
Earnings per average basic share | | $ | 1.47 | | | $ | 1.32 | | | $ | 1.16 | |
Earnings per average diluted share | | $ | 1.44 | | | $ | 1.29 | | | $ | 1.10 | |
Wealth management assetsTrust assets
TrustWealth management assets held in a fiduciary or agent capacity are not included in the accompanying consolidated balance sheets because they are not assets of the Company.
Derivative instruments and hedging activities
The Company enters into interest rate swap agreements as part of the Company’s interest rate risk management strategy for certain assets and liabilities and not for speculative purposes. Based on the Company’s intended use for the interest rate swap at inception, the Company designates the derivative as either an economic hedge of an asset or liability or a hedging instrument subject to the hedge accounting provisions of SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities”.
For interest rate swaps subject to SFAS No. 133, the Company formally documents at inception all relationships between hedging instruments and hedged items, as well as its risk management objectives and strategies for undertaking the various hedges. Additionally, the Company uses dollar offset or regression analysis at the hedge’s inception and for each reporting period thereafter, to assess whether the derivative used in its hedging transaction is expected to be and has been highly effective in offsetting changes in the fair value or cash flows of the hedged item. The Company discontinues hedge accounting when it is determined that a derivative is not expected to be or has ceased to be highly effective as a hedge, and then reflects changes in fair value of the derivative in earnings after termination of the hedge relationship.
The Company has characterized its interest rate swaps subject to SFAS No. 133 hedge accounting as cash flow hedges. Cash flow hedges are used to minimize the variability in cash flows of assets or liabilities, or forecasted transactions caused by interest rate fluctuations, and are recorded in other assets or liabilities within the Company’s balance sheets. Changes in the fair value of these cash flow hedges are initially recorded in accumulated other comprehensive income and subsequently reclassified into earnings when the forecasted transaction affects earnings. Any hedge ineffectiveness assessed as part of the Company’s quarterly analysis is recorded directly to earnings.
Interest rate swaps designated as economic hedges are also recorded at fair value within other assets or liabilities. Changes in the fair value of these derivatives are recorded directly through earnings.
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Off-balance sheet financial instruments
In the ordinary course of business, the Bank enters into other off-balance sheet financial instruments, consisting primarily of credit related financial instruments. These financial instruments are recorded in the consolidated financial statements when they are funded or related fees are incurred or received.received.
Fair Value of Financial Assets and Liabilities -59-On January 1, 2008, the Company adopted the provisions of SFAS No. 157,“Fair Value Measurements,” for financial assets and financial liabilities. In accordance with Financial Accounting Standards Board Staff Position (FSP) No. SFAS No. 157-2,“Effective Date of FASB Statement No. 157,”the Company will delay application of SFAS No. 157 for non-financial assets and non-financial liabilities, until January 1, 2009. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles based on exit price, and expands disclosures about fair value measurements.
The Company elected to carry its trading account security at fair value in accordance with SFAS No. 159,“The Fair Value Option for Financial Assets and Liabilities". SFAS No. 159 allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis.IndexWhen available, the fair values of the Company’s financial instruments are based on quoted market prices. If such quoted market prices are not available, fair value is based primarily on inputs that are observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality and the Company’s credit worthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time.BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Recent accounting pronouncements
Financial Accounting Standards Board (“FASB”) Statements of Financial Accounting Standards, Staff Positions , and Interpretations
In September 2006, the FASB issued SFAS No. 157,“Fair Value Measurements”.This Statement defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. It clarifies that fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. This Statement does not require any new fair value measurements, but rather, it provides enhanced guidance to other pronouncements that require or permit assets or liabilities to be measured at fair value. This Statement isstatement became effective for fiscal years beginning after November 15, 2007.the Company in 2008; please see the note on Fair Value Measurements. The adoption of this statement did not have a material impact on the Company’s financial position, results of operations, or cash flows. On February 12, 2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 157-2, “Effective Date of FASB Statement No.157.No.157.” This FSP defers the effective date of SFAS No.157 for nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), to years beginning after November 15, 2008, and interim periods within those fiscal years. The Company does not expect that the adoption of this Staff Position will have a material impact on its financial position, results of operations or cash flows. In October, 2008, the FASB issued FSP No. 157-3,“Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active”.FSP No. 157-3 clarifies the application of SFAS No. 157 in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP No. 157-3 was effective immediately upon issuance, and did not have a material impact on the financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”, including an amendment of SFAS No. 115. This Statement permits companies to elect to follow fair value accounting for certain financial assets and liabilities in an effort to mitigate volatility in earnings without having to apply complex hedge accounting provisions. The Statement also establishes presentation and disclosure requirements designed to facilitate comparison between entities that choose different measurement attributes for similar types of assets and liabilities. This Statement was adopted by the Company on January 1, 2008 and did not have a material impact on the Company’s financial statements. The Company has elected to apply this statement to its trading account security.
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In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141(R)”). This Statement replaces SFAS No. 141, “Business Combinations” (“SFAS No. 141”). SFAS No. 141(R), among other things, establishes principles and requirements for how the acquirer in a business combination (i) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquired business, (ii) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase, and (iii) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This Statement became effective for all business combinations for which the acquisition date is on or after January 1, 2009. The Statement will change the Company’s accounting treatment for business combinations on a prospective basis.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51.” This Statement establishes accounting and reporting standards for noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. Minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. The Statement also establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary and requires expanded disclosures. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. The Company does not expect that the adoption of this Statement will have a material impact on its financial position, results of operations or cash flows.
In March 2008, the FASB issued SFAS No. 161,“Disclosures About Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133.”SFAS No. 161 amends SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities,”to amend and expand the disclosure requirements of SFAS No. 133 to provide greater transparency about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedge items are accounted for under SFAS No. 133 and its related interpretations, and (iii) how derivative instruments and related hedged items affect an entity’s financial position, results of operations and cash flows. To meet those objectives, SFAS No. 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. SFAS No. 161 is effective for the Company on January 1, 2009 and is not expected to have a significant impact on the Company’s financial statements.
In May 2008, the FASB issued SFAS No. 162,“The Hierarchy of Generally Accepted Accounting Principles.”SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy). The hierarchical guidance provided by SFAS No. 162 did not have a significant impact on the Company’s financial statements.
In December 2008, the FASB issued FSP No. 48-1,“Definition of Settlement in FASB Interpretation No. 48.”FSP No. 48-1 provides guidance on how to determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. FSP No. 48-1 was effective retroactively to January 1, 2007 and did not significantly impact the Company’s financial statements.
FASB Emerging Issues Task Force Issues
At its September 2006 meeting, the Emerging Issues Task Force ("EITF"(“EITF”) reached a final consensus on Issue 06-04, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements."” The consensus stipulates that an agreement by an employer to share a portion of the proceeds of a life insurance policy with an employee during the postretirement period is a postretirement benefit arrangement required to be accounted for under SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions” or Accounting Principles Board Opinion ("APB"(“APB”) No. 12, "“Omnibus Opinion -— 1967."” The consensus concludes that the purchase of a split-dollar life insurance policy does not constitute a settlement under SFAS No. 106 and, therefore, a liability for the postretirement obligation must be recognized under SFAS No. 106 if the benefit is offered under an arrangement that constitutes a plan or under APB No. 12, if it is not part of a plan. Issue 06-04 is effective for annual or interim reporting periods beginning after December 15, 2007. TheThis EITF was adopted by the Company doeson January 1, 2008 and did not expect that the adoption of this Statement will have a material impact on itsthe Company’s financial position, results of operations or cash flows.statements.
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In March 2007, the FASB ratified the consensus of the EITF and released Issue 06-10, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Collateral Assignment Split-Dollar Life Insurance Arrangements.Arrangements.” This Issue addresses questions raised about whether the consensus reached in Issue 06-4 should apply to collateral assignment split-dollar life insurance arrangements and the recognition and measurement of the employer’s asset in such arrangements. The EITF concluded that an employer should recognize a liability for the postretirement benefit related to a collateral assignment split-dollar life insurance arrangement in accordance with either SFAS No. 106 or APB No. 12 based on the substantive agreement with the employee. In addition the EITF reached a conclusion that an employer should recognize and measure an asset based on the nature and substance of the collateral assignment split-dollar arrangement based on what future cash flows the employer is entitled to, if any, as well as the employee’s obligation and ability to repay the employer. The effective date ofThis EITF 06-10 is for fiscal years beginning after December 15, 2007. Thewas adopted by the Company does not expect that the implementation of EITF 06-10 will have a material impact on its financial position, results of operations or cash flows.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” This Statement permits companies to elect to follow fair value accounting for certain financial assets and liabilities in an effort to mitigate volatility in earnings without having to apply complex hedge accounting provisions. The Statement also establishes presentation and disclosure requirements designed to facilitate comparison between entities that choose different measurement attributes for similar types of assets and liabilities. The effective date of SFAS No. 159 is for fiscal years beginning after November 15, 2007. The Company does not expect that the adoption of this Statement will have a material impact on its financial position, results of operations or cash flows.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141(R)”). This Statement replaces SFAS No. 141, “Business Combinations” (“SFAS 141”). SFAS No.141(R), among other things, establishes principles and requirements for how the acquirer in a business combination (i) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquired business, (ii) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase, and (iii) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The Company is required to adopt SFAS No. 141(R) for all business combinations for which the acquisition date is on or after January 1, 2009. Earlier adoption is prohibited. The Statement will change the Company’s accounting treatment for business combinations on a prospective basis.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements-an amendment of ARB No. 51.” This Statement establishes accounting and reporting standards for noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. Minority interests will be recharacterized as noncontrolling interests and classified as a component of equity. The Statement also establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary and requires expanded disclosures. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 with earlier adoption prohibited. The Company does not expect that the adoption of this Statement will have a material impact on its financial position, results of operations or cash flows.
In June 2007, the FASB ratified the consensus reached in EITF 06-11 “Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards.” EITF 06-11 applies to entities that have share-based payment arrangements that entitle employees to receive dividends or dividend equivalents on equity-classified unvested shares when those dividends or dividend equivalents are charged to retained earnings and result in an income tax deduction. Entities that have share-based payment arrangements that fall within the scope of EITF 06-11 will be required to increase capital surplus for any realized income tax benefit associated with dividends or dividend equivalents paid to employees for equity classified unvested equity awards. The Company adopted EITF 06-11 on January 1, 2008 for dividends declared on share-based payment awards subsequent to this date. The adoptionand did not have a material impact on the Company’s financial condition, results of operations, or liquidity.
statements.
Securities and Exchange Commission BulletinsIn November 2007, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 109, “"Written Loan Commitments Recorded at Fair Value Through Earnings” (SAB 109)(“SAB No. 109”). SAB No. 109 supersedes SAB No. 105, “Application of Accounting Principles to Loan Commitments,” and indicates that the expected net future cash flows related to the associated servicing of the loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. The guidance in SAB No. 109 is applied on a prospective basis tobecame effective for the Company for derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007.on January 1, 2008. SAB No. 109 isdid not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
2. MERGERS AND ACQUISITIONS
2. | MERGERS AND ACQUISITIONS |
In January 2008, the Company acquired the Center for Financial Planning (“CFP”) in Albany, New York. This acquisition provides a foundation for the Bank’s New York region wealth management and investment services. The acquisition was accounted for as a purchase transaction with all cash consideration funded through internal sources. The operating results of CFP are included with the Company’s results of operations since the date of acquisition. The purchase of CFP did not significantly impact the Company’s financial statements.
On September 21, 2007, the Company completed its acquisition of Factory Point Bancorp, Inc. and its subsidiary, Factory Point National Bank of Manchester Center, (collectively “Factory Point”) for $79.4 million, including the assumption of Factory Point stock options. Under the terms of the agreement, the Company issued 1,913,353 shares of the Company’s common stock and paid $16.0 million in cash in exchange for all outstanding Factory Point shares and also assumed all outstanding Factory Point stock options. Concurrent with the merger of Berkshire Hills Bancorp and Factory Point Bancorp, the Bank and Factory Point National Bank merged, with the Bank surviving. The results of operations for Factory Point are included in our resultsthe financial statements subsequent to the acquisition date.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed as the date of acquisition. The Company is in the process of finalizing the purchase accounting for the acquisition; thus, the allocation of purchase price is subject to change.
(In Thousands) | | September 21, 2007 | |
Assets | | | |
Cash and cash equivalents | | $ | 14,076 | |
Investments | | | 68,403 | |
Loans, net | | | 231,846 | |
Premises and equipment, net | | | 7,509 | |
Cash surrender value of life insurance policies | | | 3,900 | |
Goodwill | | | 53,385 | |
Intangible assets | | | 7,092 | |
Other assets | | | 4,521 | |
Total assets acquired | | $ | 390,732 | |
| | | | |
Liabilities | | | | |
Deposits | | $ | 269,027 | |
Borrowings | | | 34,202 | |
Other liabilities | | | 2,363 | |
Total liabilities assumed | | $ | 305,592 | |
| | | | |
Net assets acquired | | $ | 85,140 | |
The $7.1 million of acquired intangible assets was assigned to the core deposit premium intangible, subject to amortization. The core deposit premiums are being amortized over their estimated useful life of eight years using an accelerated method. At December 31, 2007, the goodwill recognized in the acquisition of approximately $53.7 million is not expected to be deductible for tax purposes.
The Company’s cost to acquire Factory Point is as follows:
Cash paid to Factory Point stockholders | | $ | 16,015 | |
Common stock issued to Factory Point | | | | |
stockholders and stock options assumed | | | 63,350 | |
Total consideration | | | 79,365 | |
Professional fees and other acquisition costs | | | 5,775 | |
Net assets acquired | | $ | 85,140 | |
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The unaudited pro forma financial information assumes that the Factory Point acquisition was consummated on January 1 of the periods presented. The pro forma adjustments are based on information available and certain assumptions that we believe are reasonable. Certain acquisition related adjustments are not included in the pro forma information since they were recorded after completion of the acquisition. This pro forma information is presented for informational purposes only and is not necessarily indicative of the results of future operations that would have been achieved had the acquisition taken place at the beginning of 2006. Pro forma information is as follows:
| | For the years ended December 31, | |
(In thousands, except per share data) | | 2007 | | | 2006 | |
Interest income | | $ | 147,382 | | | $ | 138,852 | |
Interest expense | | | 74,881 | | | | 66,518 | |
Net interest income | | | 72,501 | | | | 72,334 | |
Provision for loan losses | | | 4,840 | | | | 8,250 | |
Net interest income after provision for loan losses | | | 67,661 | | | | 64,084 | |
Non-interest income | | | 27,192 | | | | 15,758 | |
Non-interest expense | | | 74,921 | | | | 57,358 | |
Income before income taxes | | | 19,932 | | | | 22,484 | |
Income tax expense | | | 5,561 | | | | 6,556 | |
Net income | | $ | 14,371 | | | $ | 15,928 | |
| | | | | | | | |
Basic earnings per share | | $ | 1.35 | | | $ | 1.52 | |
Diluted earnings per share | | $ | 1.33 | | | $ | 1.49 | |
On October 31, 2006, the Company acquired five western Massachusetts insurance agencies: Reynolds, Barnes & Hebb and McCormick, Smith & Curry Insurance Agency, both of Pittsfield; Minkler Insurance Agency of Stockbridge; H.S. Andrews Insurance Agency of Great Barrington; and MassOne Insurance Agency of Greenfield. These acquisitions were all structured as the purchase of all outstanding common shares, except that the assets and liabilities of the Andrews agency were acquired by the Minkler agency as part of the purchase agreement and the transaction with MassOne Insurance Agency was an asset purchase.agencies. The acquisitions were accounted for under the purchase method of accounting, with their results from operations included in the Company’s financial statements beginning on the acquisition date. The purchase price of $22.5 million was paid in cash. The Company recorded an identifiable intangible asset of $7.3 million for the appraised value of the purchased insurance contracts. This asset is being amortized over ten years on a straight-line basis. The other assets and liabilities of the acquired agencies were recorded at their fair values of $2.5 million and $3.5 million, respectively. The Company recorded goodwill in the amount of $16.2 million, which is not expected to be deductible for tax purposes. Additionally, the Company recorded $2.9 million in conditional purchase consideration based on performance targets in 2007 which was recorded to goodwill.
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3. | CASH AND CASH EQUIVALENTS |
3. CASH AND CASH EQUIVALENTS
Cash and cash equivalents includes cash on hand, amounts due from banks, and short-term investments with original maturities of three months or less. The Bank generally maintains cash balances in other financial institutions in excess of federally insured deposit limits. Short-term investments included $14.3 million pledged as collateral support for derivative financial contracts at December 31, 2007 and 2006year-end 2008; there were as follows:
(In thousands) | | 2006 | | | 2006 | |
| | | | | | |
Cash and due from banks | | $ | 41,091 | | | $ | 30,774 | |
Short-term investments | | | 51 | | | | 211 | |
Total cash and cash equivalents | | $ | 41,142 | | | $ | 30,985 | |
no amounts pledged at year-end 2007. The Federal Reserve system requires nonmember banks to maintain certain reserve requirements of vault cash and/or deposits. The reserve requirement included in cash and equivalents was $6.0$8.0 million and $3.1$6.0 million at year-end 2008 and 2007, respectively.
4. TRADING ACCOUNT SECURITY
During the second quarter of 2008, the Company originated a $15.0 million economic development bond that is being accounted for at fair value in accordance with SFAS No. 159’s fair value election. The security had an amortized cost of $15.0 million and 2006, respectively. a fair value of $18.1 million at year-end 2008. As discussed further in the note on derivative instruments and hedging activities, the Company has entered into a swap contract to swap-out the fixed rate of the security in exchange for a variable rate. In accordance with the guidance of SFAS No. 159, this security is classified as a trading security. The Company does not purchase securities with the intent of selling them in the near term, thus there are no other securities in the trading portfolio at year-end 2008.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4.5. SECURITIES
A summary of securities available for sale (“AFS”) and securities held to maturity (“HTM”) follows:
| | | | | | | | | | | | | | | | |
| | | | | | Gross | | | Gross | | | | |
| | Amortized | | | Unrealized | | | Unrealized | | | | |
(In thousands) | | Cost | | | Gains | | | Losses | | | Fair Value | |
| | | | | | | | | | | | | | | | |
December 31, 2008 | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Securities available for sale | | | | | | | | | | | | | | | | |
Debt securities: | | | | | | | | | | | | | | | | |
Municipal bonds and obligations | | $ | 76,843 | | | $ | 401 | | | $ | (1,830 | ) | | $ | 75,414 | |
Mortgaged-backed securities | | | 174,896 | | | | 2,275 | | | | (193 | ) | | | 176,978 | |
Other bonds and obligations | | | 24,341 | | | | 170 | | | | (3,622 | ) | | | 20,889 | |
| | | | | | | | | | | | |
Total debt securities | | | 276,080 | | | | 2,846 | | | | (5,645 | ) | | | 273,281 | |
Equity securities: | | | | | | | | | | | | | | | | |
Marketable equity securities | | | 1,177 | | | | 32 | | | | (110 | ) | | | 1,099 | |
| | | | | | | | | | | | |
Total securities available for sale | | | 277,257 | | | | 2,878 | | | | (5,755 | ) | | | 274,380 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Securities held to maturity | | | | | | | | | | | | | | | | |
Municipal bonds and obligations | | | 25,066 | | | | 860 | | | | — | | | | 25,926 | |
Mortgaged-backed securities | | | 806 | | | | 1 | | | | (4 | ) | | | 803 | |
| | | | | | | | | | | | |
Total securities held to maturity | | | 25,872 | | | | 861 | | | | (4 | ) | | | 26,729 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Total | | $ | 303,129 | | | $ | 3,739 | | | $ | (5,759 | ) | | $ | 301,109 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
December 31, 2007 | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Securities available for sale | | | | | | | | | | | | | | | | |
Debt securities: | | | | | | | | | | | | | | | | |
Municipal bonds and obligations | | $ | 74,223 | | | $ | 1,028 | | | $ | (65 | ) | | $ | 75,186 | |
Mortgaged-backed securities | | | 103,387 | | | | 1,152 | | | | (21 | ) | | | 104,518 | |
Other bonds and obligations | | | 15,601 | | | | 38 | | | | (374 | ) | | | 15,265 | |
| | | | | | | | | | | | |
Total debt securities | | | 193,211 | | | | 2,218 | | | | (460 | ) | | | 194,969 | |
Equity securities: | | | | | | | | | | | | | | | | |
Marketable equity securities | | | 793 | | | | 197 | | | | (38 | ) | | | 952 | |
| | | | | | | | | | | | |
Total securities available for sale | | | 194,004 | | | | 2,415 | | | | (498 | ) | | | 195,921 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Securities held to maturity | | | | | | | | | | | | | | | | |
Municipal bonds and obligations | | | 36,981 | | | | 377 | | | | (125 | ) | | | 37,233 | |
Mortgaged-backed securities | | | 2,475 | | | | — | | | | (19 | ) | | | 2,456 | |
| | | | | | | | | | | | |
Total securities held to maturity | | | 39,456 | | | | 377 | | | | (144 | ) | | | 39,689 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Total | | $ | 233,460 | | | $ | 2,792 | | | $ | (642 | ) | | $ | 235,610 | |
| | | | | | | | | | | | |
At year-end 2008 and 2007, accumulated net unrealized (losses) gains on AFS securities included in accumulated other comprehensive (loss) income were $(2.9) million and $1.9 million, net of the related income tax benefit (expense) of $1.2 million and $(0.7) million.
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(In thousands) | | Amortized Cost | | | Gross Unrealized Gains | | | Gross Unrealized Losses | | | Fair Value | |
December 31, 2007 | | | | | | | | | | | | |
Securities available for sale | | | | | | | | | | | | |
Debt securities: | | | | | | | | | | | | |
Municipal bonds and obligations | | $ | 74,223 | | | $ | 1,028 | | | $ | (65 | ) | | $ | 75,186 | |
Mortgaged-backed securities | | | 103,387 | | | | 1,152 | | | | (21 | ) | | | 104,518 | |
Other bonds and obligations | | | 15,601 | | | | 38 | | | | (374 | ) | | | 15,265 | |
Total debt securities | | | 193,211 | | | | 2,218 | | | | (460 | ) | | | 194,969 | |
Equity securities: | | | | | | | | | | | | | | | | |
Federal Home Loan Bank stock | | | 21,077 | | | | - | | | | - | | | | 21,077 | |
Other equity securities | | | 2,836 | | | | 197 | | | | (38 | ) | | | 2,995 | |
Total equity securities | | | 23,913 | | | | 197 | | | | (38 | ) | | | 24,072 | |
Total securities available for sale | | | 217,124 | | | | 2,415 | | | | (498 | ) | | | 219,041 | |
| | | | | | | | | | | | | | | | |
Securities held to maturity | | | | | | | | | | | | | | | | |
Municipal bonds and obligations | | | 36,981 | | | | 377 | | | | (125 | ) | | | 37,233 | |
Mortgaged-backed securities | | | 2,475 | | | | - | | | | (19 | ) | | | 2,456 | |
Total securities held to maturity | | | 39,456 | | | | 377 | | | | (144 | ) | | | 39,689 | |
| | | | | | | | | | | | | | | | |
Total securities | | $ | 256,580 | | | $ | 2,792 | | | $ | (642 | ) | | $ | 258,730 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
December 31, 2006 | | | | | | | | | | | | | | | | |
Securities available for sale | | | | | | | | | | | | | | | | |
Debt securities: | | | | | | | | | | | | | | | | |
Municipal bonds and obligations | | $ | 63,788 | | | $ | 799 | | | $ | (84 | ) | | $ | 64,503 | |
Mortgaged-backed securities | | | 85,102 | | | | 112 | | | | (880 | ) | | | 84,334 | |
Other bonds and obligations | | | 20,392 | | | | 169 | | | | (122 | ) | | | 20,439 | |
Total debt securities | | | 169,282 | | | | 1,080 | | | | (1,086 | ) | | | 169,276 | |
Equity securities: | | | | | | | | | | | | | | | | |
Federal Home Loan Bank stock | | | 21,766 | | | | - | | | | - | | | | 21,766 | |
Other equity securities | | | 2,921 | | | | 253 | | | | (10 | ) | | | 3,164 | |
Total equity securities | | | 24,687 | | | | 253 | | | | (10 | ) | | | 24,930 | |
Total securities available for sale | | | 193,969 | | | | 1,333 | | | | (1,096 | ) | | | 194,206 | |
| | | | | | | | | | | | | | | | |
Securities held to maturity | | | | | | | | | | | | | | | | |
Municipal bonds and obligations | | | 35,572 | | | | - | | | | (286 | ) | | | 35,286 | |
Mortgaged-backed securities | | | 4,396 | | | | 49 | | | | (45 | ) | | | 4,400 | |
Total securities held to maturity | | | 39,968 | | | | 49 | | | | (331 | ) | | | 39,686 | |
| | | | | | | | | | | | | | | | |
Total securities | | $ | 233,937 | | | $ | 1,382 | | | $ | (1,427 | ) | | $ | 233,892 | |
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The amortized cost and estimated fair value of debtAFS and HTM securities by contractual final maturity at year-end 2007 was as follows:2008 are presented below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Mortgage-backed securities are shown in total, as their maturities are highly variable. Equity securities have no maturity and are therefore shown in total.
| | | | | | | | | | | | | | | | | |
| | Available for sale | | | Held to maturity | | | Available for sale | | Held to maturity | |
| | Amortized | | | Fair | | | Amortized | | | Fair | | | Amortized | | Fair | | Amortized | | Fair | |
(In thousands) | | Cost | | | Value | | | Cost | | | Value | | | Cost | | Value | | Cost | | Value | |
| | | | | | | | | | | | |
Within 1 year | | $ | 4,571 | | | $ | 4,579 | | | $ | 6,879 | | | $ | 6,879 | | | $ | 2,365 | | $ | 2,380 | | $ | 7,662 | | $ | 7,662 | |
Over 1 year to 5 years | | | 7,351 | | | | 7,423 | | | | 1,163 | | | | 1,172 | | | 15,635 | | 15,824 | | 1,376 | | 1,380 | |
Over 5 years to 10 years | | | 19,343 | | | | 19,441 | | | | 2,470 | | | | 2,470 | | | 27,413 | | 27,311 | | 2,150 | | 2,212 | |
Over 10 years | | | 58,559 | | | | 59,008 | | | | 26,469 | | | | 26,712 | | | 55,771 | | 50,788 | | 13,878 | | 14,672 | |
| | | | | | | | | | |
Total bonds and obligations | | | 89,824 | | | | 90,451 | | | | 36,981 | | | | 37,233 | | | 101,184 | | 96,303 | | 25,066 | | 25,926 | |
| | | | | | | | | | | | | | | | | |
Marketable equity securities | | | 1,177 | | 1,099 | | — | | — | |
Mortgage-backed securities | | | 103,387 | | | | 104,518 | | | | 2,475 | | | | 2,456 | | | 174,896 | | 176,978 | | 806 | | 803 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
Total debt securities | | $ | 193,211 | | | $ | 194,969 | | | $ | 39,456 | | | $ | 39,689 | | |
| | |
Total | | | $ | 277,257 | | $ | 274,380 | | $ | 25,872 | | $ | 26,729 | |
| | | | | | | | | | |
At year-end 20072008 and 2006,2007, the Company had pledged securities as collateral for certain municipal deposits, to the Federal Reserve Bank of Boston for certain customer deposits, and for interest rate swaps with certain counterparties. The total amortized costs of $12.6 million and $15.2 millioncost and fair values of $12.8 million and $15.0 million, respectively.on these pledged securities were as follows. Additionally, there is a blanket lien on certain securities to collateralize borrowings from the Federal Home Loan Bank of Boston (“FHLBB”), as discussed further in the Borrowings note to these financial statements.and Junior Subordinated Debentures note.
| | | | | | | | | | | | | | | | |
| | 2008 | | | 2007 | |
| | Amortized | | | Fair | | | Amortized | | | Fair | |
(In thousands) | | Cost | | | Value | | | Cost | | | Value | |
|
Securities pledged to swap counterparties | | $ | 9,844 | | | $ | 10,032 | | | $ | — | | | $ | — | |
Securities pledged for municipal deposits | | | 8,257 | | | | 8,480 | | | | 8,394 | | | | 8,520 | |
Securities pledged to the Federal Reserve Bank of Boston | | | 3,219 | | | | 3,221 | | | | 4,212 | | | | 4,280 | |
| | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Total | | $ | 21,320 | | | $ | 21,733 | | | $ | 12,606 | | | $ | 12,800 | |
| | | | | | | | | | | | |
SalesProceeds from the sale of AFS securities available forin 2008, 2007, and 2006 were $10.1 million, $59.1 million and $190.0 million respectively. The components of net realized gains (losses) on the sale of AFS securities were as follows:follows, these amounts were reclassified out of accumulated other comprehensive income and into earnings:
| | | | | | | | | | | | |
(In thousands) | | 2008 | | | 2007 | | | 2006 | |
| | | | | | | | | | | | |
Gross realized gains | | $ | 62 | | | $ | 88 | | | $ | 2,449 | |
Gross realized losses | | | 84 | | | | 679 | | | | 5,579 | |
| | | | | | | | | |
| | | | | | | | | | | | |
Net realized losses | | $ | (22 | ) | | $ | (591 | ) | | $ | (3,130 | ) |
| | | | | | | | | |
The income tax benefit attributable to net realized losses in 2008, 2007, and 2006 was $7 thousand, $216 thousand, and $1.2 million, respectively. Realized gains and losses from the sales of AFS and HTM securities were determined using the specific identification method.
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(In thousands) | | 2007 | | | 2006 | | | 2005 | |
| | | | | | | | | |
Proceeds from sales | | $ | 59,141 | | | $ | 190,009 | | | $ | 134,195 | |
Gross realized gains | | | 88 | | | | 2,449 | | | | 6,134 | |
Gross realized losses | | | 679 | | | | 5,579 | | | | 1,851 | |
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Year-end securities with unrealized losses, segregated by lengththe duration of impairment,their continuous unrealized loss positions, are summarized as follows:
| | Less Than Twelve Months | | | Over Twelve Months | |
| | Gross | | | | | | Gross | | | | |
| | Unrealized | | | Fair | | | Unrealized | | | Fair | |
(In thousands) | | Losses | | | Value | | | Losses | | | Value | |
December 31, 2007 | | | | | | | | | | | | |
| | | | | | | | | | | | |
Securities available for sale: | | | | | | | | | | | | |
Mortgaged-backed securities | | $ | - | | | $ | 149 | | | $ | 21 | | | $ | 6,713 | |
Other bonds and obligations | | | 259 | | | | 7,281 | | | | 180 | | | | 8,213 | |
Total available for sale | | | 259 | | | | 7,430 | | | | 201 | | | | 14,926 | |
Securities held to maturity: | | | | | | | | | | | | | | | | |
Mortgaged-backed securities | | | 2 | | | | 1,382 | | | | 17 | | | | 1,032 | |
Municipal and other bonds and obligations | | | 125 | | | | 8,243 | | | | - | | | | - | |
| | | | | | | | | | | | | | | | |
Total | | $ | 386 | | | $ | 17,055 | | | $ | 218 | | | $ | 15,958 | |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
December 31, 2006 | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Securities available for sale: | | | | | | | | | | | | | | | | |
Mortgaged-backed securities | | $ | 71 | | | $ | 30,944 | | | $ | 809 | | | $ | 34,453 | |
Other bonds and obligations | | | 14 | | | | 1,598 | | | | 202 | | | | 17,289 | |
Total available for sale | | | 85 | | | | 32,542 | | | | 1,011 | | | | 51,742 | |
Securities held to maturity: | | | | | | | | | | | | | | | | |
Mortgaged-backed securities | | | - | | | | 35 | | | | 45 | | | | 1,330 | |
Municipal and other bonds and obligations | | | - | | | | - | | | | 286 | | | | 35,286 | |
| | | | | | | | | | | | | | | | |
Total | | $ | 85 | | | $ | 32,577 | | | $ | 1,342 | | | $ | 88,358 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | Less Than Twelve Months | | | Over Twelve Months | | | Total | |
| | Gross | | | | | | | Gross | | | | | | | Gross | | | | |
| | Unrealized | | | Fair | | | Unrealized | | | Fair | | | Unrealized | | | Fair | |
(In thousands) | | Losses | | | Value | | | Losses | | | Value | | | Losses | | | Value | |
|
December 31, 2008 | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Securities available for sale | | | | | | | | | | | | | | | | | | | | | | | | |
Debt securities: | | | | | | | | | | | | | | | | | | | | | | | | |
Municipal bonds and obligations | | $ | 1,585 | | | $ | 39,573 | | | $ | 245 | | | $ | 4,070 | | | $ | 1,830 | | | $ | 43,643 | |
Mortgaged-backed securities | | | 139 | | | | 16,292 | | | | 54 | | | | 2,142 | | | | 193 | | | | 18,434 | |
Other bonds and obligations | | | 472 | | | | 3,741 | | | | 3,150 | | | | 7,142 | | | | 3,622 | | | | 10,883 | |
| | | | | | | | | | | | | | | | | | |
Total debt securities | | | 2,196 | | | | 59,606 | | | | 3,449 | | | | 13,354 | | | | 5,645 | | | | 72,960 | |
Equity securities: | | | | | | | | | | | | | | | | | | | | | | | | |
Marketable equity securities | | | — | | | | 85 | | | | 110 | | | | 640 | | | | 110 | | | | 725 | |
| | | | | | | | | | | | | | | | | | |
Total securities available for sale | | | 2,196 | | | | 59,691 | | | | 3,559 | | | | 13,994 | | | | 5,755 | | | | 73,685 | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Securities held to maturity | | | | | | | | | | | | | | | | | | | | | | | | |
Municipal bonds and obligations | | | — | | | | — | | | | — | | | | — | | | | — | | | | — | |
Mortgaged-backed securities | | | — | | | | — | | | | 4 | | | | 553 | | | | 4 | | | | 553 | |
| | | | | | | | | | | | | | | | | | |
Total securities held to maturity | | | — | | | | — | | | | 4 | | | | 553 | | | | 4 | | | | 553 | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 2,196 | | | $ | 59,691 | | | $ | 3,563 | | | $ | 14,547 | | | $ | 5,759 | | | $ | 74,238 | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2007 | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Securities available for sale | | | | | | | | | | | | | | | | | | | | | | | | |
Debt securities: | | | | | | | | | | | | | | | | | | | | | | | | |
Municipal bonds and obligations | | $ | 5 | | | $ | 2,255 | | | $ | 60 | | | $ | 3,274 | | | $ | 65 | | | $ | 5,529 | |
Mortgaged-backed securities | | | — | | | | 149 | | | | 21 | | | | 6,713 | | | | 21 | | | | 6,862 | |
Other bonds and obligations | | | 254 | | | | 5,026 | | | | 120 | | | | 4,939 | | | | 374 | | | | 9,965 | |
| | | | | | | | | | | | | | | | | | |
Total debt securities | | | 259 | | | | 7,430 | | | | 201 | | | | 14,926 | | | | 460 | | | | 22,356 | |
Equity securities: | | | | | | | | | | | | | | | | | | | | | | | | |
Marketable equity securities | | | 38 | | | | 412 | | | | — | | | | — | | | | 38 | | | | 412 | |
| | | | | | | | | | | | | | | | | | |
Total securities available for sale | | | 297 | | | | 7,842 | | | | 201 | | | | 14,926 | | | | 498 | | | | 22,768 | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Securities held to maturity: | | | | | | | | | | | | | | | | | | | | | | | | |
Municipal bonds and obligations | | | 125 | | | | 8,423 | | | | — | | | | — | | | | 125 | | | | 8,423 | |
Mortgaged-backed securities | | | 2 | | | | 1,382 | | | | 17 | | | | 1,032 | | | | 19 | | | | 2,414 | |
| | | | | | | | | | | | | | | | | | |
Total securities held to maturity | | | 127 | | | | 9,805 | | | | 17 | | | | 1,032 | | | | 144 | | | | 10,837 | |
| | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total | | $ | 424 | | | $ | 17,647 | | | $ | 218 | | | $ | 15,958 | | | $ | 642 | | | $ | 33,605 | |
| | | | | | | | | | | | | | | | | | |
Management evaluates impairedAFS and HTM securities for other than-temporary-impairment (“OTTI”) at least quarterly. Securities are evaluated individually based on various factors including, (1) the length of time and the extent to determine ifwhich the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the intent and ability of the Company to hold the investment for a period of time sufficient to allow for any impairmentsanticipated recovery of cost. Declines in the fair value of securities below their cost that are deemed to be other than temporary. The determination includes an evaluation oftemporarily impaired, are recognized through earnings as realized losses in the severity ofperiod in which the impairment the duration of the impairment, changes in market conditions, changes in credit quality, and the performance and prospects for the securities.is identified. Based on management'smanagement’s review, there were no securities were deemed impaired on an other-than-temporary basis in 2008, 2007, 2006, and 2005, and all2006.
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Securities with unrealized losses increased in 2008 due to the widespread disruption in financial markets in the fourth quarter, offset in part by very low interest rates resulting from the Federal Reserve Bank’s stabilizing interventions. Unrealized losses on these securities performed in accordance with their terms during these periods. At year-end 2007, all impairments were deemed to be temporary and related to changescaused by increases in market interest rates notrelative to the underlying credit qualitycontractual interest rates of the issuers. Theresecurities. The higher market rates generally reflected higher perceived risk in the overall credit markets and lower liquidity in the markets for these securities at year-end 2008. The unrealized losses were 46generated by 130 securities, primarily from the AFS debt portfolio, with a total amortized cost of $80.0 million. Municipal bonds and mortgage-backed securities comprised approximately $2 million of the gross unrealized losses at year-end 2007, with no unrealized loss exceeding 10%2008. All available for sale debt securities were rated investment grade as of amortized cost. Total unrealized losses existing for more than twelve months were 1.3% of amortized cost ofyear-end 2008. Additionally, the related securities. The Company expects that thesemortgage pools underlying the securities will continue to perform in accordance with their terms. The unrealized losses primarily relate to pass-throughthe mortgage-backed securities issuedportfolio are backed by one of three government-sponsored agencies: the Federal National Mortgage Association (“Fannie Mae and Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac. The largest number of impaired securities were either purchased at a discountMac”), or were adjustable-rate securities expected to improve to premium pricing at the time of the rate adjustment.Government National Home Mortgage Association (“GNMA”). The Company has the intent and ability to hold the securities until maturity and believes in the overall recoverability of the amortized cost. Accordingly, the Company has not recognized any other-than-temporary impairment for securities in the municipal bond or mortgage-backed portfolios. There was no unrealized loss on held to maturity municipal securities at year-end 2008. The issuers of these investmentssecurities are unrated local governments and non-profit organizations and the interest rates on these securities were above year-end origination rates that were used to establish their value and the credit outlook for these companies remained stable at year-end 2008.
Other bonds and obligations, including corporate debentures and trust-preferred securities, made up $3.6 million of the gross unrealized losses at year-end 2008. Unrealized losses on these securities resulted from overall increases in market rates reflecting higher credit risk spreads and lower market liquidity at year-end 2008. The unrealized loss included one investment grade-rated $2.6 million security with a $700 thousand fair value which was the only pooled trust preferred security owned by the Company. Securities in these portfolios were rated investment grade at year-end 2008. The portfolios’ credit quality declined modestly during 2008, but there were no individual downgrades of more than one rating throughout the year. The Company has the intent and ability to hold the securities in these portfolios for a period of time necessary to recover the amortized cost. cost thus no other-than-temporary impairment was recognized.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. LOANS
Year-end loans consisted of the following:
| | | | | | | | | |
(In thousands) | | 2007 | | | 2006 | | | 2008 | | 2007 | |
| | | | | | | |
Residential mortgages | | | | | | | |
1-4 family | | $ | 610,231 | | | $ | 566,951 | | | $ | 642,733 | | $ | 610,231 | |
Construction | | | 46,814 | | | | 32,322 | | | 34,521 | | 46,814 | |
| | | | | | |
Total residential mortgages | | | 657,045 | | | | 599,273 | | | 677,254 | | 657,045 | |
| | | | | | | | | |
Commercial mortgages | | | | | | | | | |
Construction | | | 125,349 | | | | 129,798 | | | 129,704 | | 125,349 | |
Single and multifamily | | | 69,724 | | | | 64,570 | | | 69,964 | | 69,724 | |
Other | | | 509,691 | | | | 371,971 | | | 605,788 | | 509,691 | |
| | | | | | |
Total commercial mortgages | | | 704,764 | | | | 566,339 | | | 805,456 | | 704,764 | |
| | | | | | | | | |
Commercial business | | | 203,564 | | | | 190,493 | | | 178,934 | | 203,564 | |
| | | | | | | | | |
Consumer | | | | | | | | | |
Auto | | | 196,748 | | | | 195,912 | | | 134,846 | | 196,748 | |
Home equity and other | | | 181,895 | | | | 146,970 | | | 210,662 | | 181,895 | |
| | | | | | |
Total consumer | | | 378,643 | | | | 342,882 | | | 345,508 | | 378,643 | |
| | | | | | | | | |
Total loans | | $ | 1,944,016 | | | $ | 1,698,987 | | | $ | 2,007,152 | | $ | 1,944,016 | |
| | | | | | |
Included in year-end total loans were the following:
| | | | | | | | |
Unamortized net loan origination costs | | $ | 8,329 | | | $ | 9,574 | |
Unamortized net premium on purchased loans | | | 129 | | | | 199 | |
| | | | | | |
Total unamortized net costs and premiums | | $ | 8,458 | | | $ | 9,773 | |
| | | | | | |
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Unamortized net loan origination costs | | $ | 9,574 | | | $ | 8,537 | |
Unamortized net premium on purchased loans | | | 199 | | | | 166 | |
Total unamortized net costs and premiums | | $ | 9,773 | | | $ | 8,703 | |
Activity in the allowance for loan losses was as follows:
| | | | | | | | | | | | | |
(In thousands) | | 2007 | | | 2006 | | | 2005 | | | 2008 | | 2007 | | 2006 | |
| | | | | | | | | | |
Balance at beginning of year | | $ | 19,370 | | | $ | 13,001 | | | $ | 9,337 | | | $ | 22,116 | | $ | 19,370 | | $ | 13,001 | |
Provision for loan losses | | | 4,300 | | | | 7,860 | | | | 1,313 | | | 4,580 | | 4,300 | | 7,860 | |
Transfer of commitment reserve | | | - | | | | (425 | ) | | | - | | | — | | — | | | (425 | ) |
Allowance attributed to acquired loans | | | 4,453 | | | | - | | | | 3,321 | | | — | | 4,453 | | — | |
Loans charged-off | | | (6,376 | ) | | | (1,776 | ) | | | (1,542 | ) | | | (4,442 | ) | | | (6,376 | ) | | | (1,776 | ) |
Recoveries | | | 369 | | | | 710 | | | | 572 | | | 654 | | 369 | | 710 | |
| | | | | | | | | | | | | | | | | | | |
Balance at end of year | | $ | 22,116 | | | $ | 19,370 | | | $ | 13,001 | | | $ | 22,908 | | $ | 22,116 | | $ | 19,370 | |
| | | | | | | | |
Most of the Company’s lending activity occurs within its primary markets in western Massachusetts, southern Vermont and northeastern New York.York, along with commercial loan originations in Massachusetts, Connecticut, and Rhode Island. Most of the loan portfolio is secured by real estate, including residential mortgages, commercial mortgages, and home equity loans. During 2007 and 2006, thereAs of year-end 2008, loans to operators of nonresidential buildings totaled $231 million, or 11.5% of total loans. There were no other concentrations of loans related to any one industry in excess of 10% of total loans.loans at year-end 2008 or 2007.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At year-end 20072008 and 2006,2007, the Bank’s commitments outstanding to related parties totaled $11.0$10.5 million and $7.6and$11.0 million, respectively, and the loans outstanding against these commitments totaled $6.5$6.4 million and $6.3$6.5 million, respectively. Related parties include directors and executive officers of the Company and its subsidiaries and their respective affiliates in which they have a controlling interest, and immediate family members. For the years 20072008 and 2006,2007, all related party loans were performing. Year-end Bank aggregate extensions of credit to one related party interest totaled $4.6 million in 2008 and $5.4 million in 2007 and $5.8 million in 2006.2007. In 2007,2008, there were no new extensions of credit to this party in the amount of $30 thousand and related aggregate reductionsno new extensions to this party in 2007. Reductions of extensions of credit (including loan repayments) to this party were $0.8 million and $0.4 million in 2008 and $0.1 million in 2007 and 2006, respectively.
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The following is a summary of year-end (unless otherwise stated) information pertaining to impaired loans and non-accrual loans as of year-end (unless otherwise stated):
| | | | | | | | | | | | |
(In thousands) | | 2008 | | | 2007 | | | 2006 | |
| | | | | | | | | | | | |
Investment in impaired loans | | $ | 28,607 | | | $ | 14,751 | | | $ | 13,632 | |
Impaired loans with no valuation allowance | | | 21,503 | | | | 7,224 | | | | 5,115 | |
Impaired loans with a valuation allowance | | | 7,104 | | | | 7,527 | | | | 8,517 | |
Specific valuation allowance allocated to impaired loans | | | 1,014 | | | | 1,230 | | | | 812 | |
Average investment in impaired loans during the year | | | 16,293 | | | | 9,259 | | | | 2,954 | |
Cash basis impaired loan income received during the year | | | 560 | | | | 881 | | | | 290 | |
Non-accrual loans | | | 12,171 | | | | 10,508 | | | | 7,592 | |
Total loans past due ninety days or more and still accruing | | | 923 | | | | 823 | | | | 281 | |
7. PREMISES AND EQUIPMENT
Year-end premises and troubled debt restructurings:equipment are summarized as follows:
| | | | | | | | |
(In thousands) | | 2008 | | | 2007 | |
| | | | | | | | |
Land | | $ | 4,146 | | | $ | 4,175 | |
Buildings and improvements | | | 33,335 | | | | 32,512 | |
Furniture and equipment | | | 20,732 | | | | 18,794 | |
Construction in process | | | 254 | | | | 555 | |
| | | | | | |
Premises and equipment, gross | | | 58,467 | | | | 56,036 | |
Accumulated depreciation and amortization | | | (21,019 | ) | | | (17,230 | ) |
| | | | | | |
| | | | | | | | |
Premises and equipment, net | | $ | 37,448 | | | $ | 38,806 | |
| | | | | | |
Depreciation and amortization expense for the years 2008, 2007 and 2006 amounted to $3.8 million, $3.4 million, and $2.8 million, respectively. (In thousands) | | 2007 | | | 2006 | | | 2005 | |
| | | | | | | | | |
Investment in impaired loans | | $ | 14,751 | | | $ | 13,632 | | | $ | 1,914 | |
Impaired loans with no valuation allowance | | | 7,224 | | | | 5,115 | | | | 1,430 | |
Impaired loans with a valuation allowance | | | 7,527 | | | | 8,517 | | | | 484 | |
Specific valuation allowance allocated to impaired loans | | | 1,230 | | | | 812 | | | | 257 | |
Average investment in impaired loans during the year | | | 9,259 | | | | 2,954 | | | | 3,806 | |
Cash basis impaired loan income received during the year | | | 881 | | | | 290 | | | | 66 | |
Non-accrual loans | | | 10,508 | | | | 7,592 | | | | 1,186 | |
Total loans past due ninety days or more and still accruing | | | 823 | | | | 281 | | | | 110 | |
8. GOODWILL AND OTHER INTANGIBLESThe components of total goodwill were as follows:
There | | | | | | | | |
(In thousands) | | 2008 | | | 2007 | |
| | | | | | | | |
Woronoco acquisition | | $ | 77,954 | | | $ | 77,954 | |
Factory Point acquisition | | | 53,014 | | | | 53,721 | |
Insurance agencies | | | 23,176 | | | | 23,176 | |
Other | | | 7,034 | | | | 6,781 | |
| | | | | | |
Total | | $ | 161,178 | | | $ | 161,632 | |
| | | | | | |
No impairments of goodwill were two residential mortgage properties totaling $866recognized by the Company for the years 2008, 2007, and 2006.
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The components of total other intangible assets were as follows:
| | | | | | | | | | | | |
| | Gross | | | | | | Net | |
| | Intangible | | | Accumulated | | | Intangible | |
(In thousands) | | Assets | | | Amortization | | | Assets | |
December 31, 2008 | | | | | | | | | | | | |
Non-maturity deposits | | $ | 16,978 | | | $ | (5,718 | ) | | $ | 11,260 | |
Insurance contracts | | | 7,463 | | | | (1,708 | ) | | | 5,755 | |
Non-compete agreements | | | 2,318 | | | | (2,318 | ) | | | — | |
All other intangible assets | | | 1,037 | | | | (400 | ) | | | 637 | |
| | | | | | | | | |
Total | | $ | 27,796 | | | $ | (10,144 | ) | | $ | 17,652 | |
| | | | | | | | | |
| | | | | | | | | | | | |
December 31, 2007 | | | | | | | | | | | | |
Non-maturity deposits | | $ | 16,978 | | | $ | (3,140 | ) | | $ | 13,838 | |
Insurance contracts | | | 7,463 | | | | (961 | ) | | | 6,502 | |
Non-compete agreements | | | 2,318 | | | | (1,996 | ) | | | 322 | |
All other intangible assets | | | 375 | | | | (217 | ) | | | 158 | |
| | | | | | | | | |
Total | | $ | 27,134 | | | $ | (6,314 | ) | | $ | 20,820 | |
| | | | | | | | | |
Other intangible assets are amortized on a straight-line or accelerated basis over their estimated lives, which range from five to ten years. Amortization expense related to intangible assets totaled $3.8 million in 2008, $3.1 million in 2007, and $2.0 million in 2006. Gross intangible assets related to wealth management contracts increased by $722 thousand classifiedin 2008 in connection with the Center for Financial Planning acquisition.
The estimated aggregate future amortization expense for intangible assets remaining as foreclosed real estate atof year-end 2007. There was no foreclosed real estate at year-end 2006. There were no commitments to lend additional funds to debtors of troubled debt restructurings. 2008 is as follows: 2009- $3.3 million; 2010- $3.3 million; 2011- $3.3 million; 2012- $2.8 million; 2013- $1.9 and thereafter- $3.0 million.
9. OTHER ASSETS
Year-end other assets are summarized as follows:
| | | | | | | | |
(In thousands) | | 2008 | | | 2007 | |
| | | | | | | | |
Loans held for sale | | $ | 1,768 | | | $ | 3,444 | |
Net deferred tax asset | | | 12,235 | | | | 4,310 | |
Capitalized mortgage servicing rights | | | 901 | | | | 1,203 | |
Accrued interest receivable | | | 8,995 | | | | 10,077 | |
Investment in tax credits | | | 4,908 | | | | 4,799 | |
Foreclosed and repossesed assets | | | 871 | | | | 1,327 | |
Derivative assets | | | 3,740 | | | | — | |
Other | | | 10,807 | | | | 10,159 | |
| | | | | | |
Total other assets | | $ | 44,225 | | | $ | 35,319 | |
| | | | | | |
The Bank has sold loans in the secondary market and has retained the servicing responsibility and receives fees for the services provided. Mortgage loans sold and serviced for others amounted to $110.9 million, $128.0 million, and $90.3 million at year-end 2008, 2007, and 2006, respectively.
Included in other assets are capitalized Capitalized mortgage servicing rights which represent the capitalized net present value of fee income streams generated from servicing residential mortgage loans for other financial institutions.these loans. The fair value of these rights is based on discounted cash flow projections. The fair value approximated carrying value at year-end 20072008 and 2006,2007, and no impairment charges were recognized at these dates.
The fair value of mortgage servicing rights at December 31, 2007 was $1.3 million and the contractually Contractually specified servicing fees were $178 thousand, $72 thousand, and $97 thousand for the year ended December 31,years 2008, 2007, were $168 thousand.and 2006, respectively. The significant assumptions used in the valuation at year-end 2008 included a discount rate of 10% and a pre-payment speed assumption of 12.4%12.2%.
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BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of mortgage servicing rights were as follows:
| | | | | | | | | | | | |
(In thousands) | | 2008 | | | 2007 | | | 2006 | |
| | | | | | | | | | | | |
Balance at beginning of year | | $ | 1,203 | | | $ | 986 | | | $ | 1,168 | |
Additions | | | — | | | | 395 | | | | — | |
Amortization | | | (302 | ) | | | (178 | ) | | | (182 | ) |
| | | | | | | | | |
Balance at end of year | | $ | 901 | | | $ | 1,203 | | | $ | 986 | |
| | | | | | | | | |
(In thousands) | | 2007 | | | 2006 | | | 2005 | |
| | | | | | | | | |
Balance at beginning of year | | $ | 986 | | | $ | 1,168 | | | $ | 279 | |
Additions | | | 395 | | | | - | | | | 988 | |
Amortization | | | (179 | ) | | | (182 | ) | | | (99 | ) |
Balance at end of year | | $ | 1,203 | | | $ | 986 | | | $ | 1,168 | |
Year-end premises and equipment are summarized as follows:
(In thousands) | | 2007 | | | 2006 | |
| | | | | | |
Land | | $ | 4,175 | | | $ | 3,524 | |
Buildings and improvements | | | 39,427 | | | | 30,863 | |
Furniture and equipment | | | 24,437 | | | | 20,237 | |
Construction in process | | | 555 | | | | 890 | |
Premises and equipment, gross | | | 68,594 | | | | 55,514 | |
Accumulated depreciation and amortization | | | (29,788 | ) | | | (26,384 | ) |
| | | | | | | | |
Premises and equipment, net | | $ | 38,806 | | | $ | 29,130 | |
Depreciation and amortization expense for the years 2007, 2006 and 2005 amounted to $3.4 million, $2.8 million, and $2.3 million, respectively.
7. | GOODWILL AND OTHER INTANGIBLES |
The Company recorded $53.4 million of goodwill related to the acquisition of Factory Point in September 2007 and recorded an additional $2.9 million in goodwill in 2007 related to contingent consideration for the acquisition of five insurance agencies in 2006. The Company recorded $16.2 million of goodwill related to the acquisition of five insurance agencies in October 2006. Goodwill totaled $161.6 million and $104.5 million at year-end 2007 and 2006, respectively. See Note 2 – Mergers and Acquisitions for further information about goodwill and other intangible assets acquired in 2007 and 2006.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Other intangible assets were as follows:
(In thousands) | | Gross Intangible Assets | | | Accumulated Amortization | | | Net Intangible Assets | |
| | | | | | | | | |
December 31, 2007 | | | | | | | | | |
Non-maturity deposits | | $ | 16,978 | | | $ | (3,140 | ) | | $ | 13,838 | |
Insurance contracts | | | 7,463 | | | | (961 | ) | | | 6,502 | |
Non-compete agreements | | | 2,318 | | | | (1,996 | ) | | | 322 | |
All other intangible assets | | | 375 | | | | (217 | ) | | | 158 | |
Total | | $ | 27,134 | | | $ | (6,314 | ) | | $ | 20,820 | |
| | | | | | | | | | | | |
December 31, 2006 | | | | | | | | | | | | |
Non-maturity deposits | | $ | 9,886 | | | $ | (1,673 | ) | | $ | 8,213 | |
Insurance contracts | | $ | 7,463 | | | $ | (194 | ) | | | 7,269 | |
Non-compete agreements | | | 2,318 | | | | (1,224 | ) | | | 1,094 | |
All other intangible assets | | | 375 | | | | (141 | ) | | | 234 | |
Total | | $ | 20,042 | | | $ | (3,232 | ) | | $ | 16,810 | |
Other intangible assets are amortized on a straight-line and accelerated basis over their estimated lives, which range from five to ten years. Amortization expense related to intangible assets totaled $3.1 million in 2007, $2.0 million in 2006, and $1.1 million in 2005. The estimated aggregate future amortization expense for intangible assets remaining as of year-end 2007 is as follows: 2008 - $3.8 million; 2009 - $3.3 million; 2010 - $3.2 million; 2011 - $3.2 million; 2012 - $2.8 million and thereafter – $4.7 million.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Year-end other assets are summarized as follows:
(In thousands) | | 2007 | | | 2006 | |
| | | | | | |
Loans held for sale | | $ | 3,444 | | | $ | - | |
Net deferred tax asset | | | 4,310 | | | | 4,432 | |
Capitalized mortgage servicing rights | | | 1,203 | | | | 986 | |
Accrued interest receivable | | | 10,077 | | | | 9,165 | |
Other equity investments | | | 5,884 | | | | 4,737 | |
Other | | | 10,401 | | | | 4,737 | |
Total other assets | | $ | 35,319 | | | $ | 24,057 | |
10. DEPOSITS
A summary of year-end time deposits is as follows:
| | | | | | | | |
(In thousands) | | 2008 | | | 2007 | |
Maturity date: | | | | | | | | |
Within 1 year | | $ | 453,435 | | | $ | 596,319 | |
Over 1 year to 2 years | | | 149,452 | | | | 67,767 | |
Over 2 years to 3 years | | | 67,506 | | | | 18,245 | |
Over 3 years to 4 years | | | 19,511 | | | | 9,261 | |
Over 4 years to 5 years | | | 52,286 | | | | 12,841 | |
Over 5 years | | | 4,128 | | | | 23,459 | |
| | | | | | |
Total | | $ | 746,318 | | | $ | 727,892 | |
| | | | | | |
| | | | | | | | |
Account balance: | | | | | | | | |
Less than $100,000 | | $ | 394,655 | | | $ | 429,884 | |
$100,000 or more | | | 351,663 | | | | 298,008 | |
| | | | | | |
Total | | $ | 746,318 | | | $ | 727,892 | |
| | | | | | |
11. BORROWINGS AND JUNIOR SUBORDINATED DEBENTURES (In thousands) | | 2007 | | | 2006 | |
Maturity date: | | | | | | |
Within 1 year | | $ | 596,319 | | | $ | 513,854 | |
Over 1 year to 2 years | | | 67,767 | | | | 106,318 | |
Over 2 years to 3 years | | | 18,245 | | | | 20,036 | |
Over 3 years to 4 years | | | 9,261 | | | | 11,127 | |
Over 4 years to 5 years | | | 12,841 | | | | 5,887 | |
Over 5 years | | | 23,459 | | | | 34,152 | |
Total | | $ | 727,892 | | | $ | 691,374 | |
| | | | | | | | |
Account balance: | | | | | | | | |
Less than $100,000 | | $ | 429,884 | | | $ | 369,590 | |
$100,000 or more | | | 298,008 | | | | 321,784 | |
Total | | $ | 727,892 | | | $ | 691,374 | |
Short-term debt includes FHLBB advances with an original maturity of less than one year and outstanding borrowings on lines of credit. Total short-term debt was $23.2 million and $92.8 million at year-end 2008 and 2007, respectively. The weighted-average interest rates on total short-term debt at year-end 2008 and 2007 were 0.37% and 3.50%, respectively. BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. | BORROWINGS & JUNIOR SUBORDINATED DEBENTURES |
The Bank is approved to borrow on a short-term basis from the Federal Home LoanReserve Bank of Boston (“FHLBB”)as a non-member bank. The Bank has pledged certain loans and securities to the Federal Reserve Bank to support this arrangement. The Bank had no borrowings with the Federal Reserve Bank in 2008, 2007, or 2006.
At year-end 2008, the Company had a $15.0 million unsecured line of credit. At year-end 2007, the Company had two unsecured lines of credit totaling $30.0 million. The interest on these lines of credit was variable, based on either prime or overnight LIBOR rates. There was no outstanding balance on the line of credit at year-end 2008. The outstanding balance on lines of credit was $15.0 million at year-end 2007.
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At year-end 2008 and 2007, other long-term debt consisted of unsecured term notes totaling $17.0 million and $20 million, respectively, maturing in September 2010. These loans bear interest based either on prime or short-term LIBOR rates. The year end weighted-average interest rates on these notes were 1.98% and 6.09%, respectively.
Long-term FHLBB advances consisted of advances with an original maturity of more than one year. Total outstandings were $319.0 million at year-end 2008 and $221.7 million at year-end 2007 with year-end weighted-average interest rates of 3.34% and 4.39%, respectively. The advances outstanding at year-end 2007 and 2006 consisted of various advances totaling $299.7 million and $330.0 million, respectively. The year-end weighted average interest rate on outstanding advances was 4.03% in 2007 and 4.18% in 2006. The contractual maturities of FHLBB advances at year-end 2007 were as follows: 2008 - $124.4 million; 2009 - $55.5 million; 2010 - $40.0 million; 2011 - $45.6 million; 2012 - $10.0 million; and thereafter - $24.2 million. Year-end 2007 advances outstanding included callable advances totaling $61.5 million, adjustable rate advances totaling $135 million, and amortizing advances totaling $11.8$7.0 million. The Bank maintains a $13.1 millionAll FHLBB borrowings, including the line of credit, with the FHLBB which carries interest at a rate that adjusts daily and had no outstanding balance at year-end 2007. All FHLBB borrowings are secured by a blanket security agreement on certain qualified collateral; principally all residential first mortgage loans and certain securities,securities.
Scheduled maturities of FHLBB advances at year-end 2008 were as follows: 2009 — $54.3 million; 2010 - - $50.0 million; 2011 — $45.6 million; 2012 — $40.0 million; 2013 — $38.0 million; and any funds on deposit with the FHLBB. thereafter - $91.0 million.
The Bank has a $50.0 million repurchase agreement line of credit with a major broker-dealer to be secured by securities or other assetsCompany holds 100% of the Bank. There was no usagecommon stock of this agreement in 2007 or 2006.
At year-end 2007, the Company had two unsecured lines of credit totaling $30.0 million, of which $15 million had been drawn down and had a rate of 6.07%. Both lines have available credit of $15 million and the first bears interest of overnight LIBOR plus 1.25% and matures in September 2008. The second bears interest of one-month LIBOR plus 1.625% and matures in September 2008. The Company also has two $10 million unsecured term notes that mature in September 2010 that bear interest of overnight LIBOR plus 1.25% and 3 three month LIBOR plus 1.25%, respectively, and had rates of 6.07% and 6.11%, respectively, at year-end 2007.
In June 2005, a statutory business trust, Berkshire Hills Capital Trust I (“Trust I”), was formed which is included in other assets with a cost of which the Company holds 100% of the common stock.$0.5 million. The sole asset of Trust I is $15.5 million of the Company’s junior subordinated debentures due in 2035. These debentures bear interest at a variable rate equal to LIBOR plus 1.85% and had a rate of 6.84%4.00% at year-end 2007.2008. The Company has the right to defer payments of interest for up to five years on the debentures at any time, or from time to time, with certain limitations, including a restriction on the payment of dividends to stockholders while such interest payments on the debentures have been deferred. The Company has not exercised this right to defer payments. The Company has the right to redeem the debentures without penalty after August 23, 2010. Trust I is considered a variable interest entity for which the Company is not the primary beneficiary. Accordingly, the financial statements of Trust I areis not included inconsolidated into the Company’s Financial Statements.financial statements.
-72-Year-end other liabilities are summarized as follows:
| | | | | | | | |
(In thousands) | | 2008 | | | 2007 | |
| | | | | | | | |
Due to broker | | $ | 19,895 | | | $ | — | |
Derivative liabilities | | | 24,068 | | | | — | |
Other | | | 10,140 | | | | 14,094 | |
| | | | | | |
Total other liabilities | | $ | 54,103 | | | $ | 14,094 | |
| | | | | | |
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. INCOME TAXES
Income tax expense was as follows:
| | | | | | | | | | | | |
(In thousands) | | 2008 | | | 2007 | | | 2006 | |
Current | | | | | | | | | | | | |
Federal | | $ | 4,993 | | | $ | 2,924 | | | $ | 5,159 | |
State | | | 2,914 | | | | 1,329 | | | | 1,506 | |
| | | | | | | | | |
Total current | | | 7,907 | | | | 4,253 | | | | 6,665 | |
Deferred | | | | | | | | | | | | |
Federal | | | 1,327 | | | | 677 | | | | (1,779 | ) |
State | | | 371 | | | | 461 | | | | (335 | ) |
| | | | | | | | | |
Total deferred | | | 1,698 | | | | 1,138 | | | | (2,114 | ) |
Change in valuation allowance | | | (793 | ) | | | (152 | ) | | | 352 | |
| | | | | | | | | |
Total income tax expense | | $ | 8,812 | | | $ | 5,239 | | | $ | 4,903 | |
| | | | | | | | | |
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(In thousands) | | 2007 | | | 2006 | | | 2005 | |
| | | | | | | | | |
Current | | | | | | | | | |
Federal | | $ | 2,924 | | | $ | 5,159 | | | $ | 5,501 | |
State | | | 1,329 | | | | 1,506 | | | | 813 | |
Total current | | | 4,253 | | | | 6,665 | | | | 6,314 | |
Deferred | | | | | | | | | | | | |
Federal | | | 677 | | | | (1,779 | ) | | | 1,647 | |
State | | | 461 | | | | (335 | ) | | | (93 | ) |
Total deferred | | | 1,138 | | | | (2,114 | ) | | | 1,554 | |
Change in valuation reserve | | | (152 | ) | | | 352 | | | | 135 | |
Total income tax expense | | $ | 5,239 | | | $ | 4,903 | | | $ | 8,003 | |
The reasons for the differences between the statutory federaleffective income tax rate anddiffers from the effectivestatutory tax rates are summarizedrate as follows:a result of the following:
| | | | | | | | | | | | | |
| | 2007 | | | 2006 | | | 2005 | | | 2008 | | 2007 | | 2006 | |
| | | | | | | | | | |
Statutory tax rate | | | 35.0 | % | | | 35.0 | % | | | 35.0 | % | | | 35.0 | % | | | 35.0 | % | | | 35.0 | % |
Increase (decrease) resulting from: | | | | | | | | | | | | | |
State taxes, net of federal tax benefit | | | 6.2 | | | | 6.1 | | | | 3.4 | | | 6.9 | | 6.2 | | 6.1 | |
Dividends received deduction | | | (0.1 | ) | | | (0.2 | ) | | | (0.7 | ) | | | (0.1 | ) | | | (0.1 | ) | | | (0.2 | ) |
Tax exempt income - investments | | | (8.0 | ) | | | (8.3 | ) | | | (5.6 | ) | |
Bank owned life insurance | | | (2.0 | ) | | | (2.2 | ) | | | (1.9 | ) | |
Employee stock ownership plan termination | | | - | | | | - | | | | 17.7 | | |
Tax exempt income — investments | | | | (5.5 | ) | | | (8.0 | ) | | | (8.3 | ) |
Bank-owned life insurance | | | | (1.6 | ) | | | (2.0 | ) | | | (2.2 | ) |
Change in valuation allowance | | | (0.8 | ) | | | 2.2 | | | | 0.8 | | | | (2.6 | ) | | | (0.8 | ) | | 2.2 | |
Investment tax credits | | | (1.9 | ) | | | (1.4 | ) | | | - | | | | (2.0 | ) | | | (1.9 | ) | | | (1.4 | ) |
Other, net | | | (0.5 | ) | | | (0.9 | ) | | | 0.6 | | | | (1.7 | ) | | | (0.5 | ) | | | (0.9 | ) |
| | | | | | | | |
Effective tax rate | | | 27.9 | % | | | 30.3 | % | | | 49.3 | % | | | 28.4 | % | | | 27.9 | % | | | 30.3 | % |
| | | | | | | | |
Year-end deferred tax assets (liabilities) related to the following:
| | | | | | | | |
(In thousands) | | 2008 | | | 2007 | |
Allowance for loan losses | | $ | 9,358 | | | $ | 9,395 | |
Employee benefit plans | | | 1,270 | | | | 1,835 | |
Net unrealized loss (gain) on swaps and securities available for sale in OCI | | | 8,131 | | | | (700 | ) |
Goodwill amortization | | | (3,594 | ) | | | (1,525 | ) |
Investments | | | (840 | ) | | | (711 | ) |
Purchase accounting adjustments | | | (3,548 | ) | | | (3,786 | ) |
Investment tax credits | | | 2,243 | | | | 396 | |
Other | | | (785 | ) | | | 199 | |
Valuation allowance | | | — | | | | (793 | ) |
| | | | | | |
Deferred tax asset, net | | $ | 12,235 | | | $ | 4,310 | |
| | | | | | |
(In thousands) | | 2007 | | | 2006 | |
Allowance for loan losses | | $ | 9,395 | | | $ | 8,169 | |
Employee benefit plans | | | 1,835 | | | | 1,208 | |
Net unrealized loss (gain) on securities available for sale | | | (699 | ) | | | (113 | ) |
Goodwill amortization | | | (1,525 | ) | | | (1,348 | ) |
Investments | | | (711 | ) | | | (730 | ) |
Purchase accounting adjustments | | | (3,786 | ) | | | (717 | ) |
Other | | | 594 | | | | (1,092 | ) |
Valuation allowance | | | (793 | ) | | | (945 | ) |
Deferred tax asset, net | | $ | 4,310 | | | $ | 4,432 | |
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A valuation allowance has been established for the full amount of the Massachusetts net deferred tax asset, due to uncertainties of realization. Management believes that it is more likely than not that the Company will realize its remaining net deferred tax assets, based on its recent historical and anticipated future levels of pre-tax income. There can be no absolute assurance, however, that any specific level ofActual future income may differ from management’s expectations.
A valuation allowance of $793 thousand was established by the Company in 2007 for the full amount of the Massachusetts net deferred tax asset due to uncertainties of realization based on the Bank’s income. In 2008, management concluded that it is more likely than not that the Company will be generated.
realize this tax asset, and the valuation allowance was reduced to zero.
The Bank does not intendCompany is no longer subject to pay nondividend distributions that would result in a recapture of any portion of its base year bad debt reserves, and a related deferredU.S. federal income tax liabilityexaminations for tax years before 2005. Adjustments, penalties and interest resulting from the most recent examination of $346the 2002 and 2003 tax years did not have a significant impact on the Company’s financial statements. Management believes that the tax benefits taken by the Company for the years 2005-2008 will more likely than not be sustained upon examination by taxing authorities, thus no unrecognized tax benefits were recorded at year-end 2008 and 2007.
14. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
As part of the Company’s risk management strategy, in 2008, the Company entered into interest rate swap agreements with a total notional value of $243 million to mitigate the interest rate risk inherent in certain of the Company’s assets and liabilities. Of this total, interest rate swaps with a combined notional value of $150 million were designated as cash flow hedges as defined in Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities”(“SFAS No. 133”). The remaining $93 million have been designated as economic hedges, which are hedges not subject to the hedge accounting rules of SFAS No. 133. At year-end 2008, no derivatives were designated as hedges of net investments in foreign operations. Additionally, the Company does not use derivatives for trading or speculative purposes.
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Interest rate swap agreements involve the risk of dealing with both Bank customers and institutional derivative counterparties and their ability to meet contractual terms. The agreements are entered into with counterparties that meet established credit standards and contain master netting and collateral provisions protecting the at-risk party. The derivatives program is overseen by the Risk Management Committee of the Company’s Board of Directors. Based on adherence to the Company’s credit standards and the presence of the netting and collateral provisions, the Company believes that the credit risk inherent in these contracts was not significant in 2008.
The Company pledged collateral to derivative counterparties in the form of cash totaling $14.3 million and securities with an amortized cost of $9.8 million and a fair value of $10.0 million as of year-end 2008. No collateral was posted from counterparties to the Company in 2008 as most of the company’s derivatives were in an unrealized loss position throughout the year.
Information about interest rate swap agreements entered into for interest rate risk management purposes at year-end 2008, summarized by type of financial instrument the swap agreements were intended to hedge, follows:
| | | | | | | | | | | | | | | | | | | | |
| | | | | | Weighted | | | | | | | | | | | Estimated | |
| | Notional | | | Average | | | Weighted Average Rate | | | Fair Value | |
| | Amount | | | Maturity | | | Received | | | Paid | | | Gain (Loss) | |
| | (In thousands) | | | (In years) | | | | | | | | | (In thousands) | |
Cash flow hedges | | | | | | | | | | | | | | | | | | | | |
Interest rate swaps on FHLBB borrowings | | $ | 135,000 | | | | 5.7 | | | | 2.57 | % | | | 4.24 | % | | $ | (15,657 | ) |
Interest rate swaps on junior subordinated debentures | | | 15,000 | | | | 5.4 | | | | 4.00 | | | | 5.54 | | | | (1,171 | ) |
| | | | | | | | | | | | | | | |
Total cash flow hedges | | | 150,000 | | | | | | | | | | | | | | | | (16,828 | ) |
| | | | | | | | | | | | | | | | | | | | |
Economic hedges | | | | | | | | | | | | | | | | | | | | |
Interest rate swap on industrial revenue bond | | | 15,000 | | | | 20.9 | | | | 2.27 | | | | 5.09 | | | | (3,299 | ) |
Interest rate swaps on loans with commercial loan customers | | | 38,948 | | | | 6.2 | | | | 4.14 | | | | 6.42 | | | | (3,941 | ) |
Reverse interest rate swaps on loans with commercial loan customers | | | 38,948 | | | | 6.2 | | | | 6.42 | | | | 4.14 | | | | 3,740 | |
| | | | | | | | | | | | | | | |
Total economic hedges | | | 92,896 | | | | | | | | | | | | | | | | (3,500 | ) |
| | | | | | | | | | | | | | | | | | | | |
Total | | $ | 242,896 | | | | | | | | | | | | | | | $ | (20,328 | ) |
| | | | | | | | | | | | | | | |
Cash flow hedges
The fair value of interest rate swaps designated as cash flow hedges are included in other liabilities in the accompanying Consolidated Balance Sheets. The effective portion of unrealized changes in the fair value of the derivatives are reported in other comprehensive income and subsequently reclassified to earnings when gains or losses are realized. Each quarter, the Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged item or transaction. The ineffective portion of changes in the fair value of the derivatives is recognized directly in earnings.
In 2008, the Company entered into several interest rate swaps with an aggregate notional value of $135 million to convert the LIBOR based floating interest rates on a $135 million portfolio of Federal Home Loan Bank of Boston (“FHLBB”) advances to fixed rates, with the objective of fixing the Company’s monthly interest expense on these borrowings. As of year-end 2008, the weighted average fixed interest rate on interest payments payable from the Company to its counterparties and the weighted average variable interest rate receivable from the counterparties was 4.24% and 2.57%, respectively, on these swaps.
In April 2008, the Company entered into an interest rate swap with a notional value of $15 million to convert the floating rate interest on its junior subordinated debentures to a fixed rate of interest. The purpose of the hedge was to protect the Company from the risk of variability arising from the floating rate interest on the debentures. The Company received a 4.00% floating rate from the counterparty and paid a fixed rate of 5.54% as of year-end 2008.
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Unrealized losses recorded in other comprehensive loss on interest rate swaps designated as cash flow hedges at year-end 2008 totaled $16.8 million, net of the related income tax benefit of $6.9 million. Interest expense recognized on cash flow derivatives totaled $1.1 million for the year-ended 2008 and was included in interest expense on borrowings and junior subordinated debentures in the Consolidated Statements of Income. Hedge ineffectiveness on interest rate swaps designated as cash flow hedges was immaterial to the Company’s 2008 financial statements.
Economic hedges
The fair value of interest rate swaps designated as economic hedges are included in other assets and other liabilities in the accompanying Consolidated Balance Sheets. Unrealized gains and losses on these derivatives are recognized through earnings.
In the second quarter of 2008, the Company applied the fair value option permitted under Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), to a $15.0 million economic development bond bearing a fixed-rate of 5.09%. The bond is classified as a trading security. The Company simultaneously entered into an interest rate swap with a $15.0 million notional, to swap out the fixed rate of interest on the bond in exchange for a LIBOR based floating rate. The intent of the economic hedge was to improve the Company’s asset sensitivity to changing interest rates in anticipation of favorable average floating rates of interest over the 21-year life of the bond. Unrealized gains on the economic development bond totaling $3.1 million for 2008 were offset against unrealized losses of $3.3 million on the related interest rate swap within other non-interest income on the Consolidated Statements of Income at year-end 2008. Interest expense on the swap totaled $186 thousand hasin 2008 and is reflected through interest and dividend income on securities in the Consolidated Statements of Income.
In addition to the hedging activities above, in 2008 the Company began offering certain derivative products directly to qualified commercial borrowers. The Company economically hedges derivative transactions executed with commercial borrowers by entering into mirror-image, offsetting derivatives with third-party financial institutions. The transaction allows the Company’s customer to effectively convert a variable-rate loan to a fixed rate. Because the Company acts as an intermediary for its customer, changes in the fair value of the underlying derivative contracts for the most part offset each other and do not been provided.significantly impact the Company’s earnings. Because the derivatives have mirror-image contractual terms, the changes in fair value substantially offset through earnings. As of year-end 2008, the unrealized gains (losses) on the interest rate swaps with customers and the reverse swaps with financial institutions totaled $3.7 million and $(3.9) million, respectively. These unrealized gains (losses) are reflected within other non-interest income on the income statement. Credit value adjustments arising from the difference in credit worthiness of the commercial loan and financial institution counterparties were not material to the financial statements. Interest income and expense on these swaps and related fee income from customers are posted to non-interest income. The interest income and expense offset each other; the related fee income totaled $437 thousand.
15. COMMITMENTS, CONTINGENCIES, AND OFF-BALANCE SHEET ACTIVITIES
12. | COMMITMENTS, CONTINGENCIES, AND OFF-BALANCE SHEET ACTIVITIES |
Credit related financial instruments.The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the accompanying consolidated balance sheets.
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The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument is represented by the contractual amount of these commitments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments. A summary of financial instruments outstanding whose contract amounts represent credit risk is as follows at year-end:
(In thousands) | | 2007 | | | 2006 | |
| | | | | | |
Commitments to grant loans | | $ | 46,813 | | | $ | 54,439 | |
Unused funds on commercial lines of credit | | | 204,527 | | | | 120,090 | |
Unadvanced funds on home equity, reddi-cash and other consumer lines of credit | | | 187,015 | | | | 150,600 | |
Unadvanced funds on construction loans | | | 102,311 | | | | 113,497 | |
Standby letters of credit | | | 29,013 | | | | 16,019 | |
Commercial letters of credit | | | 1,500 | | | | 1,500 | |
| | | | | | | | |
(In thousands) | | 2008 | | | 2007 | |
Commitments to originate new loans | | $ | 63,108 | | | $ | 46,813 | |
Unused funds on commercial and other lines of credit | | | 70,156 | | | | 210,747 | |
Unadvanced funds on home equity lines of credit | | | 197,343 | | | | 180,795 | |
Unadvanced funds on construction and real estate loans | | | 66,135 | | | | 102,311 | |
Standby letters of credit | | | 41,402 | | | | 29,013 | |
Commercial letters of credit | | | — | | | | 1,500 | |
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. Funds to be disbursed for loans and home equity lines of credit are collateralized by real estate. Commercial lines of credit are generally secured by business assets and securities. Reddi-cash lines of credit are unsecured.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These letters of credit are primarily issued to support borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company considers standby letters of credit to be guarantees and the amount of the recorded liability related to such guarantees was not material at December 31, 2007.2008.
Operating lease commitments.Future minimum rental payments required under operating leases at December 31, 20072008 are as follows: 2008 –2009 — $2.6 million; 2010 — $2.5 million; 2011 — $2.4 million; 2009 –2012 — $2.4 million; 2013 — $2.3 million; 2010 – $2.3 million; 2011 – $2.3 million; 2012 – $2.2 million; and all years thereafter – $20.6— $30.0 million. The leases contain options to extend for periods up to twenty years. The cost of such rental options is not included above. Total rent expense for the years 2008, 2007, 2006 and 20052006 amounted to $2.6 million, $2.4 million, and $1.4 million, and $0.9 million, respectively.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Employment and change in control agreements.The Company has entered into an employment agreement with one senior executive with a two-yearthree-year term. Berkshire Insurance Group has entered into an employment agreement with one senior executive with a term ending on December 31, 2009. The Bank also has change in control agreements with several officers which provide a severance payment in the event employment is terminated in conjunction with a defined change in control.
Derivative Contracts. At December 31, 2007, the Company was committed to pay fixed-receive floating interest rate swap agreements with notional amounts aggregating $60 million that settled in January 2008.
Legal claims.Various legal claims arise from time to time in the normal course of business. In the opinion of management, claims outstanding at December 31, 20072008 will have no material effect on the Company’s consolidated financial statements.
16. STOCKHOLDERS’ EQUITY
Minimum regulatory capital requirements
The Bank is subject to various regulatory capital requirements administered by the federal and state 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 consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting and other factors. The Company, as a savings and loan holding company, has no specific quantitative capital requirements.
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Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital to average assets (as defined). As of December 31,year-end 2008 and 2007, and 2006, the Bank met the capital adequacy requirements.
Regulators may set higher expected capital requirements in some cases based on their examinations. In 2009, regulators announced new stress tests that may be applied prospectively to certain banks.
As of December 31,year-end 2008 and 2007, Berkshire Bank met the conditions to be classified as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following tables.
The Bank’s actual and required capital amounts were as follows:
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | Minimum to be Well | |
| | | | | | | | | | Minimum | | | Capitalized Under | |
| | | | | | | | | | Capital | | | Prompt Corrective | |
| | Actual | | | Requirement | | | Action Provisions | |
(Dollars in thousands) | | Amount | | | Ratio | | | Amount | | | Ratio | | | Amount | | | Ratio | |
|
December 31, 2008 | | | | | | | | | | | | | | | | | | | | | | | | |
Total capital to risk-weighted assets | | $ | 250,729 | | | | 12.28 | % | | $ | 163,314 | | | | 8.00 | % | | $ | 204,142 | | | | 10.00 | % |
Tier 1 capital to risk-weighted assets | | | 227,821 | | | | 11.16 | | | | 81,657 | | | | 4.00 | | | | 122,485 | | | | 6.00 | |
Tier 1 capital to average assets | | | 227,821 | | | | 9.34 | | | | 97,602 | | | | 4.00 | | | | 122,002 | | | | 5.00 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2007 | | | | | | | | | | | | | | | | | | | | | | | | |
Total capital to risk-weighted assets | | $ | 206,080 | | | | 10.40 | % | | $ | 158,462 | | | | 8.00 | % | | $ | 198,077 | | | | 10.00 | % |
Tier 1 capital to risk-weighted assets | | | 183,530 | | | | 9.27 | | | | 79,231 | | | | 4.00 | | | | 118,846 | | | | 6.00 | |
Tier 1 capital to average assets | | | 183,530 | | | | 7.97 | | | | 92,136 | | | | 4.00 | | | | 115,169 | | | | 5.00 | |
| | | | | | | | | | | | | | Minimum to be well |
| | | | | | | | Minimum | | Capitalized Under |
| | | | | | | | Capital | | Prompt Corrective |
| | Actual | | Requirement | | Action Provisions |
(Dollars in thousands) | | Amount | | | Ratio | | Amount | | | Ratio | | Amount | | | Ratio |
| | | | | | | | | | | | | | | | | | |
December 31, 2007 | | | | | | | | | | | | | | | | | | |
Total capital to risk weighted assets | | $ | 206,080 | | | | 10.40 | % | | $ | 158,462 | | | | 8.00 | % | | $ | 198,077 | | | | 10.00 | % |
Tier 1 capital to risk weighted assets | | | 183,530 | | | | 9.27 | | | | 79,231 | | | | 4.00 | | | | 118,846 | | | | 6.00 | |
Tier 1 capital to average assets | | | 183,530 | | | | 7.97 | | | | 92,136 | | | | 4.00 | | | | 115,169 | | | | 5.00 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
December 31, 2006 | | | | | | | | | | | | | | | | | | | | | | | | |
Total capital to risk weighted assets | | $ | 175,808 | | | | 10.27 | % | | $ | 136,925 | | | | 8.00 | % | | $ | 171,156 | | | | 10.00 | % |
Tier 1 capital to risk weighted assets | | | 156,013 | | | | 9.12 | | | | 68,463 | | | | 4.00 | | | | 102,694 | | | | 6.00 | |
Tier 1 capital to average assets | | | 156,013 | | | | 7.69 | | | | 81,183 | | | | 4.00 | | | | 101,479 | | | | 5.00 | |
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A reconciliation of the Company’s year-end total stockholders’ equity to the Bank’s regulatory capital is as follows:
| | | | | | | | |
(In thousands) | | 2008 | | | 2007 | |
Total stockholders’ equity per consolidated financial statements | | $ | 408,425 | | | $ | 326,837 | |
| | | | | | | | |
Adjustments for Bank Tier 1 Capital: | | | | | | | | |
Holding company equity adjustment | | | (45,161 | ) | | | 10,648 | |
Net unrealized loss (gain) on available for sale securities | | | 1,778 | | | | (1,241 | ) |
Net unrealized loss on cash flow hedges | | | 9,046 | | | | — | |
Disallowed goodwill and intangible assets | | | (146,267 | ) | | | (152,714 | ) |
| | | | | | |
Total Bank Tier 1 Capital | | | 227,821 | | | | 183,530 | |
| | | | | | | | |
Adjustments for total capital: | | | | | | | | |
Allowed unrealized gains on equity securities | | | — | | | | 89 | |
Includible allowances for loan losses and unused lines of credit | | | 22,908 | | | | 22,461 | |
| | | | | | |
Total Bank capital per regulatory reporting | | $ | 250,729 | | | $ | 206,080 | |
| | | | | | |
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Preferred stock and warrant
On December 19, 2008, the Company entered into a definitive agreement with the U.S. Treasury. Pursuant to the agreement, the Company sold 40,000 shares of Senior Perpetual Preferred Stock, par value $.01 per share, having a liquidation amount equal to $1,000 per share, with an attached warrant (“The Warrant”) to purchase 226,330 shares of the Company’s common stock, par value $0.01 per share, for the aggregate price of $6.0 million, to the U.S. Treasury. The preferred stock is senior to the Company’s common stock with respect to dividends and distributions. The preferred stock qualifies as Tier 1 capital and will pay cumulative dividends at a rate of 5% per year, for the first five years, and 9% per year thereafter. Under the amended terms of the agreement, the preferred stock may be redeemed at par and the warrant extinguished with the approval of the FDIC and the OTS. The Warrant has a 10-year term with 50% vesting immediately upon issuance and the remaining 50% vesting on January 1, 2010 if certain qualified equity offerings are not satisfied. The Warrant has an exercise price, subject to anti-dilution adjustments, equal to $26.51 per share of common stock. Under the terms of the agreement, the U.S. Congress may impose additional conditions and requirements which will be binding on the company and which may be made retroactive. Additionally, the Treasury Department has established an Office of the Special Inspector General for the Troubled Assets Relief Program which is empowered to perform audits, conduct investigations and issue subpoenas related to the operations of the program. Under the original terms of the agreement, the Company could not repurchase common shares or increase its dividend for three years from the date of the agreement unless the preferred shares sold to the U.S. Treasury have been redeemed in whole or transferred to a third party. Additionally, there were significant restrictions on the Company’s ability to redeem the preferred shares. Based on the American Recovery and Reinvestment Act passed in February 2009, these redemption restrictions were significantly reducted and additional operating restrictions were placed on program recipients. Please see the note on Subsequent Events for additional information. (In thousands) | | 2007 | | | 2006 | |
Total stockholders' equity per consolidated financial statements | | $ | 326,837 | | | $ | 258,161 | |
Adjustments for Bank Tier 1 Capital: | | | | | | | | |
Holding company equity adjustment | | | 10,648 | | | | (8,300 | ) |
Net unrealized gains on available for sale securities | | | (1,241 | ) | | | (92 | ) |
Disallowed goodwill and intangible assets | | | (152,714 | ) | | | (93,756 | ) |
Total Bank Tier 1 Capital | | | 183,530 | | | | 156,013 | |
Adjustments for total capital: | | | | | | | | |
Allowed unrealized gains on equity securities | | | 89 | | | | - | |
Includible allowances for loan losses and unused lines of credit | | | 22,461 | | | | 19,795 | |
Total Bank capital per regulatory reporting | | $ | 206,080 | | | $ | 175,808 | |
The Company accounted for this transaction in accordance with Accounting Principles Board Opinion No. 14,Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants (“APB 14”). APB 14 requires the proceeds from the issuance to be allocated between the preferred stock and warrant based on relative fair value. Accordingly, the fair value of the warrant, in the amount of $3.2 million was recorded as an increase to additional paid-in-capital. A discount in the amount of $3.2 million was recorded on the preferred stock and is being accreted over an estimated period of five years using the effective interest method. The accretion of the discount on the preferred will be treated as a deemed dividend and as a reduction to net income available to common shareholders.The fair value of the warrant was calculated based on the Black-Scholes valuation model. Significant inputs to the model are as follows: expected dividends — 2.3%; expected term — 10 years; expected volatility — 30%; risk free interest rate — 1.35%.
Common stock
The Bank is subject to dividend restrictions imposed by various regulators, including a limitation on the total of all dividends that the Bank may pay to the Company in any calendar year, to an amount that shall not exceed the Bank’s net income for the current year, plus the Bank’s net income retained for the two previous years, without regulatory approval. Due to the dividend paid by the Bank to the Company to fund the cash consideration paid in the Woronoco acquisition in 2005, the Bank’s cumulative dividends exceed the regulatory limit. The Bank received approval in 2007 and 2006 to pay dividends to the Company in an amount exceeding the preceding regulatory restriction. ForAs of year-end 2008, the Bank cancould declare aggregate additional dividends of $9approximately $14 million without obtaining regulatory approval.
approval based on the above statutory calculation. Dividends from the Bank are an important source of funds to the Company to make dividend payments on its common and preferred stock, to make payments on its borrowings, and for its other cash needs. The ability of the Company and the Bank to pay dividends is dependent on regulatory policies and regulatory capital requirements. The ability to pay such dividends in the future may be adversely affected by new legislation or regulations, or by changes in regulatory policies relating to capital, safety and soundness, and other regulatory concerns.
In conjunction with Massachusetts conversion regulations, the Bank established a liquidation account for eligible account holders, which at the time of conversion amounted to approximately $70 million. In the event of a liquidation of the Bank, the eligible account holders willwould be entitled to receive their pro-rata share of the net worth of the Bank prior to conversion. However, as qualifying deposits are reduced, the liquidation account will also beis reduced in an amount proportionate to the reduction in the qualifying deposit accounts.
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The payment of dividends by the Company is subject to Delaware law, which generally limits dividends to an amount equal to an excess of the net assets of a company (the amount by which total assets exceed total liabilities) over statutory capital, or if there is no excess, to the company’s net profits for the current and/or immediately preceding fiscal year.
In the fourth quarter of 2008, the Company issued 1.725 million common shares in a public offering and received net cash proceeds of $38.5 million. On December 19, 2008, the Company entered into an agreement with the U.S. Treasury related to its purchase of $40 million of preferred stock. Under this agreement, the Company may not repurchase common shares or increase its dividend for three years from the date of the agreement subject to certain conditions described in the preferred stock note above. BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Other comprehensive income
Comprehensive income is the total of net income and all other non-owner changes in equity. It is displayed in the Consolidated Statements of Changes in Stockholders’ Equity. Reclassification detail is shown for the years below.
(In thousands) | | 2007 | | | 2006 | | | 2005 | |
Change in net unrealized holding losses (gains) on | | | | | | | | | |
available for sale securities | | $ | 1,089 | | | $ | 768 | | | $ | (5,901 | ) |
Reclassification adjustment for net loss (gains) realized in income | | | 591 | | | | 3,130 | | | | (4,283 | ) |
Net change in unrealized gains/losses | | | 1,680 | | | | 3,898 | | | | (10,184 | ) |
Tax effects | | | (626 | ) | | | (1,549 | ) | | | 3,784 | |
Net-of-tax change in available for sale securities | | | 1,054 | | | | 2,349 | | | | (6,400 | ) |
Net loss (gain) on other instruments | | | 71 | | | | (18 | ) | | | (53 | ) |
Total other comprehensive income (loss), net | | $ | 1,125 | | | $ | 2,331 | | | $ | (6,453 | ) |
| | | | | | | | | | | | |
(In thousands) | | 2008 | | | 2007 | | | 2006 | |
Unrealized holding (loss) gain on available for sale securities during the period | | $ | (4,816 | ) | | $ | 1,089 | | | $ | 768 | |
Reclassification adjustment for net loss realized in income | | | 22 | | | | 591 | | | | 3,130 | |
| | | | | | | | | |
Unrealized (loss) gain on available for sale securities | | | (4,794 | ) | | | 1,680 | | | | 3,898 | |
Net loss (gain) on effective cash flow hedging derivatives | | | (16,828 | ) | | | 71 | | | | (18 | ) |
Tax effects | | | 8,831 | | | | (626 | ) | | | (1,549 | ) |
| | | | | | | | | |
Total other comprehensive (loss) income, net | | $ | (12,791 | ) | | $ | 1,125 | | | $ | 2,331 | |
| | | | | | | | | |
Year-end components of accumulated other comprehensive (loss) income (loss) waswere as follows:
| | | | | | | | |
(In thousands) | | 2008 | | | 2007 | |
Net unrealized holding (loss) gain on available for sale securities | | $ | (2,877 | ) | | $ | 1,917 | |
Net loss on effective cash flow hedging derivatives | | | (16,828 | ) | | | — | |
Tax effects | | | 8,131 | | | | (700 | ) |
| | | | | | |
Accumulated other comprehensive (loss) income | | $ | (11,574 | ) | | $ | 1,217 | |
| | | | | | |
(In thousands) | | 2007 | | | 2006 | |
Net unrealized holding gains on available for sale securities | | $ | 1,917 | | | $ | 237 | |
Net loss on other instruments | | | - | | | | (71 | ) |
Tax effects | | | (700 | ) | | | (74 | ) |
Accumulated other comprehensive income | | $ | 1,217 | | | $ | 92 | |
14. | EMPLOYEE BENEFIT PLANS |
17. EMPLOYEE BENEFIT PLANS
The Company provides a 401(k) Plan which most employees participate in. The Company contributes a non-elective 3% of gross annual wages for each participant, regardless of the participant’s deferral, in addition to a 100% match up to 4% of gross annual wages. The Company’s contributions vest immediately. Expense related to the plan was $1.5 million, $1.3 million, $893 thousand and $771 thousand$0.9 million for the years 2008, 2007, and 2006, and 2005, respectively.
The Company maintains a supplemental executive retirement plan (“SERP”) for one executive officer. Benefits generally commence no earlier than age sixty-two and are payable at the executive’s option, either as an annuity or as a lump sum. At year-end 20072008 and 2006,2007, the accrued liability for this SERP was $756$994 thousand and $443$756 thousand, respectively. SERP expense was $238 thousand in 2008, $313 thousand in 2007, and $175 thousand in 2006, and $148 thousand in 2005, and is recognized over the required service period.
The Company owns endorsement split-dollar life insurance arrangements pertaining to certain prior executives. Under these arrangements, the Company purchased policies insuring the lives of the executives, and separately entered into agreements to split the policy benefits with the executive. The
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18. STOCK-BASED COMPENSATION PLANS AND EMPLOYEE STOCK OWNERSHIP PLAN
In April 2008 the stockholders of the Company has no recorded liability for these arrangements. EITF 06-4, effective for fiscal years beginning after December 15, 2007 sets forth requirements for the recognition of a liability. See Note 1 – Recent Accounting Pronouncements.
15. | STOCK-BASED COMPENSATION PLANS AND EMPLOYEE STOCK OWNERSHIP PLAN |
The Company has two stock-based compensation plans:voted to terminate the 2001 Stock-Based Incentive Plan andwhile simultaneously increasing by 200 thousand the number of shares of common stock that the Company may issue under the 2003 Equity Compensation Plan. These plans, which are stockholder-approved, permitamendments represented a net increase of 118 thousand shares available to grant stock and option awards.
The 2003 Equity Compensation Plan permits the grantgranting of a combination of stock awards and incentive and non-qualified stock options to employees and directors. The plansA total of 500 thousand common stock shares were authorized 1.374 million sharesunder the plan, as amended. As of year-end 2008, the Company had the ability to grant approximately 261 thousand additional stock and option awards under this plan.
On September 21, 2007, the Company assumed the outstanding unexercised options issued by Factory Point Bancorp as part of the merger agreement between the Company and Factory Point. Each Factory Point option was converted to a vested option for one of the Company’s commonshares with an exercise price equal to the market price of Factory Point’s stock forat the date of grant and a maximum original term of ten years based on the original grant date subject to the exchange ratio set forth in the merger agreement. In 2007, the total stock-based compensation cost capitalized as part of the goodwill of the Factory Point acquisition was $2.1 million.
A summary of activity in the Company’s stock compensation plans is shown below:
| | | | | | | | | | | | | | | | |
| | Non-vested Stock | | | | |
| | Awards Outstanding | | | Stock Options Outstanding | |
| | | | | | Weighted- | | | | | | | Weighted- | |
| | | | | | Average | | | | | | | Average | |
| | Number of | | | Grant Date | | | Number of | | | Exercise | |
(Shares in thousands) | | Shares | | | Fair Value | | | Shares | | | Price | |
Balance, December 31, 2007 | | | 105 | | | $ | 31.88 | | | | 644 | | | $ | 21.90 | |
Granted | | | 68 | | | | 22.80 | | | | — | | | | — | |
Stock options exercised | | | — | | | | — | | | | (185 | ) | | | 18.96 | |
Stock awards vested | | | (47 | ) | | | 30.03 | | | | — | | | | — | |
Forfeited | | | (3 | ) | | | 27.67 | | | | (6 | ) | | | 33.46 | |
| | | | | | | | | | | | |
Balance, December 31, 2008 | | | 123 | | | $ | 27.40 | | | | 453 | | | $ | 23.00 | |
| | | | | | | | | | | | |
Exercisable options, December 31, 2008 | | | | | | | | | | | 437 | | | $ | 22.61 | |
| | | | | | | | | | | | |
Stock awards as stock or options. Authorized shares included 767,000 shares reserved for options, 307,000 shares reserved
The total compensation cost for stock awards recognized as expense was $1.6 million, $1.6 million, and 300,000 shares available for either options or$1.3 million, in the years 2008, 2007 and 2006, respectively. The total recognized tax benefit associated with this compensation cost was $0.6 million, $0.6 million, and $0.5 million, respectively.
The fair value of stock awards.awards is based on the closing stock price on the grant date. The Company believes that suchweighted average fair value of stock awards better aligngranted was $22.80, $33.06 and $33.96 in 2008, 2007 and 2006. Stock awards vest over periods up to five years and are valued at the interestsclosing price of plan participants with thosethe stock on the grant date.
The total fair value of its stockholders.stock awards vested during 2008, 2007 and 2006 was $1.4 million, $1.4 million and $2.1 million, respectively. The unrecognized stock-based compensation expense related to unvested stock awards was $1.9 million as of year-end 2008. This amount is expected to be recognized over a weighted average period of 1 year.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Option awards are granted with an exercise price equal to the market price of the Company’s stock at the date of grant, and vest over periods up to five years. The options grant the holder the right to acquire a share of the Company’s common stock for each option held, and have a contractual life of ten years. The Company assumed the outstanding unexercised options issued by Factory Point Bancorp, Inc., which was acquired on September 21, 2007. Each Factory Point option was converted to a vested option for one of the Company’s shares with an exercise price equal to the market price of Factory Point’s stock at the date of grant and a maximum original term of ten years based on the original grant date subject to the exchange ratio set forth in the merger agreement. The Company generally issues shares from treasury stock as options are exercised. Stock awards vest over periods up to five years and are valued at the closing price of the stock on the grant date.
The total compensation cost for stock-based payment arrangements recognized as expense was $1.6 million, $1.3 million, and $1.4 million in the years 2007, 2006, and 2005, respectively. For all of these years, the total recognized tax benefit related to this compensation cost was $0.6 million, $0.5 million and $0.6 million in the years 2007, 2006, and 2005, respectively. In 2007, the total stock-based compensation cost capitalized as part of the goodwill of the Factory Point acquisition was $2.1 million.
The fair value of stock awards is based on the closing stock price on the grant date. The weighted average fair value of stock awards granted was $33.06, $33.96, and $35.10 in 2007, 2006, and 2005. 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 and grant date fair values (no options were granted in 2005).model. The expected dividend yield and expected term are based on management estimates. The expected volatility is based on historical volatility. The risk-free interest rates for the expected term are based on the U.S. Treasury yield curve in effect at the time of the grant.
| | 2007 | | | 2006 | |
Expected dividends | | | 1.85 | % | | | 1.85 | % |
Expected term | | 6 years | | | 6 years | |
Expected volatility | | | 19 | % | | | 19 | % |
Risk-free interest rate | | | 4.68 | % | | | 4.86 | % |
Weighted average grant date fair value | | $ | 7.67 | | | $ | 8.05 | |
A summary of activity The following weighted-average assumptions were used in the Company’s stock compensation plans is shown below:determination of the weighted average grant date fair value for option awards granted in 2007 and 2006. The Company did not grant option awards in 2008. Option awards granted in 2007 and 2006 totaled approximately 20 thousand and 3 thousand, respectively.
| | | | | | | | |
(In thousands) | | 2007 | | | 2006 | |
|
Expected dividends | | | 1.85 | % | | | 1.85 | % |
Expected term | | 6 years | | | 6 years | |
Expected volatility | | | 19 | % | | | 19 | % |
Risk-free interest rate | | | 4.68 | % | | | 4.86 | % |
Weighed average grant date fair value | | $ | 7.67 | | | $ | 8.05 | |
| | Non-vested Stock Awards Outstanding | | | Stock Options Outstanding | |
| | | | | Weighted- | | | | | | Weighted- | |
| | | | | Average | | | | | | Average | |
| | Number of | | | Grant Date | | | Number of | | | Exercise | |
(Shares in thousands) | | Shares | | | Fair Value | | | Shares | | | Price | |
Balance, December 31, 2006 | | | 93 | | | $ | 30.98 | | | | 586 | | | $ | 20.62 | |
Granted | | | 66 | | | | 33.06 | | | | 20 | | | | 33.46 | |
Acquired | | | - | | | | - | | | | 172 | | | | 20.43 | |
Stock options exercised | | | - | | | | - | | | | (132 | ) | | | 16.04 | |
Stock awards vested | | | (43 | ) | | | 31.03 | | | | - | | | | - | |
Forfeited | | | (11 | ) | | | 34.56 | | | | (2 | ) | | | 22.30 | |
Balance, December 31, 2007 | | | 105 | | | $ | 31.88 | | | | 644 | | | $ | 21.90 | |
Exercisable options, December 31, 2007 | | | | | | | | | | | 606 | | | $ | 21.46 | |
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The total intrinsic value of options exercised was $1.1 million, $1.9 million, $3.4 million, and $1.8$3.4 million for the years 2008, 2007, and 2006, and 2005, respectively. The total fair value of stock awards vested during these respective years was $1.4 million, $2.1 million, and $2.0 million. As of year end 2007,year-end 2008, unrecognized stock-based compensation expense related to unvested options amounted to $135$50 thousand. This amount is expected to be recognized over a weighted average period of 1.0less than 1 year. The weighted average year-end 2007 intrinsic value of stock options outstanding at year-end 2008 was $3.8$4.1 million, and the similar value of exercisable options was $3.7$4.1 million. The unrecognized stock-based compensation expense relatedpertaining to unvested stock awardsoptions vesting in the years 2008, 2007, and 2006 was $2.0 million. This amount is expected$55 thousand, $187 thousand, and $195 thousand, respectively.
19. FAIR VALUE MEASUREMENTS
Fair Value Hierarchy
Effective January 1, 2008, the Company adopted the provisions of SFAS No. 157, “Fair Value Measurements,” for financial assets and financial liabilities. In accordance with Financial Accounting Standards Board Staff Position (FSP) No. 157-2, “Effective Date of FASB Statement No. 157,” the Company will delay application of SFAS No. 157 for non-financial assets and non-financial liabilities until January 1, 2009. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements.
SFAS No. 157 defines fair value as the price that would be received to be recognized oversell an asset or paid to transfer a weighted average periodliability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of 1.7 years.
a principal market, the most advantageous market for the asset or liability. The following pro forma information presents net income and earnings per share for 2005 as ifprice in the principal (or most advantageous) market used to measure the fair value method of SFAS 123R had been used to measure compensation cost for stock-based compensation plan expense.
(In thousands, except per share data) | | 2005 | |
Net income as reported | | $ | 8,226 | |
Add: Stock-based employee compensation expense included | | | | |
in reported net income, net of related tax effects | | | 822 | |
| | | | |
Less: Total stock-based employee compensation expense | | | | |
determined under fair value method for all awards, net of | | | | |
related tax effects | | | (1,255 | ) |
Pro forma net income | | $ | 7,793 | |
| | | | |
Income per share: | | | | |
Basic - as reported | | $ | 1.16 | |
Basic - pro forma | | | 1.09 | |
| | | | |
Diluted - as reported | | | 1.10 | |
Diluted - pro forma | | | 1.04 | |
Employee Stock Ownership Plan
The Bank had established an Employee Stock Ownership Plan (“ESOP”) for the benefit of certain employees. This plan was terminated by the Bank as of June 30, 2005. A total of 444 thousand shares were held in trust and distributed to plan participants in 2007. These shares were treated as allocated as of July 1, 2005 for purposes of calculating earnings per share.
Berkshire Hills Funding Corporation, a subsidiary of the Company, had providedasset or liability shall not be adjusted for transaction costs. An orderly transaction is a loantransaction that assumes exposure to the Berkshire Bank Employee Stock Ownership Plan Trust which was originally usedmarket for a period prior to purchase the Company’s outstanding stockmeasurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the open market.principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.
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SFAS No. 157 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The loan bore interest equalmarket approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to 9.5%, provided for quarterly paymentsconvert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of interest and principal, and was secured byan asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the unallocated sharesassumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the plan through June 30, 2005. The Bank made contributionscircumstances. In that regard, SFAS No. 157 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the ESOP sufficientlowest priority to support the debt service of the loan and made a $900 thousand prepayment of the loan in June 2005. Following the prepayment, the Board of Directors terminated the plan. As provided in the plan, the outstanding loan was repaid through the sale of 147 thousand shares by the plan to the Company. Those shares were recorded as treasury shares at the June 30, 2005 share closing price of $33.32.
Total expense applicable to the termination of the plan was recorded in the amount of $8.7 million in 2005. The effect on capital of this expense was offset by credits to unearned compensation and additional paid in capital in stockholders’ equity. The Bank recorded an additional $168 thousand in expense related to the termination of the ESOP supplemental executive retirement plan. Additionally, total compensation expense applicable to the operation of the ESOP prior to its termination amounted to $340 thousand for 2005.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In connection with the acquisition of Woronoco, Berkshire Bank assumed the obligations of the Woronoco Savings Bank Employee Stock Ownership Plan. The Woronoco Savings Bank Employee Stock Ownership Plan was terminated by Woronoco Savings Bank as of the effective date of the merger and all outstanding loan obligations under the plan were repaid. Participant shares in the plan totaled 305 thousand shares at year-end 2005 and these shares were distributed to participants in 2006.
16. | FAIR VALUE OF FINANCIAL INSTRUMENTS |
unobservable inputs. The fair value of a financial instrumenthierarchy is as follows:
Level 1 Inputs — Unadjusted quoted prices in active markets for identical assets or liabilities that the current amount that would be exchanged between willing parties,reporting entity has the ability to access at the measurement date.
Level 2 Inputs — Inputs other than quoted prices included in a forced liquidation. Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.
Level 3 Inputs — Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets and financial liabilities carried at fair value effective January 1, 2008.
Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices, for the Company’s various financial instruments.where available. In most cases, wheresuch quoted market prices are not available, and fair value is based on inputs other than quoted prices that are market based or are derived from or corroborated by market data by correlation or other means. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect counterparty credit quality, the Company’s creditworthiness, among other things, as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein.
Recurring fair value measurements of financial instruments
The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of year-end 2008, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value.
| | | | | | | | | | | | | | | | |
| | Level 1 | | | Level 2 | | | Level 3 | | | Total | |
(In thousands) | | Inputs | | | Inputs | | | Inputs | | | Fair Value | |
| | | | | | | | | | | | | | | | |
Trading account security | | $ | — | | | $ | — | | | $ | 18,144 | | | $ | 18,144 | |
Securities available for sale | | | 381 | | | | 272,553 | | | | 1,446 | | | | 274,380 | |
Derivative assets | | | — | | | | 3,740 | | | | — | | | | 3,740 | |
Derivative liabilities | | | — | | | | 24,068 | | | | — | | | | 24,068 | |
Trading Security at Fair Value.The Company holds one security designated as a trading security. It is a tax advantaged economic development bond issued by the Company to a local nonprofit organization which provides wellness and health programs. The determination of the fair value for this security is determined based on a discounted cash flow methodology. Certain of the inputs to the fair value calculation are unobservable and there is little to no market activity in the security. The security meets FAS No.157’s definition of a level 3 security and has been classified as such.
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Securities Available for Sale (“AFS”).AFS securities classified as Level 1 consist of publicly-traded equity securities for which the fair values can be obtained through quoted market prices in active exchange markets. AFS securities classified as Level 2 include certain agency mortgage-backed securities and investment grade-rated municipal bonds and corporate bonds. The pricing on Level 2 was primarily sourced from third party pricing services and is based on models that consider standard input factors such as dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and condition, among other things. Securities classified as Level 3 are structured securities for which fair value is based on issuer- provided financial information or which are priced based on discounted cash flow models that are dependent on unobservable inputs.
Derivative Assets and Liabilities.The valuation of the Company’s interest rate swaps is obtained from a third-party pricing service and is determined using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis is based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves.
The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings.
Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of year-end 2008, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
The table below presents the changes in Level 3 assets that were measured at fair value on a recurring basis for the year-ended 2008.
| | | | | | | | |
| | Assets | |
| | Trading | | | Securities | |
| | Account | | | Available | |
(In thousands) | | Security | | | for Sale | |
| | | | | | | | |
Balance as of January 1, 2008 | | $ | — | | | $ | — | |
| | | | | | | | |
Transfers into Level 3 | | | 18,144 | | | | 1,446 | |
| | | | | | |
Balance as of December 31, 2008 | | $ | 18,144 | | | $ | 1,446 | |
| | | | | | |
| | | | | | | | |
Change in unrealized gains/(losses) relating to instruments still held at the reporting date | | $ | 3,144 | | | $ | (1,799 | ) |
Assets were transferred from Level 2 to Level 3 during 2008 due to low liquidity for the assets and the significance of unobservable inputs in the determination of the assets’ fair values.
Non-recurring fair value measurements of financial instruments
The Company is required, on a non-recurring basis, to adjust the carrying value of certain assets or provide valuation allowances related to certain assets using fair value measurements in accordance with GAAP. The following is a summary of applicable non-recurring fair value measurements.
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Loans.Loans are generally not recorded at fair value on a recurring basis. Periodically, the Company records non-recurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Non-recurring adjustments also include certain impairment amounts for collateral-dependent loans calculated in accordance with SFAS No. 114 when establishing the allowance for credit losses. Such amounts are generally based on the fair value of the underlying collateral supporting the loan and, as a result, the carrying value of the loan less the calculated valuation amount does not necessarily represent the fair value of the loan. Real estate collateral is typically valued using appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace. However, the choice of observable data is subject to significant judgment, and there are often adjustments based on judgment in order to make observable data comparable and to consider the impact of time, the condition of properties, interest rates, and other market factors on current values. Additionally, commercial real estate appraisals frequently involve discounting of projected cash flows, which relies inherently on unobservable data. Therefore, real estate collateral related nonrecurring fair value measurement adjustments have generally been classified as Level 3. Estimates of fair value used for other collateral supporting commercial loans generally are based on assumptions not observable in the marketplace and therefore such valuations have been classified as Level 3. Impaired loans totaling $28.6 million were subject to nonrecurring fair value measurement at year-end 2008. These loans were primarily commercial loans and these measurements were classified as Level 3. Impaired loans with a cost basis of $7.1 million were determined to require a valuation allowance, which was recorded at $1.0 million atyear-end 2008 based on estimated fair value.
Loans held for sale.Loans originated and held for sale are carried at the lower of aggregate cost or market value. Market value is based on committed secondary market prices, which was a Level 2 classification.
Capitalized mortgage loan servicing rights.A loan servicing right asset represents the amount by which the present value of the estimated future net cash flows to be received from servicing loans are expected to more than adequately compensate the Company for performing the servicing. The fair value of servicing rights is estimated using a present value cash flow model. The most important assumptions used in the valuation model are the anticipated rate of the loan prepayments and discount rates. Adjustments are only recorded when the discounted cash flows derived from the valuation model are less than the carrying value of the asset. Although some assumptions in determining fair value are based on standards used by market participants, some are based on unobservable inputs and therefore are classified in Level 3 of the valuation hierarchy.
Summary of estimated fair values of financial instruments
As required under FASB Statement No. 107, “Disclosures about Fair Value of Financial Instruments,” the estimated fair values, and related carrying amounts, of the Company’s financial instruments are as follows. Statement No. 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented herein may not necessarily represent the underlying fair value of the Company.
| | | | | | | | | | | | | | | | |
| | 2008 | | | 2007 | |
| | Carrying | | | Fair | | | Carrying | | | Fair | |
(In thousands) | | Amount | | | Value | | | Amount | | | Value | |
| | | | | | | | | | | | | | | | |
Financial Assets | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 44,798 | | | $ | 44,798 | | | $ | 41,142 | | | $ | 41,142 | |
Trading security | | | 15,000 | | | | 18,144 | | | | — | | | | — | |
Securities available for sale | | | 274,380 | | | | 274,380 | | | | 195,921 | | | | 195,921 | |
Securities held to maturity | | | 25,872 | | | | 26,729 | | | | 39,456 | | | | 39,689 | |
Restricted equity securities | | | 23,120 | | | | 23,120 | | | | 23,120 | | | | 23,120 | |
Net loans | | | 1,984,244 | | | | 1,994,103 | | | | 1,921,900 | | | | 1,964,983 | |
Loans held for sale | | | 1,768 | | | | 1,768 | | | | 3,444 | | | | 3,444 | |
Capitalized mortgage servicing rights | | | 901 | | | | 901 | | | | 1,203 | | | | 1,203 | |
Accrued interest receivable | | | 8,995 | | | | 8,995 | | | | 10,077 | | | | 10,077 | |
Cash surrender value of life insurance policies | | | 35,668 | | | | 35,668 | | | | 35,316 | | | | 35,316 | |
Derivative assets | | | 3,740 | | | | 3,740 | | | | — | | | | — | |
| | | | | | | | | | | | | | | | |
Financial Liabilities | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | |
Total deposits | | $ | 1,829,580 | | | $ | 1,836,921 | | | $ | 1,822,563 | | | $ | 1,827,705 | |
Short-term debt | | | 23,200 | | | | 23,200 | | | | 92,800 | | | | 92,800 | |
Long term Federal Home Loan Bank advances | | | 318,957 | | | | 329,356 | | | | 221,674 | | | | 223,431 | |
Long-term debt | | | 17,000 | | | | 16,683 | | | | 20,000 | | | | 20,054 | |
Junior subordinated debentures | | | 15,464 | | | | 13,403 | | | | 15,464 | | | | 15,506 | |
Derivative liabilities | | | 24,068 | | | | 24,068 | | | | — | | | | — | |
Other than as discussed above, the following methods and assumptions were used by management to estimate the fair value of significant classes of financial instruments for which it is practicable to estimate that value.
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Cash and cash equivalents.Carrying value is assumed to represent fair value for cash and due from banks and short-term investments, which have original maturities of 90 days or less.
Securities held to maturity.Fair values of held to maturity securities are based on quoted market prices of identical or similar securities or dealer quotes when available. In other cases, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates
Cash surrender value of future cash flows. Accordingly, thelife insurance policies.Carrying value is assumed to represent fair value.
Loans, net.The carrying value estimates may not be realized in an immediate settlement of the instrument. Certain financial instrumentsloans in the loan portfolio is based on the cash flows of the loans discounted over their respective loan origination rates. The origination rates are adjusted for substandard and all nonfinancial instruments are excluded from its disclosure requirements.special mention loans to factor the impact of declines in the loan’s credit standing. The aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.loans is estimated by discounting future cash flows using the current interest rates at which similar loans with similar terms would be made to borrowers of similar credit quality.
The following methods and assumptions were used by the Company in estimating fairAccrued interest receivable.Carrying value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts of these instruments approximate fair values.
Securities: Fair values for securities are based on quoted market prices, where available. Non-marketable equity securities areis assumed to haverepresent fair values equal to carrying values. value.
Deposits.The fair value of municipal securities without quoteddemand, non-interest bearing checking, savings and certain money market pricesdeposits is based on discounted cash flow analyses using year-end market rates for similar instruments.
Loans: For variable-rate loans that reprice frequently, fair values are based on carrying values. Fair values for all other loans are estimated using discounted cash flow analyses, using interest rates offered at year-end for loans with similar terms. These values are stated net of the allowance for loan losses, which is the estimated adjustment of fair value due to credit quality.
Non-maturity deposits: The fair values for non-maturity deposits are, by definition, equal todetermined as the amount payable on demand at the reporting date which is their carrying amounts.
Time deposits: Fair values fordate. The fair value of time deposits areis estimated by discounting the estimated future cash flows using a discounted cash flow calculation that applies interestmarket rates offered at year-end for deposits of similar remaining maturities.maturities as of year-end.
Borrowings: Borrowed funds.The fair valuesvalue of borrowings areborrowed funds is estimated using discountedby discounting the future cash flow analysesflows using year-end market rates for similar borrowings. Such funds include all categories of debt and debentures in the table above.
Junior subordinated debentures:debentures.Junior subordinated debentures reprice every ninety days and the carrying amount approximates fair value.
Off-balance-sheet financial instruments: instruments.Fair values for off-balance-sheet lending commitments are immaterial. In its credit commitments, the Company does not normally provide interest rate locks exceeding sixty days, and most credit commitments are for adjustable rate loans.
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The year-end carrying amounts and estimated fair values of the Company’s financial instruments are as follows:
| | 2007 | | | 2006 | |
| | Carrying | | | Fair | | | Carrying | | | Fair | |
(In thousands) | | Amount | | | Value | | | Amount | | | Value | |
| | | | | | | | | | | | |
Financial assets: | | | | | | | | | | | | |
Cash and cash equivalents | | $ | 41,142 | | | $ | 41,142 | | | $ | 30,985 | | | $ | 30,985 | |
Securities available for sale | | | 219,041 | | | | 219,041 | | | | 194,206 | | | | 194,206 | |
Securities held to maturity | | | 39,456 | | | | 39,689 | | | | 39,968 | | | | 39,686 | |
Loans, net | | | 1,921,900 | | | | 1,964,983 | | | | 1,679,617 | | | | 1,683,030 | |
| | | | | | | | | | | | | | | | |
Financial liabilities: | | | | | | | | | | | | | | | | |
Non-maturity deposits | | | 1,094,671 | | | | 1,094,671 | | | | 830,564 | | | | 830,564 | |
Time deposits | | | 727,892 | | | | 733,034 | | | | 691,374 | | | | 692,298 | |
Borrowings | | | 334,474 | | | | 336,231 | | | | 345,005 | | | | 338,669 | |
Junior subordinated debentures | | | 15,464 | | | | 15,464 | | | | 15,464 | | | | 15,464 | |
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instruments. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. These estimates are subjective in nature and require considerable judgment to interpret market data. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange, nor are they intended to represent the fair value of the Company as a whole. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The fair value estimates presented herein are based on pertinent information available to management as of the respective balance sheet dates. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein.
In addition, other assets, such as property and equipment, and liabilities of the Company that are not defined as financial instruments are not included in the above disclosures. Also, nonfinancial instruments typically not recognized in financial statements nevertheless may have value but are not included in the above disclosures. These include, among other items, the estimated earning power of non-maturity deposit accounts, the trained work force, customer goodwill and similar items.
20. OPERATING SEGMENTS
The Company has two reportable operating segments, Banking and Insurance, which are delineated by the consolidated subsidiaries of Berkshire Hills Bancorp. Banking includes the activities of Berkshire Bank and its subsidiaries, which provide retail and commercial banking, along with wealth management and consumer bankinginvestment services. Insurance includes the activities of Berkshire Insurance Group, which provides commercialretail and consumercommercial insurance services. The only other consolidated financial activity of the Company is the Parent, which consists of the transactions of Berkshire Hills Bancorp. Management fees for corporate services provided by the Bank to Berkshire Insurance Group and the Parent are eliminated.
The accounting policies of each reportable segment are the same as those of the Company. The Insurance segment and the Parent reimburse the Bank for administrative services provided to them. Income tax expense for the individual segments is calculated based on the activity of the segments, and the Parent records the tax expense or benefit necessary to reconcile to the consolidated total. The Parent does not allocate capital costs. Average assets include securities available-for-sale based on amortized cost.
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BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the Company’s operating segments was as follows:
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | Total | |
(In thousands) | | Banking | | | Insurance | | | Parent | | | Eliminations | | | Consolidated | |
Year ended December 31, 2008 | | | | | | | | | | | | | | | | | | | | |
Net interest income | | $ | 77,486 | | | $ | — | | | $ | 18,722 | | | $ | (20,468 | ) | | $ | 75,740 | |
Provision for loan losses | | | 4,580 | | | | — | | | | — | | | | — | | | | 4,580 | |
Non-interest income | | | 17,906 | | | | 13,694 | | | | 3,277 | | | | (3,282 | ) | | | 31,595 | |
Non-interest expense | | | 60,448 | | | | 10,450 | | | | 801 | | | | — | | | | 71,699 | |
| | | | | | | | | | | | | | | |
Income before income taxes | | | 30,364 | | | | 3,244 | | | | 21,198 | | | | (23,750 | ) | | | 31,056 | |
Income tax expense (benefit) | | | 8,528 | | | | 1,330 | | | | (1,046 | ) | | | — | | | | 8,812 | |
| | | | | | | | | | | | | | | |
Net income | | $ | 21,836 | | | $ | 1,914 | | | $ | 22,244 | | | $ | (23,750 | ) | | $ | 22,244 | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Average assets (in millions) | | $ | 2,515 | | | $ | 32 | | | $ | 340 | | | $ | (336 | ) | | $ | 2,551 | |
| | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | Total | |
(In thousands) | | Banking | | | Insurance | | | Parent | | | Eliminations | | | Consolidated | |
Year ended December 31, 2007 | | | | | | | | | | | | | | | | | | | | |
Net interest income | | $ | 66,115 | | | $ | — | | | $ | 6,265 | | | $ | (8,455 | ) | | $ | 63,925 | |
Provision for loan losses | | | 4,300 | | | | — | | | | — | | | | — | | | | 4,300 | |
Non-interest income | | | 11,010 | | | | 13,954 | | | | 6,981 | | | | (7,302 | ) | | | 24,643 | |
Non-interest expense | | | 55,198 | | | | 9,919 | | | | 775 | | | | (398 | ) | | | 65,494 | |
| | | | | | | | | | | | | | | |
Income before income taxes | | | 17,627 | | | | 4,035 | | | | 12,471 | | | | (15,359 | ) | | | 18,774 | |
Income tax expense (benefit) | | | 4,746 | | | | 1,557 | | | | (1,064 | ) | | | — | | | | 5,239 | |
| | | | | | | | | | | | | | | |
Net income | | $ | 12,881 | | | $ | 2,478 | | | $ | 13,535 | | | $ | (15,359 | ) | | $ | 13,535 | |
| | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | |
Average assets (in millions) | | $ | 2,229 | | | $ | 31 | | | $ | 378 | | | $ | (376 | ) | | $ | 2,262 | |
| | | | | | | | | | | | | | Total | | |
(In thousands) | | Banking | | | Insurance | | Parent | | | Eliminations | | Consolidated | | |
Year ended December 31, 2007 | | | | | | | | | | | | | | | | |
Net interest income | | $ | 66,115 | | | $ | - | | | $ | 6,265 | | | $ | (8,455 | ) | | $ | 63,925 | | |
Provision for loan losses | | | 4,300 | | | | - | | | | - | | | | - | | | | 4,300 | | |
Net interest income after provision for loan losses | | | 61,815 | | | | - | | | | 6,265 | | | | (8,455 | ) | | | 59,625 | | |
Non-interest income | | | 11,010 | | | | 13,954 | | | | 6,981 | | | | (7,302 | ) | | | 24,643 | | |
Non-interest expense | | | 55,198 | | | | 9,919 | | | | 775 | | | | (398 | ) | | | 65,494 | | |
Income (loss) before income taxes | | | 17,627 | | | | 4,035 | | | | 12,471 | | | | (15,359 | ) | | | 18,774 | | |
Income tax expense (benefit) | | | 4,746 | | | | 1,557 | | | | (1,064 | ) | | | - | | | | 5,239 | | |
Net income (loss) | | $ | 12,881 | | | $ | 2,478 | | | $ | 13,535 | | | $ | (15,359 | ) | | $ | 13,535 | | |
| | | | | | | | | | | | | | | | | | | | | |
Average assets(in millions) | | $ | 2,229 | | | $ | 31 | | | $ | 378 | | | $ | (376 | ) | | $ | 2,262 | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | Total | | | Total | |
(In thousands) | | Banking | | | Insurance | | Parent | | | Eliminations | | Consolidated | | | Banking | | Insurance | | Parent | | Eliminations | | Consolidated | |
Year ended December 31, 2006 | | | | | | | | | | | | | | | | | | | | | |
Net interest income | | $ | 61,478 | | | $ | - | | | $ | 13,741 | | | $ | (14,979 | ) | | $ | 60,240 | | |
Net Interest income | | | $ | 61,478 | | $ | — | | $ | 13,741 | | $ | (14,979 | ) | | $ | 60,240 | |
Provision for loan losses | | | 7,860 | | | | - | | | | - | | | | - | | | | 7,860 | | | 7,860 | | — | | — | | — | | 7,860 | |
| | | | | | | | | | | | |
Net interest income after provision for loan losses | | | 53,618 | | | | - | | | | 13,741 | | | | (14,979 | ) | | | 52,380 | | | 53,618 | | — | | 13,741 | | | (14,979 | ) | | 52,380 | |
Non-interest income | | | 8,321 | | | | 3,811 | | | | - | | | | (84 | ) | | | 12,048 | | | 8,321 | | 3,811 | | — | | | (84 | ) | | 12,048 | |
Non-interest expense | | | 44,865 | | | | 3,372 | | | | 3,630 | | | | (2,999 | ) | | | 48,868 | | | 44,865 | | 3,372 | | 3,630 | | | (2,999 | ) | | 48,868 | |
| | | | | | | | | | | | |
Income (loss) from continuing operations before income taxes | | | 17,074 | | | | 439 | | | | 10,111 | | | | (12,064 | ) | | | 15,560 | | | 17,074 | | 439 | | 10,111 | | | (12,064 | ) | | 15,560 | |
Income tax expense (benefit) | | | 5,273 | | | | 176 | | | | (781 | ) | | | - | | | | 4,668 | | | 5,273 | | 176 | | | (781 | ) | | — | | 4,668 | |
| | | | | | | | | | | | |
Net income (loss) from continuing operations | | | 11,801 | | | | 263 | | | | 10,892 | | | | (12,064 | ) | | | 10,892 | | | 11,801 | | 263 | | 10,892 | | | (12,064 | ) | | 10,892 | |
| | | | | | | | | | | | |
Net income from discontinued operations | | | - | | | | - | | | | 371 | | | | - | | | | 371 | | | — | | — | | 371 | | — | | 371 | |
| | | | | | | | | | | | |
Net income (loss) | | $ | 11,801 | | | $ | 263 | | | $ | 11,263 | | | $ | (12,064 | ) | | $ | 11,263 | | | $ | 11,801 | | $ | 263 | | $ | 11,263 | | $ | (12,064 | ) | | $ | 11,263 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | |
Average assets(in millions) | | $ | 2,103 | | | $ | 10 | | | $ | 289 | | | $ | (286 | ) | | $ | 2,116 | | | $ | 2,103 | | $ | 10 | | $ | 289 | | $ | (286 | ) | | $ | 2,116 | |
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED21. CONDENSED FINANCIAL STATEMENTS
18. | CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY |
OF PARENT COMPANY
Condensed financial information pertaining only to the parent company, Berkshire Hills Bancorp, Inc., is as follows:
CONDENSED BALANCE SHEETS
| | | | | | | | |
| | December 31, | |
(In thousands) | | 2008 | | | 2007 | |
Assets | | | | | | | | |
| | | | | | | | |
Cash due from Berkshire Bank | | $ | 46,529 | | | $ | 8,804 | |
Investment in subsidiaries | | | 389,982 | | | | 364,808 | |
Other assets | | | 5,745 | | | | 4,007 | |
| | | | | | |
Total assets | | $ | 442,256 | | | $ | 377,619 | |
| | | | | | |
| | | | | | | | |
Liabilities and Stockholders’ Equity | | | | | | | | |
|
Accrued expenses payable | | $ | 1,367 | | | $ | 318 | |
Notes payable | | | 17,000 | | | | 35,000 | |
Junior subordinated debentures | | | 15,464 | | | | 15,464 | |
Stockholders’ equity | | | 408,425 | | | | 326,837 | |
| | | | | | |
Total liabilities and stockholders’ equity | | $ | 442,256 | | | $ | 377,619 | |
| | | | | | |
| | December 31, | |
(In thousands) | | 2007 | | | 2006 | |
Assets | | | | | | |
| | | | | | |
Cash due from Berkshire Bank | | $ | 8,804 | | | $ | 5,520 | |
Investment in subsidiaries | | | 364,808 | | | | 278,328 | |
Other assets | | | 4,007 | | | | 5,259 | |
Total assets | | $ | 377,619 | | | $ | 289,107 | |
| | | | | | | | |
Liabilities and Stockholders' Equity | | | | | | | | |
| | | | | | | | |
Accrued expenses payable | | $ | 318 | | | $ | 482 | |
Notes payable | | | 35,000 | | | | 15,000 | |
Junior subordinated debentures | | | 15,464 | | | | 15,464 | |
Stockholders' equity | | | 326,837 | | | | 258,161 | |
Total liabilities and stockholders' equity | | $ | 377,619 | | | $ | 289,107 | |
CONDENSED STATEMENTS OF INCOME
| | | | | | | | | | | | |
| | Years Ended December 31, | |
(In thousands) | | 2008 | | | 2007 | | | 2006 | |
| | | | | | | | | | | | |
Income: | | | | | | | | | | | | |
Dividends from subsidiaries | | $ | 20,500 | | | $ | 8,445 | | | $ | 15,087 | |
Other | | | 27 | | | | 113 | | | | 606 | |
| | | | | | | | | |
Total income | | | 20,527 | | | | 8,558 | | | | 15,693 | |
| | | | | | | | | |
Interest expense | | | 1,778 | | | | 2,227 | | | | 1,271 | |
Operating expenses | | | 801 | | | | 775 | | | | 714 | |
| | | | | | | | | |
Total expense | | | 2,579 | | | | 3,002 | | | | 1,985 | |
Income before income taxes and equity in undistributed income of subsidiaries | | | 17,948 | | | | 5,556 | | | | 13,708 | |
Income tax benefit | | | (1,046 | ) | | | (1,064 | ) | | | (471 | ) |
| | | | | | | | | |
Income before equity in undistributed income of subsidiaries | | | 18,994 | | | | 6,620 | | | | 14,179 | |
Equity in undistributed income (loss) of subsidiaries | | | 3,250 | | | | 6,915 | | | | (2,916 | ) |
| | | | | | | | | |
| | | | | | | | | | | | |
Net income | | $ | 22,244 | | | $ | 13,535 | | | $ | 11,263 | |
| | | | | | | | | |
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| | Years Ended December 31, |
(In thousands) | | 2007 | | | 2006 | | | 2005 | |
| | | | | | | | | |
Income: | | | | | | | | | |
Dividends from subsidiaries | | $ | 8,445 | | | $ | 15,087 | | | $ | 43,255 | |
Other | | | 113 | | | | 606 | | | | 67 | |
Total income | | | 8,558 | | | | 15,693 | | | | 43,322 | |
Interest expense | | | 2,227 | | | | 1,271 | | | | 450 | |
Operating expenses | | | 775 | | | | 714 | | | | 325 | |
Total expense | | | 3,002 | | | | 1,985 | | | | 775 | |
Income before income taxes and equity in | | | | | | | | | | | | |
undistributed income of subsidiaries | | | 5,556 | | | | 13,708 | | | | 42,547 | |
Income tax benefit | | | (1,064 | ) | | | (471 | ) | | | (153 | ) |
Income before equity in undistributed | | | | | | | | | | | | |
income of subsidiaries | | | 6,620 | | | | 14,179 | | | | 42,700 | |
Equity in undistributed income (loss) of subsidiaries | | | 6,915 | | | | (2,916 | ) | | | (34,474 | ) |
| | | | | | | | | | | | |
Net income | | $ | 13,535 | | | $ | 11,263 | | | $ | 8,226 | |
BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONDENSED STATEMENTS OF CASH FLOWS
| | | | | | | | | | | | |
| | Years Ended December 31, | |
(In thousands) | | 2008 | | | 2007 | | | 2006 | |
Cash flows from operating activities: | | | | | | | | | | | | |
Net income | | $ | 22,244 | | | $ | 13,535 | | | $ | 11,263 | |
Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | | | |
Equity in undistributed (income) loss of subsidiaries | | | (3,250 | ) | | | (6,915 | ) | | | 2,916 | |
Other, net | | | (2,588 | ) | | | (1,615 | ) | | | (2,359 | ) |
| | | | | | | | | |
Net cash provided by operating activities | | | 16,406 | | | | 5,005 | | | | 11,820 | |
| | | | | | | | | |
| | | | | | | | | | | | |
Cash flows from investing activities: | | | | | | | | | | | | |
Investment in insurance subsidiary | | | — | | | | — | | | | (28,843 | ) |
Investment in bank subsidiary | | | (32,500 | ) | | | — | | | | — | |
Net cash paid for Factory Point acquisition | | | — | | | | (12,665 | ) | | | — | |
Purchase of investment securities | | | (300 | ) | | | (120 | ) | | | (300 | ) |
| | | | | | | | | |
Net cash used by investing activities | | | (32,800 | ) | | | (12,785 | ) | | | (29,143 | ) |
| | | | | | | | | |
| | | | | | | | | | | | |
Cash flows from financing activities: | | | | | | | | | | | | |
Net (repayment of) proceeds from notes payable | | | (18,000 | ) | | | 20,000 | | | | 15,000 | |
Net proceeds from issuance of preferred stock and warrant | | | 40,000 | | | | | | | | | |
Net proceeds from issuance of common stock | | | 38,521 | | | | — | | | | — | |
Proceeds from reissuance of treasury stock | | | 5,315 | | | | 4,284 | | | | 5,218 | |
Payments to acquire treasury stock | | | (4,880 | ) | | | (7,822 | ) | | | (2,876 | ) |
Cash dividends declared and paid | | | (6,837 | ) | | | (5,398 | ) | | | (4,834 | ) |
| | | | | | | | | |
Net cash provided by financing activities | | | 54,119 | | | | 11,064 | | | | 12,508 | |
| | | | | | | | | |
| | | | | | | | | | | | |
Net change in cash and cash equivalents | | | 37,725 | | | | 3,284 | | | | (4,815 | ) |
|
Cash and cash equivalents at beginning of year | | | 8,804 | | | | 5,520 | | | | 10,335 | |
| | | | | | | | | |
|
Cash and cash equivalents at end of year | | $ | 46,529 | | | $ | 8,804 | | | $ | 5,520 | |
| | | | | | | | | |
22. DISCONTINUED OPERATIONS | | Years Ended December 31, | |
(In thousands) | | 2007 | | | 2006 | | | 2005 | |
| | | | | | | | | |
Cash flows from operating activities: | | | | | | | | | |
Net income | | $ | 13,535 | | | $ | 11,263 | | | $ | 8,226 | |
Adjustments to reconcile net income | | | | | | | | | | | | |
to net cash provided by operating activities: | | | | | | | | | | | | |
Equity in undistributed (income) loss of subsidiaries | | | (6,915 | ) | | | 2,916 | | | | 34,474 | |
Other, net | | | 1,207 | | | | (2,359 | ) | | | (1,394 | ) |
Net cash provided by operating activities | | | 7,827 | | | | 11,820 | | | | 41,306 | |
| | | | | | | | | | | | |
Cash flows from investing activities: | | | | | | | | | | | | |
Investment in insurance subsidiary | | | - | | | | (28,843 | ) | | | - | |
Investment in bank subsidiary | | | - | | | | - | | | | (14,898 | ) |
Liquidation of Berkshire Hills Funding Corporation | | | - | | | | - | | | | 6,680 | |
Net cash paid for Factory Point acquisition | | | (12,665 | ) | | | - | | | | - | |
Net cash paid for Woronoco acquisition | | | - | | | | - | | | | (35,088 | ) |
Purchase of investment securities | | | (120 | ) | | | (300 | ) | | | - | |
Net cash used by investing activities | | | (12,785 | ) | | | (29,143 | ) | | | (43,306 | ) |
| | | | | | | | | | | | |
Cash flows from financing activities: | | | | | | | | | | | | |
Net proceeds from notes payable | | | 20,000 | | | | 15,000 | | | | - | |
Proceeds from junior subordinated debentures | | | - | | | | - | | | | 15,464 | |
Proceeds from reissuance of treasury stock | | | 1,462 | | | | 5,218 | | | | 2,329 | |
Payments to acquire treasury stock | | | (7,822 | ) | | | (2,876 | ) | | | (7,953 | ) |
Cash dividends paid | | | (5,398 | ) | | | (4,834 | ) | | | (3,707 | ) |
Net cash provided by financing activities | | | 8,242 | | | | 12,508 | | | | 6,133 | |
| | | | | | | | | | | | |
Net change in cash and cash equivalents | | | 3,284 | | | | (4,815 | ) | | | 4,133 | |
| | | | | | | | | | | | |
Cash and cash equivalents at beginning of year | | | 5,520 | | | | 10,335 | | | | 6,202 | |
| | | | | | | | | | | | |
Cash and cash equivalents at end of year | | $ | 8,804 | | | $ | 5,520 | | | $ | 10,335 | |
19. | DISCONTINUED OPERATIONS |
On June 18,In 2004, the business assets of EastPoint Technologies, LLC were sold to a subsidiary of Open Solutions Inc. for $7.0 million. EastPoint was a vendor of bank core systems software.vendor, were sold. The Company owned a 60% interest in EastPoint, with the remaining 40% interest recorded as minority interest. Net of escrows and minority interest, the Company received $2.6 million in net cash proceeds. The transaction resulted in a net loss of $75 thousand ($50 thousand after taxes), which was included in the net loss from discontinued operations in 2004. The Company recorded contingent revenue receipts of $606 thousand in 2006. There were no contingent future revenues remaining at year-end 2006. Net income and cash flows related to EastPoint have been reclassified in 2006 as related to discontinued operations in the financial statements.
23. SUBSEQUENT EVENTS
On February 17, 2009, the President of the United States signed the American Recovery and Reinvestment Act. This Act contained several additional terms applicable retroactively to Banks participating in the U.S. Treasury Capital Purchase Program. Berkshire Hills Bancorp issued $40 million of preferred stock in 2008 under this program. The additional terms include additional restrictions on executive compensation and corporate governance procedures. Additionally, the Act eliminated the preferred stock redemption restrictions which were part of the original purchase program agreement, but continued to require approval of any redemption by bank regulatory authorities during an initial period.
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On February 26, 2009, the Federal Home Loan Bank of Boston announced a 2008 annual loss of $73 million. The FHLBB suspended its first quarter dividend and announced that 2009 dividend payments are unlikely. The FHLBB stated that it meets all of its regulatory capital requirements and remains confident of its ability to fulfill its core mission of providing liquidity to member banks. Berkshire Bank’s investment in the FHLBB totaled $21 million at year-end 2008. It recorded dividend income of $821 thousand in 2008 from FHLBB dividends.
On February 27, 2009, the FDIC announced a 0.20% emergency special assessment on the industry on June 30, 2009, payable on September 30, 2009. This assessment would equal $3.7 million based on Berkshire Bank’s deposits as of year-end 2008. It also announced that, under its interim rule, it is permitted to charge an additional emergency special assessment up to 0.10% after June 30, 2009 if necessary to maintain public confidence in federal deposit insurance. It additionally announced increases in ongoing FDIC deposit insurance premium assessments, along with changes in the assessment system. On March 6, 2009, the FDIC announced that it may reduce the June 30, 2009 special assessment if Congress passes legislation to increase the FDIC’s borrowing authority. In 2008, the Company recorded FDIC insurance premium expense of $760 thousand. BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
20. | QUARTERLY DATA (UNAUDITED) |
24. QUARTERLY DATA (UNAUDITED)
Quarterly results of operations were as follows. Quarterly data may not sum to annual datafollows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 2008 | | | 2007 | |
| | Fourth | | | Third | | | Second | | | First | | | Fourth | | | Third | | | Second | | | First | |
(In thousands, except per share data) | | Quarter | | | Quarter | | | Quarter | | | Quarter | | | Quarter | | | Quarter | | | Quarter | | | Quarter | |
|
Interest and dividend income | | $ | 32,762 | | | $ | 33,092 | | | $ | 32,834 | | | $ | 34,523 | | | $ | 35,849 | | | $ | 32,631 | | | $ | 31,994 | | | $ | 31,470 | |
Interest expense | | | 13,292 | | | | 13,763 | | | | 14,187 | | | | 16,229 | | | | 17,631 | | | | 17,152 | | | | 16,956 | | | | 16,280 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income | | | 19,470 | | | | 19,329 | | | | 18,647 | | | | 18,294 | | | | 18,218 | | | | 15,479 | | | | 15,038 | | | | 15,190 | |
Non-interest income | | | 6,377 | | | | 7,235 | | | | 8,511 | | | | 9,472 | | | | 7,069 | | | | 2,444 | | | | 6,893 | | | | 8,237 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total revenue | | | 25,847 | | | | 26,564 | | | | 27,158 | | | | 27,766 | | | | 25,287 | | | | 17,923 | | | | 21,931 | | | | 23,427 | |
Provision for loan losses | | | 1,400 | | | | 1,250 | | | | 1,105 | | | | 825 | | | | 3,060 | | | | 390 | | | | 100 | | | | 750 | |
Non-interest expense | | | 17,256 | | | | 17,737 | | | | 18,632 | | | | 18,074 | | | | 18,393 | | | | 16,589 | | | | 15,103 | | | | 15,409 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Income before income taxes | | | 7,191 | | | | 7,577 | | | | 7,421 | | | | 8,867 | | | | 3,834 | | | | 944 | | | | 6,728 | | | | 7,268 | |
Income tax expense | | | 1,985 | | | | 2,301 | | | | 1,708 | | | | 2,818 | | | | 761 | | | | — | | | | 2,152 | | | | 2,326 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net income | | $ | 5,206 | | | $ | 5,276 | | | $ | 5,713 | | | $ | 6,049 | | | $ | 3,073 | | | $ | 944 | | | $ | 4,576 | | | $ | 4,942 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Basic earnings per share | | $ | 0.44 | | | $ | 0.51 | | | $ | 0.55 | | | $ | 0.58 | | | $ | 0.29 | | | $ | 0.11 | | | $ | 0.52 | | | $ | 0.57 | |
Diluted earnings per share | | $ | 0.44 | | | $ | 0.51 | | | $ | 0.55 | | | $ | 0.58 | | | $ | 0.29 | | | $ | 0.11 | | | $ | 0.52 | | | $ | 0.56 | |
2008 quarterly interest income and expense declined due to rounding.
| | 2007 | | | 2006 |
| | Fourth | | | Third | | | Second | | | First | | | Fourth | | | Third | | | Second | | | First | |
(In thousands, except per share data) | | Quarter | | | Quarter | | | Quarter | | | Quarter | | | Quarter | | | Quarter | | | Quarter | | | Quarter | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Interest and dividend income | | $ | 35,849 | | | $ | 32,631 | | | $ | 31,994 | | | $ | 31,470 | | | $ | 31,381 | | | $ | 31,388 | | | $ | 28,212 | | | $ | 27,070 | |
Interest expense | | | 17,631 | | | | 17,152 | | | | 16,956 | | | | 16,280 | | | | 15,810 | | | | 15,785 | | | | 13,754 | | | | 12,462 | |
Net interest income | | | 18,218 | | | | 15,479 | | | | 15,038 | | | | 15,190 | | | | 15,571 | | | | 15,603 | | | | 14,458 | | | | 14,608 | |
Non-interest income | | | 7,069 | | | | 2,444 | | | | 6,893 | | | | 8,237 | | | | 5,831 | | | | (1,784 | ) | | | 3,910 | | | | 4,091 | |
Total revenue | | | 25,287 | | | | 17,923 | | | | 21,931 | | | | 23,427 | | | | 21,402 | | | | 13,819 | | | | 18,368 | | | | 18,699 | |
Provision for loan losses | | | 3,060 | | | | 390 | | | | 100 | | | | 750 | | | | 785 | | | | 6,185 | | | | 600 | | | | 290 | |
Non-interest expense | | | 18,393 | | | | 16,589 | | | | 15,103 | | | | 15,409 | | | | 14,652 | | | | 11,353 | | | | 11,638 | | | | 11,225 | |
Income from continuing operations before | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
income taxes | | | 3,834 | | | | 944 | | | | 6,728 | | | | 7,268 | | | | 5,965 | | | | (3,719 | ) | | | 6,130 | | | | 7,184 | |
Income taxes-continuing operations | | | 761 | | | | - | | | | 2,152 | | | | 2,326 | | | | 1,880 | | | | (1,466 | ) | | | 1,888 | | | | 2,366 | |
Income (loss) from continuing operations | | | 3,073 | | | | 944 | | | | 4,576 | | | | 4,942 | | | | 4,085 | | | | (2,253 | ) | | | 4,242 | | | | 4,818 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net income from discontinued operations | | | - | | | | - | | | | - | | | | - | | | | 18 | | | | 133 | | | | 221 | | | | - | |
Net income (loss) | | $ | 3,073 | | | $ | 944 | | | $ | 4,576 | | | $ | 4,942 | | | $ | 4,103 | | | $ | (2,120 | ) | | $ | 4,463 | | | $ | 4,818 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Basic earnings (loss) per share | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Continuing operations | | $ | 0.29 | | | $ | 0.11 | | | $ | 0.52 | | | $ | 0.57 | | | $ | 0.48 | | | $ | (0.26 | ) | | $ | 0.50 | | | $ | 0.57 | |
Discontinued operations | | | - | | | | - | | | | - | | | | - | | | | - | | | | 0.01 | | | | 0.02 | | | | - | |
Net income (loss) | | $ | 0.29 | | | $ | 0.11 | | | $ | 0.52 | | | $ | 0.57 | | | $ | 0.48 | | | $ | (0.25 | ) | | $ | 0.52 | | | $ | 0.57 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Diluted earnings (loss) per share | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Continuing operations | | $ | 0.29 | | | $ | 0.11 | | | $ | 0.52 | | | $ | 0.56 | | | $ | 0.47 | | | $ | (0.26 | ) | | $ | 0.48 | | | $ | 0.55 | |
Discontinued operations | | | - | | | | - | | | | - | | | | - | | | | - | | | | 0.01 | | | | 0.03 | | | | - | |
Net income (loss) | | $ | 0.29 | | | $ | 0.11 | | | $ | 0.52 | | | $ | 0.56 | | | $ | 0.47 | | | $ | (0.25 | ) | | $ | 0.51 | | | $ | 0.55 | |
declining interest rates, but net interest income increased and the net interest margin reached the highest level since 2003, including the benefit of improved pricing spreads between loans and deposits. Non-interest income included the seasonal benefit of contingent insurance revenues in the first half of the year. Non-interest expense included $683 thousand in charges in the second quarter related to severance payments and reversals of deferred loan costs and late fees receivable. Fourth quarter non-interest expense included the benefit of lower incentive compensation accruals. Second quarter income tax expense included the benefit of a credit resulting from the reduction in the valuation reserve for deferred state tax assets due to higher taxable income in Berkshire Bank. Fourth quarter earnings per share reflected the issuance of 1.7 million additional common shares in a public common stock offering.
2007 quarterly interest and dividend income continuedincreased due to grow at a steady pace in accordance with organic growth and continued branch expansion in ourthe Company’s New York region, andtogether with the benefit of the Factory Point acquisition innear the end of the third quarter of 2007.quarter. Third quarter non-interest income was $2.4 million due toreduced by $3.8 million in losses,charges due to the execution of an $82 million deleverage strategy. First and second quarter non-intereststrategy related to the Factory Point acquisition. Non-interest income was up primarily fromincluded the newly acquiredseasonal benefit of contingent insurance agencies and the associated contingent premium revenues collected in the first and second quarterhalf of 2007.the year. The provision for loan losses increased in the fourth quarter due to a $2.5 million charge-off related to one commercial credit with borrower fraud. Third and fourth quarter non-interest expense increased primarily due to the Factory Point acquisition.
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2006 quarterly interest and dividend income continued to grow at a steady pace in accordance with organic growth and continued branch expansion in our New York region, and paused in the fourth quarter due to the deleveraging. Third quarter non-interest income was ($1.8) million due to $5.1 million in net securities losses, resulting from an investment portfolio repositioning. Fourth quarter non-interest income included two months of revenues from newly acquired insurance agencies. The provision for loan losses increased in the third quarter due to higher estimated loan losses reflecting economic changes observed in the third quarter. Fourth quarter non-interest expense increased primarily due to the insurance agency acquisitions. Income from discontinued operations reflected final contingency payments received from the sale of the company’s data processing subsidiary in 2004.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTINGACCOUNTING AND FINANCIAL DISCLOSURE None.
ITEM 9A. CONTROLSCONTROLS AND PROCEDURES The Company’s management, including the Company’s principal executive officer and principal financial officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”) (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
No change in the Company’s internal control over financial reporting occurred during the quarter ended December 31, 20072008 that has materially affected, or is reasonably likely to affect, the Company’s internal control over financial reporting. There was a vacancy in the position of the Company’s Controller during the period in which this Form 10-K was prepared. The Company utilized other internal resources and contracted external resources to prepare the financial statements and this Form 10-K, and management concluded that this did not materially affect the Company’s internal control over financial reporting. Management’s report on internal control over financial reporting and Wolf & Company, P.C.’s attestation report on management’s assessment of Berkshire Hills’the Company’s internal control over financial reporting are contained in “Item 8 – Financial Statements and Supplementary Data” in this annual report in Form 10-K.
ITEM 9B. OTHER INFORMATIONINFORMATION Other Events
The annual meeting of stockholders will be held on Thursday, May 15, 20087, 2009 at the Crowne Plaza Hotel, One West Street, Pittsfield, Massachusetts.
ITEM 10. DIRECTORSDIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT For information concerning the directors of the Company, the information contained under the sections captioned “Items to be Voted on by Stockholders – Item 1 --— Election of Directors” in Berkshire Hills’ Proxy Statement for the 20082009 Annual Meeting of Stockholders (“Proxy Statement”) is incorporated by reference.
The following table sets forth certain information regarding the executive officers of Berkshire Hills, Berkshire Bank and Berkshire Insurance Group.
| | | | | | |
Name | | | Age | | | Position |
| | | | | | |
Michael P. Daly | 46 | | 47 | | | President and Chief Executive Officer |
Kevin P. Riley | 48 | | 49 | | | Executive Vice President, Chief Financial Officer and Treasurer |
Michael J. Oleksak | 49 | | 50 | | | Executive Vice President of Commercial Banking |
Guy H. BoyerShepard D. Rainie | 53 | | 56 | | | Executive Vice President of Retail Bankingand Chief Risk Officer |
Ross D. GormanJohn Millet | 57 | | 43 | | | President and Chief Executive Officer -— Berkshire Insurance Group |
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The executive officers are elected annually and hold office until their successors have been elected and qualified or until they are removed or replaced. The Mr. Daly is employed pursuant to a two yearthree-year employment agreement which renews automatically if not otherwise terminated pursuant to its terms. Mr. Gorman is employed pursuant to an emplyment agreement with a term expiring in December 31, 2009.
BIOGRAPHICAL INFORMATION
Michael P. Daly was appointedis President and Chief Executive Officer of the Company and the Bank in October 2002. Prior to his appointment,Bank. Before these appointments, Mr. Daly served as Senior Vice President, Commercial Lending from October 1997 until January 2000 and then as Executive Vice President and Senior Loan Officer of the CompanyBank. He has been an employee of the Bank since 1986. Age 47. He has served as a Director of the company and the Bank from January 2000 to Octobersince 2002.
Kevin P. Rileyserves as Executive Vice President, Chief Financial Officer, Treasurer, and Treasurer.Secretary of the Company and the Bank. Mr. Riley joined the Company on August 1, 2007. In addition to Finance, Mr. Riley also manages the Company’s Information Technology and Deposit Operations departments. Mr. Riley chairs the Company’s Asset/Liability Committee and he co-chairs the Pricing Committee. Prior to joining the Company, Mr. Riley was Executive Vice President for Client Information and Relationship Management with KeyCorp where he was responsible for bank-wide customer relationship management, data governance and facilities. Previously from 1996 to 2002, he served as Executive Vice President and Chief Financial Officer of KeyBank National Association, Key Corp'sCorp’s flagship community bank and was a member of its executive team.
Michael J. Oleksakserves as Executive Vice President of Commercial Banking and Regional President of Pioneer Valley. Mr. Oleksak joined the Company and the Bank in February 2006 as Regional President for the Pioneer Valley, a position he continues to hold.. Mr. Oleksak is responsible for the development and implementation of all commercial banking strategies, including products, pricing and geography. Prior to joiningHe is responsible for all of the Company’s commercial lending activities, including small business lending. He also manages commercial loan collections, government banking, commercial cash management services, and commercial sales of derivative financial instruments. Mr. Oleksak joined the Company and the Bank in February 2006 as Regional President for the Pioneer Valley. Mr. Oleksak was Senior Vice President and Co-Regional Executive of Western Massachusetts at TD Banknorth. During his 26 year banking career, Mr. Oleksak has had extensive commercial lending experience throughout New England, and served in various capacities at Fleet Bank and Shawmut Bank.
Guy H. BoyerShepard D. Rainieserves as Executive Vice President of Retail Banking. Mr. Boyer, a Certified Public Accountant, was formerly President and Chief Risk Officer. He is responsible for all of the Company’s risk management monitoring and controls. Departments that he manages include the commercial credit department, loan review, loan documentation, internal audit, compliance, and the legal department. Mr. Rainie chairs Berkshire Bank’s Executive OfficerLoan Committee and Asset Quality Committee. He coordinates the Board’s Risk Management Committee and Audit Committee and advises the Board’s Compensation Committee on risk management aspects of Factory Point Bancorpcompensation policy. Mr. Rainie joined the Company in Manchester Center, Vermont from 1997 through September 2007 when the institutionAugust 2006. Most of his career was acquired by Berkshire. From 1980 to 1997 Mr. Boyerspent with Bank of America and its predecessor banks, Fleet Bank and First National Bank of Boston where he most recently served as Vice President and Senior Trust Officer, Senior Vice President — Credit Review and Chief Financial Officer and Executive Vice President/prior to that as Managing Director and Chief Administrative Officer in charge of Commercial Banking, Heritage Bancorp in Pottsville, Pennsylvania. Mr. Boyer is a member of the American Institute of Certified Public Accountants and has served on numerous community boards. Mr. Boyer currently is a speaker at the Northern New England School of Banking, at the University of New Hampshire. He currently serves on the boards of the Maple Street School, as Chairman of Blue Cross/Blue Shield of Vermont and the executive committee of the Vermont Bankers Association.— Strategic Risk Management — Credit Review.
Ross D. GormanJohn S. Milletserves as President and Chief Executive Officer of Berkshire Insurance Group, Inc. His current position is to coordinateGroup. He manages the integration of five independent agencies that were merged into Berkshire Insurance Group, Inc. in November of 2006. The newCompany���s insurance agency subsidiary which is one of the largest in New England with ten offices, almost 100 employees and over $80$70 million in premium volume. Mr. Gorman is a CPCU, RPLU, LicensedMillet joined Berkshire Bank in May 2005 to oversee development of strategic risk management and profitability measurement policies and systems. He was subsequently promoted to Controller and then interim Chief Financial Officer of the Company and the Bank. He joined Berkshire Insurance Advisor.Group as Chief Operating Officer in August 2007 and was promoted to his current position in July 2008. Prior to joining the CompanyBank, Mr. Millet was a senior operating officer for a medical services company in November 2006,Pittsfield. In his 17-year career as a certified public accountant, Mr. Gorman was President of MassOne Insurance Agency, Inc.Millet has also worked in Greenfield, Massachusetts since 1980.
public accounting and as a financial consultant to Fortune 50 companies.
Reference is made to the cover page of this report and to the section captioned “Other Information Relating to Directors and Executive Officers -— Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement for information regarding compliance with Section 16(a) of the Exchange Act. For information concerning the audit committee and the audit committee financial expert, reference is made to the section captioned “Corporate Governance – Committees of the Board of Directors –— Audit Committee” in the Proxy Statement.
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For information concerning the Company’s code of ethics, the information contained under the section captioned “Corporate Governance –— Code of Business Conduct” in the Proxy Statement is incorporated by reference. A copy of the Company’s code of ethics is available to stockholders on the Company’s website at “www.berkshirebank.com.”
ITEM 11. EXECUTIVEEXECUTIVE COMPENSATION For information regarding executive compensation, the sections captioned“Compensation Discussion and Analysis,” “Executive Compensation”and“Director Compensation”in the Proxy Statement are incorporated herein by reference.
For information regarding the compensation committee report, the section captioned“Compensation Committee Report”in the Proxy Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIPOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS | (a) | | Security Ownership of Certain Beneficial Owners |
Information required by this item is incorporated herein by reference to the section captioned “Stock Ownership” in the Proxy Statement.
|
| | | Information required by this item is incorporated herein by reference to the section captioned“Stock Ownership”in the Proxy Statement. | | (b) | | Security Ownership of Management | Information required by this item is incorporated herein by reference to the section captioned “Stock Ownership” in the Proxy Statement.
|
|
| | | Information required by this item is incorporated herein by reference to the section captioned“Stock Ownership”in the Proxy Statement. | | (c) | | Changes in Control | Management of Berkshire Hills knows of no arrangements, including any pledge by any person of securities of Berkshire Hills, the operation of which may at a subsequent date result in a change in control of the registrant.
| | | | Management of Berkshire Hills knows of no arrangements, including any pledge by any person of securities of Berkshire Hills, the operation of which may at a subsequent date result in a change in control of the registrant. | | | (d) | | Equity Compensation Plan Information | | | | | The following table sets forth information, as of December 31, 2008, about Company common stock that may be issued upon exercise of options under stock-based benefit plans maintained by the Company. |
| | | | | | | | | | | | | | | | | | | | | | | Number of securities | | | | Number of securities | | | | | | | remaining available for | | | | to be issued upon | | | Weighted-average | | | future issuance under | | | | exercise of | | | exercise price of | | | equity compensation plans | | | | outstanding options, | | | outstanding options, | | | (excluding securities | | Plan category | | warrants and rights | | | warrants and rights | | | reflected in the first column) | | | | | | | | | | | | | | | Equity compensation plans approved by security holders | | | 453,000 | | | $ | 23.00 | | | | 261,000 | | | | | | | | | | | | | | | Equity compensation plans not approved by security holders | | | — | | | | — | | | | — | | | | | | | | | | | | | | | | | | | | | | | | | Total | | | 453,000 | | | $ | 23.00 | | | | 261,000 | | | | | | | | | | | |
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Information required by this Item is incorporated herein by reference to the section captioned “Items to be Voted on by Stockholders – Item 2 – Approval of Amendment to the Berkshire Hills Bancorp, Inc. 2003 Equity Compensation Plan – Equity Compensation Plan Information” in the Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPSRELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is incorporated herein by reference to the sections captioned “Other Information Relating to Directors and Executive Officers – Policies and— Procedures for Approval ofGoverning Related Persons Transactions”and“Transactions with ManagementRelated Persons” in the Proxy Statement. Information regarding director independence is incorporated herein by reference to the section captioned“ItemsProposals to be Voted on by Stockholders –— Proposal 1 –— Election of Directors”in the Proxy Statement. ITEM 14. PRINCIPAL ACCOUNTINGACCOUNTING FEES AND SERVICES The information required by this item is incorporated herein by reference to the section captioned “ItemsProposals to be Voted on by Stockholders - Item 3 –— Proposal 2 — Ratification of Independent Registered Public Accounting Firm” in the Proxy Statement. - 96 -
ITEM 15. EXHIBITSEXHIBITS AND FINANCIAL STATEMENT SCHEDULES | (a) | | [1] | Financial Statements |
| ·• | | Report of Independent Registered Public Accounting Firm |
| | ·• | | Consolidated Balance Sheets as of December 31, 20072008 and 20062007 |
| | ·• | | Consolidated Statements of Income for the Years Ended December 31, 2008, 2007 2006 and 20052006 |
| | ·• | | Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2008, 2007 2006 and 20052006 |
| | ·• | | Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 2006 and 20052006 |
| | ·• | | Notes to Consolidated Financial Statements |
The consolidated financial statements required to be filed in our Annual Report on Form 10-K are included in Part II, Item 8 hereof. | | | [2] | Financial Statement Schedules |
All financial statement schedules are omitted because the required information is either included or is not applicable.
| | | All financial statement schedules are omitted because the required information is either included or is not applicable. |
| | | | | | 3.1 | | | Certificate of Incorporation of Berkshire Hills Bancorp, Inc.(1) |
| | | | | | 3.2 | | | Certificate of Designations for the Series A Preferred Stock(2) | | | | | | | 3.3 | | | Bylaws of Berkshire Hills Bancorp, Inc. (2) (3) |
| | | | | | 4.1 | Draft Stock Certificate of Berkshire Hills Bancorp, Inc.(1)
|
| 4.2 | No long-term debt instrument issued by the Registrant exceeds 10% of consolidated assets or is registered. In accordance with paragraph 4(iii) of Item 601(b) of Regulation S-K, the Registrant will furnish the Securities and Exchange Commission copies of long-term debt instruments and related agreements upon request. |
| | | | | | 10.1 | | | *Amended and Restated Employment Agreement betweenby and among Berkshire Bank, Berkshire Hills Bancorp, Inc. and Michael P. Daly(3)(4) |
| | | | | | 10.2 | | | *EmploymentAmended and Restated Three Year Change in Control Agreement by and among Berkshire Bank, Berkshire Hills Bancorp, Inc. and Kevin P. Riley(4) | | | | | | | 10.3 | | | *Amended and Restated Three Year Change in Control Agreement by and among Berkshire Bank, Berkshire Hills Bancorp, Inc. and John S. Millet(4) | | | | | | | 10.4 | | | *Amended and Restated Three Year Change in Control Agreement by and among Berkshire Bank, Berkshire Hills Bancorp, Inc. and Michael J. Oleksak(4) | | | | | | | 10.5 | | | *Amended and Restated Three Year Change in Control Agreement by and among Berkshire Bank, Berkshire Hills Bancorp, Inc. and Shepard D. Rainie(4) | | | | | | | 10.6 | | | *Consulting Agreement between Berkshire Hills Bancorp, Inc. and Michael P. Daly(3)David B. Farrell(5) |
| 10.3 | | | | | 10.7 | | | *Amended and Restated Supplemental Executive Retirement Agreement between Berkshire Bank and Michael P. Daly(4) |
| 10.4 | | | | | 10.8 | | | *Amended and Restated Berkshire Hills Bancorp, Inc. 2003 Equity Compensation Plan(5)(6) |
| 10.5 | | | | | 10.9 | | | *Form of Berkshire Bank Employee Severance Compensation Plan(1) |
| 10.6 | *Form of Berkshire Bank Supplemental Executive Retirement Plan(1)
| | |
| 10.710.10 | | | *Berkshire Hills Bancorp, Inc. 2001 Stock-Based Incentive Plan(6)(7) |
| 10.8 | | | | | 10.11 | | | *Woronoco Bancorp, Inc. 1999 Stock-Based Incentive Plan(7)(8) |
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| 10.9 | | | | | 10.12 | | | *Woronoco Bancorp, Inc. 2001 Stock Option Plan(8)(9) |
| 10.10 | | | | | 10.13 | | | *Woronoco Bancorp, Inc. 2004 Equity Compensation Plan(9)(10) |
| 10.11 | | | | | 10.14 | | | *Factory Point Bancorp, Inc. 1999 Non-Employee Directors Stock Option Plan, as amended and restated(10)(11) |
| 10.12 | | | | | 10.15 | | | *Factory Point Bancorp, Inc. 1999 Stock Incentive Plan(10)(11) |
| 10.13 | | | | | 10.16 | | | *Factory Point Bancorp, Inc. 2004 Stock Incentive Plan, as amended and restated(10)(11) |
| | * Change in Control Agreement by and between Berkshire Hills Bancorp, Inc. and Kevin P. Riley |
| | * Change in Control Agreement by and between Berkshire Bank and Kevin P. Riley |
| | * Change in Control Agreement by and between Berkshire Hills Bancorp, Inc. and Michael J. Oleksak |
| | * Change in Control Agreement by and between Berkshire Bank and Michael J. Oleksak |
| | * Senior Executive Employment Agreement by and between Berkshire Insurance Group, Inc. and Ross D. Gorman |
| 11.0 | | | Statement re: Computation of Per Share Earnings is incorporated herein by reference to Part II, Item 8, “Financial Statements and Supplementary Data” |
| | | | | | 21.0 | | | Subsidiary Information is incorporated herein by reference to Part I, Item 1, “Business -— Subsidiary Activities” |
| | | | | | 23.0 | | | Consent of Wolf & Company, P.C. |
| | | | | | 31.1 | | | Rule 13a-14(a) Certification of Chief Executive Officer |
| | | | | | 31.2 | | | Rule 13a-14(a) Certification of Chief Financial Officer |
| | | | | | 32.1 | | | Section 1350 Certification of Chief Executive Officer |
| | | | | | 32.2 | | | Section 1350 Certification of Chief Financial Officer |
_______________________________________________
| | | * | | Management contract or compensatory plan, contract or arrangement. |
| (1) | | Incorporated herein by reference from the Exhibits to Form S-1, Registration Statement and amendments thereto, initially filed on March 10, 2000, Registration No. 333-32146. |
| (2) | | Incorporated by reference from the Exhibits to the Form 8-K filed on December 23, 2008. | | (3) | | Incorporated herein by reference from the Exhibits to the Form 8-K as filed on February 29, 2008. |
| (3)(4) | | Incorporated herein by reference from the Exhibits to the Form 10-Q as8-K filed on August 13, 2003.January 6, 2009. |
| (4)(5) | | Incorporated herein by reference from the Exhibits to the Form 10-K as8-K filed on March 16, 2007.December 17, 2008. |
| (5)(6) | | Incorporated herein by reference from the Appendix to the Proxy Statement as filed on March 27, 2003.April 3, 2008. |
| (6)(7) | | Incorporated herein by reference from the Appendix to the Proxy Statement as filed on December 7, 2000. |
| (7)(8) | | Incorporated herein by reference from the Proxy Statement as filed on March 20, 2000 by Woronoco Bancorp, Inc. |
| (8)(9) | | Incorporated herein by reference from the Proxy Statement as filed on March 12, 2001 by Woronoco Bancorp, Inc. |
| (9)(10) | | Incorporated herein by reference from the Proxy Statement as filed on March 22, 2004 by Woronoco Bancorp, Inc. |
| (10)(11) | | Incorporated herein by reference from the exhibits to the registration statement on Form S-8 as filed on October 10, 2007, registration No. 333-146604. |
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SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. | | Berkshire Hills Bancorp, Inc. | | | | | Berkshire Hills Bancorp, Inc.
| | Date: March 14, 200816, 2009 | By: | /s/ Michael P. Daly | | | | Michael P. Daly | | | | President, Chief Executive Officer and Director | |
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 registrant and in the capacities and on the dates indicated. | | | | | /s/ Michael P. Daly Michael P. Daly | | President, Chief Executive Officer | | March 14, 2008 | Michael P. Daly | | and Director | | | | | (principal executive officer) | | March 16, 2009 | | | | | | /s/ Kevin P. Riley | | | | March 14, 2008 | Kevin P. Riley | | Chief Financial Officer and Treasurer | | | | (principal financial and accounting officer) | | March 16, 2009 | | | | | | /s/ Lawrence A. Bossidy Lawrence A. Bossidy | | Non-Executive Chairman | | March 14, 2008 | Lawrence A. Bossidy | | | | 16, 2009 | | | | | | /s/ Wallace W. Altes Wallace W. Altes | | Director | | March 14, 2008 | Wallace W. Altes | | | | 16, 2009 | | | | | | /s/ John B. Davies John B. Davies | | Director | | March 14, 2008 | John B. Davies | | | | 16, 2009 | | | | | | /s/ Rodney C. Dimock Rodney C. Dimock | | Director | | March 14, 2008 | Rodney C. Dimock | | | | 16, 2009 | | | | | | /s/ David B. Farrell David B. Farrell | | Director | | March 14, 2008 | David B. Farrell | | | | 16, 2009 | | | | | | /s/ Susan M. Hill Susan M. Hill | | Director | | March 14, 2008 | Susan M. Hill | | | | 16, 2009 | | | | | | /s/ Cornelius D. Mahoney Cornelius D. Mahoney | | Director | | March 14, 2008 | Cornelius D. Mahoney | | | | 16, 2009 | | | | | | /s/ Edward G. McCormick, Esq.Catherine B. MillerCatherine B. Miller | | Director | | March 14, 2008 | Edward G. McCormick, Esq. | | | | 16, 2009 | | | | | | /s/ Catherine B. MillerDavid E. PhelpsDavid E. Phelps | | Director | | March 14, 2008 | Catherine B. Miller | | | | 16, 2009 | | | | | | /s/ David E. PhelpsD. Jeffrey TempletonD. Jeffrey Templeton | | Director | | March 14, 2008 | David E. Phelps | | | | 16, 2009 | | | | | | /s/ D. Jeffrey TempletonCorydon L. ThurstonCorydon L. Thurston | | Director | | March 14, 200816, 2009 |
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EXHIBIT INDEX D. Jeffrey Templeton | | | | | Exhibit | | | Number | | Description | | 3.1 | | | Certificate of Incorporation of Berkshire Hills Bancorp, Inc.(1) | | | | | | /s/ Corydon L. Thurston | 3.2 | | Director | | March 14, 2008Certificate of Designations for the Series A Preferred Stock(2) | Corydon L. Thurston | | | | | | 3.3 | | | Bylaws of Berkshire Hills Bancorp, Inc. (3) | | | | | | | 4.1 | | | No long-term debt instrument issued by the Registrant exceeds 10% of consolidated assets or is registered. In accordance with paragraph 4(iii) of Item 601(b) of Regulation S-K, the Registrant will furnish the Securities and Exchange Commission copies of long-term debt instruments and related agreements upon request. | | | | | | | 10.1 | | | *Amended and Restated Employment Agreement by and among Berkshire Bank, Berkshire Hills Bancorp, Inc. and Michael P. Daly(4) | | | | | | | 10.2 | | | *Amended and Restated Three Year Change in Control Agreement by and among Berkshire Bank, Berkshire Hills Bancorp, Inc. and Kevin P. Riley(4) | | | | | | | 10.3 | | | *Amended and Restated Three Year Change in Control Agreement by and among Berkshire Bank, Berkshire Hills Bancorp, Inc. and John S. Millet(4) | | | | | | | 10.4 | | | *Amended and Restated Three Year Change in Control Agreement by and among Berkshire Bank, Berkshire Hills Bancorp, Inc. and Michael J. Oleksak(4) | | | | | | | 10.5 | | | *Amended and Restated Three Year Change in Control Agreement by and among Berkshire Bank, Berkshire Hills Bancorp, Inc. and Shepard D. Rainie(4) | | | | | | | 10.6 | | | *Consulting Agreement between Berkshire Hills Bancorp, Inc. and David B. Farrell(5) | | | | | | | 10.7 | | | *Amended and Restated Supplemental Executive Retirement Agreement between Berkshire Bank and Michael P. Daly | | | | | | | 10.8 | | | *Amended and Restated Berkshire Hills Bancorp, Inc. 2003 Equity Compensation Plan(6) | | | | | | | 10.9 | | | *Form of Berkshire Bank Employee Severance Compensation Plan(1) | | | | | | | 10.10 | | | *Berkshire Hills Bancorp, Inc. 2001 Stock-Based Incentive Plan(7) | | | | | | | 10.11 | | | *Woronoco Bancorp, Inc. 1999 Stock-Based Incentive Plan(8) | | | | | | | 10.12 | | | *Woronoco Bancorp, Inc. 2001 Stock Option Plan(9) | | | | | | | 10.13 | | | *Woronoco Bancorp, Inc. 2004 Equity Compensation Plan(10) | | | | | | | 10.14 | | | *Factory Point Bancorp, Inc. 1999 Non-Employee Directors Stock Option Plan, as amended and restated(11) | | | | | | | 10.15 | | | *Factory Point Bancorp, Inc. 1999 Stock Incentive Plan(11) | | | | | | | 10.16 | | | *Factory Point Bancorp, Inc. 2004 Stock Incentive Plan, as amended and restated(11) | | | | | | | 11.0 | | | Statement re: Computation of Per Share Earnings is incorporated herein by reference to Part II, Item 8, “Financial Statements and Supplementary Data” | | | | | | | 21.0 | | | Subsidiary Information is incorporated herein by reference to Part I, Item 1, “Business — Subsidiary Activities” | | | | | | | 23.0 | | | Consent of Wolf & Company, P.C. | | | | | | | 31.1 | | | Rule 13a-14(a) Certification of Chief Executive Officer | | | | | | | 31.2 | | | Rule 13a-14(a) Certification of Chief Financial Officer | | | | | | | 32.1 | | | Section 1350 Certification of Chief Executive Officer | | | | | | | 32.2 | | | Section 1350 Certification of Chief Financial Officer |
-92- | | | * | | Management contract or compensatory plan, contract or arrangement. | | (1) | | Incorporated herein by reference from the Exhibits to Form S-1, Registration Statement and amendments thereto, initially filed on March 10, 2000, Registration No. 333-32146. | | (2) | | Incorporated by reference from the Exhibits to the Form 8-K filed on December 23, 2008. | | (3) | | Incorporated herein by reference from the Exhibits to the Form 8-K as filed on February 29, 2008. | | (4) | | Incorporated by reference from the Exhibits to the Form 8-K filed on January 6, 2009. | | (5) | | Incorporated by reference from the Exhibits to the Form 8-K filed on December 17, 2008. | | (6) | | Incorporated herein by reference from the Appendix to the Proxy Statement as filed on April 3, 2008. | | (7) | | Incorporated herein by reference from the Appendix to the Proxy Statement as filed on December 7, 2000. | | (8) | | Incorporated herein by reference from the Proxy Statement as filed on March 20, 2000 by Woronoco Bancorp, Inc. | | (9) | | Incorporated herein by reference from the Proxy Statement as filed on March 12, 2001 by Woronoco Bancorp, Inc. | | (10) | | Incorporated herein by reference from the Proxy Statement as filed on March 22, 2004 by Woronoco Bancorp, Inc. | | (11) | | Incorporated herein by reference from the exhibits to the registration statement on Form S-8 as filed on October 10, 2007, registration No. 333-146604. |
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