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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2003
|_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to __________
Commission File Number: 1-15781
BERKSHIRE HILLS BANCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware 04-3510455
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
24 North Street, Pittsfield, Massachusetts 01201
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (413) 443-5601
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class: on which registered:
Common Stock, par value $0.01 per share American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: None
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.
Yes |X| No |_|
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. |X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).
Yes |X| No |_|
The aggregate market value of the voting and non-voting common equity held by
non-affiliates was $156.5 million, based upon the closing price of $28.40 as
quoted on the American Stock Exchange 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 February 26, 2004, was 5,936,461.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2004 Annual Meeting of
Stockholders are incorporated by reference in Part III of this Form 10-K.
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INDEX
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PART I ............................................................................. 15
ITEM 1. BUSINESS ................................................................ 15
ITEM 1A. EXECUTIVE OFFICERS OF THE REGISTRANT ................................... 44
ITEM 2. PROPERTIES .............................................................. 45
ITEM 3. LEGAL PROCEEDINGS ....................................................... 46
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ..................... 46
PART II ............................................................................ 46
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ... 46
ITEM 6. SELECTED FINANCIAL DATA ................................................. 47
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS ................................................... 49
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ............. 59
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ............................. 61
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE .................................................... 107
ITEM 9a. CONTROLS AND PROCEDURES ................................................ 107
PART III ........................................................................... 107
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ..................... 107
ITEM 11. EXECUTIVE COMPENSATION ................................................. 107
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS ............................................ 107
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ......................... 108
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES ................................. 108
PART IV ............................................................................ 109
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K ....... 109
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PART I
ITEM 1. BUSINESS
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General
Berkshire Hills Bancorp, Inc. (the "Company" or "Berkshire Hills"), a
Delaware corporation, was organized in January 2000 to become the holding
company for Berkshire Bank (the "Bank") upon the conversion of the Bank's former
parent holding company, Berkshire Bancorp, from the mutual to stock form of
organization, which occurred on June 27, 2000. The Company owns all of the
outstanding shares of the Bank. The Company has no significant liabilities.
Management of the Company and the Bank are substantially similar and the Company
neither owns nor leases any property, but instead uses the premises, equipment
and furniture of the Bank. Accordingly, the information set forth in this
report, including the consolidated financial statements and related financial
data, relates primarily to the Bank.
The Bank is regulated by the Massachusetts Division of Banks and the
Federal Deposit Insurance Corporation (the "FDIC"). The Bank's deposits are
insured to the maximum allowable amount by the Bank Insurance Fund (the "BIF")
of the FDIC and the Depositors Insurance Fund (the "DIF"). Berkshire Bank has
been a member of the Federal Home Loan Bank system since 1973.
Berkshire Bank is a community bank that accepts retail deposits from the
general public in the areas surrounding its 11 full-service banking offices and
uses those funds, together with funds generated from operations and borrowings,
to originate residential mortgage loans, commercial business and real estate
loans and consumer loans, primarily automobile loans and home equity lines of
credit. Berkshire Bank primarily holds the loans that it originates for
investment, but occasionally sells or securitizes some of its loans, including
automobile and fixed-rate residential mortgage loans, in the secondary market.
Berkshire Bank also invests in U.S. Government and Agency securities, mortgage-
and asset-backed securities, including real estate mortgage investment conduits
and collateralized mortgage obligations, debt and equity securities and other
permissible investments. Berkshire Bank's revenues are derived principally from
the generation of interest and fees on loans originated and, to a lesser extent,
interest and dividends on its investment securities. Berkshire Bank's primary
sources of funds are deposits, principal and interest payments on loans and
securities and advances from the Federal Home Loan Bank of Boston.
Company Website and Availability of Securities and Exchange Commission Filings
The Company's Internet website is www.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 or furnished 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, or furnishes it to,
the Securities and Exchange Commission.
Market Area
Berkshire Bank is headquartered in Pittsfield, Massachusetts, in Berkshire
County. Berkshire Bank's primary deposit gathering and lending areas are
concentrated in the communities surrounding its 11 full-service banking offices
located in Berkshire County. However, Berkshire Bank also makes loans throughout
western Massachusetts, northern Connecticut, eastern New York and southern
Vermont and occasionally other geographic areas.
Berkshire County, the western-most county in Massachusetts, is
approximately two and one-half hours from both Boston and New York City.
Berkshire County borders Vermont, Connecticut and New York. Berkshire County has
experienced a shift in its economy as manufacturing jobs have been replaced with
service-related jobs, primarily in tourism, social service and health care.
Other than Berkshire Bank, the major employers in the area include Berkshire
Life Insurance Company of America, Crane & Company, GE Plastics, Kay Bee Toys,
Berkshire Health Systems, General Dynamics Defense Systems, Mead Corporation and
several institutions of higher education.
Competition
The Bank faces intense competition for the attraction of deposits and
origination of loans in its primary market area. As of June 30, 2003, according
to information presented on the Federal Deposit Insurance Corporation's website,
the Bank held approximately 32% of the deposits in Berkshire County, which was
the largest share of deposits out of 12 financial institutions in the county.
Berkshire Bank's most direct competition for deposits comes from one large
credit union in the area, which has a competitive advantage as credit unions do
not have to pay state or federal taxes. The Bank also competes with
super-regional banks, such as Banknorth and Citizens Bank. These competitors
have substantially greater resources and lending limits than the Bank does and
offers services that the Bank does not provide. Additionally, Berkshire Bank
faces competition for deposits from several commercial and savings banks
operating in its primary market area and, to a lesser extent, from other
financial institutions, such as brokerage firms, insurance companies and the
mutual fund industry, as customers seek alternative sources of investment for
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their funds. Berkshire Bank also faces significant competition for investors'
funds due to its direct purchase of short-term money market securities and other
corporate and government securities. Berkshire Bank faces competition for loans
from a significant number of traditional financial institutions, primarily
savings banks and commercial banks in its market area, as well as the mortgage
companies and mortgage brokers operating in its primary market area. The
increase of Internet-accessible financial institutions which solicit deposits
and originate loans on a nationwide basis also increases competition for
Berkshire Bank's customers. Additionally, competition has increased as a result
of regulatory actions and legislative changes, most notably the enactment of the
Gramm-Leach-Bliley Act of 1999. These changes have eased restrictions on
interstate banking and the entrance into the financial services market by
non-depository and non-traditional financial services providers, including
insurance companies, securities brokerage and underwriting firms and specialty
financial services companies (such as Internet-based providers).
Lending Activities
General. The types of loans that Berkshire Bank may originate are limited
by federal and state laws and regulations. Interest rates charged by Berkshire
Bank on loans are affected principally by Berkshire Bank's current
asset/liability strategy, the demand for such loans, the supply of money
available for lending purposes and the rates offered by competitors. 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.
Loan Portfolio Analysis. The following table sets forth the composition of
Berkshire Bank's loan portfolio in dollar amounts and as a percentage of the
portfolio at the dates indicated.
At December 31,
-----------------------------------------------------------------------
2003 2002 2001
--------------------- --------------------- ---------------------
Percent Percent Percent
of of of
Amount Total Amount Total Amount Total
--------- ------- --------- ------- --------- -------
(Dollars in thousands)
Real estate loans:
One- to four-family $ 266,753 33.70% $ 246,938 34.15% $ 240,852 30.01%
Commercial 154,244 19.49 119,198 16.48 84,741 10.56
Multi-family 15,514 1.96 14,920 2.06 13,183 1.64
Construction and land
development 34,719 4.39 17,627 2.44 22,936 2.86
--------- ------ --------- ------ --------- ------
Total real estate loans 471,230 59.54 398,683 55.13 361,712 45.07
--------- ------ --------- ------ --------- ------
Consumer loans:
Home equity lines of credit 45,783 5.78 40,713 5.63 34,439 4.29
Automobile 103,674 13.10 113,321 15.67 228,412 28.46
Other 4,506 0.57 5,017 0.69 7,792 0.97
--------- ------ --------- ------ --------- ------
Total consumer loans 153,963 19.45 159,051 21.99 270,643 33.72
--------- ------ --------- ------ --------- ------
Commercial loans 166,451 21.01 165,447 22.88 170,230 21.21
--------- ------ --------- ------ --------- ------
Total loans 791,644 100.00% 723,181 100.00% 802,585 100.00%
====== ====== ======
Net deferred loan origination
costs 110 41 172
Unamortized discount on
purchased loans 473 (200) (203)
Allowance for loan losses (8,969) (10,308) (11,034)
--------- --------- ---------
Total loans, net $ 783,258 $ 712,714 $ 791,520
========= ========= =========
At December 31,
----------------------------------------------
2000 1999
--------------------- ---------------------
Percent Percent
of of
Amount Total Amount Total
--------- ------- --------- -------
(Dollars in thousands)
Real estate loans:
One- to four-family $ 249,440 31.44% $ 245,240 36.39%
Commercial 63,871 8.05 46,419 6.89
Multi-family 15,699 1.98 14,793 2.20
Construction and land
development 14,290 1.80 12,534 1.86
--------- ------ --------- ------
Total real estate loans 343,300 43.27 318,986 47.34
--------- ------ --------- ------
Consumer loans:
Home equity lines of credit 34,471 4.34 33,168 4.92
Automobile 241,862 30.48 171,527 24.46
Other 6,800 0.87 4,041 1.59
--------- ------ --------- ------
Total consumer loans 283,133 35.69 208,736 30.97
--------- ------ --------- ------
Commercial loans 166,956 21.04 146,196 21.69
--------- ------ --------- ------
Total loans 793,389 100.00% 673,918 100.00%
====== ======
Net deferred loan origination
costs 232 170
Unamortized discount on
purchased loans -- --
Allowance for loan losses (10,216) (8,534)
--------- ---------
Total loans, net $ 783,405 $ 665,554
========= =========
Real Estate Lending
One- to Four-Family Real Estate Loans. One of Berkshire Bank's primary
lending activities is to originate loans secured by one- to four-family
residences located in its primary market area. At December 31, 2003, $266.8
million, or 33.7%, of Berkshire Bank's total loans consisted of one- to
four-family mortgage loans. Of the one- to four-family loans outstanding at that
date, 49.0% were fixed-rate mortgage loans and 51.0% were adjustable-rate loans.
Berkshire Bank originates fixed-rate fully amortizing loans with
maturities of 15, 20 and 30 years. Management establishes the loan interest
rates based on market conditions. Berkshire Bank offers mortgage loans that
conform to Fannie Mae and Freddie Mac guidelines. In addition, Berkshire Bank
offers jumbo loan products, which presently are loans in amounts over
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$333,700. Berkshire Bank generally originates loans for its own portfolio, but
occasionally sells or securitizes some fixed-rate one- to four-family loans in
the secondary market. The determination of whether to sell or securitize loans
is reviewed periodically by management as a means of managing the Company's
interest rate risk profile or providing liquidity.
Berkshire Bank also currently offers adjustable-rate mortgage loans, with
an interest rate based on the one-year, three- year or five-year Constant
Maturity Treasury index, which adjust every one, three or five years from the
outset of the loan, with terms of up to 30 years. Interest rate adjustments on
such loans range from 2% to 5% during any adjustment period and are limited to
no more than 6% over the life of the loan.
Adjustable-rate mortgage loans help reduce Berkshire Bank's exposure to
changes in interest rates. There are, however, unquantifiable credit risks
resulting from the potential of increased costs due to changed rates to be paid
by borrowers. During periods of rising interest rates, the risk of default on
adjustable-rate mortgage loans increases as a result of repricing and the
increased payments required to be made by borrowers. In addition, although
adjustable-rate mortgage loans allow Berkshire Bank to increase the sensitivity
of its asset base to changes in interest rates, the extent of this interest
sensitivity is limited by the periodic and lifetime interest rate adjustment
limits. Because of these considerations, Berkshire Bank has no assurance that
yields on adjustable-rate mortgage loans will be sufficient to offset increases
in Berkshire Bank's cost of funds during periods of rising interest rates. These
risks have not had a material adverse effect on Berkshire Bank to date.
Berkshire Bank underwrites one- to four-family residential mortgage loans
with loan-to-value ratios of up to 100% on a one- to two-family primary
residence, up to 90% on a three- to four-family primary residence or a vacation
home, and up to 75% on a condominium. A borrower is required to obtain private
mortgage insurance on loans that exceed 80%, or 75% in the case of a
condominium, of the appraised value or sales price, whichever is less, of the
secured property. Berkshire Bank also generally requires fire, casualty, title,
hazard insurance and, if appropriate, flood insurance to be maintained on all
properties securing real estate loans made by Berkshire Bank. An independent
licensed appraiser generally appraises all properties.
To provide financing for low- and moderate-income families, Berkshire Bank
offers Federal Housing Authority, Veterans Administration and Massachusetts
Housing Finance Agency residential mortgage loans to qualified individuals with
adjustable- and fixed-rates of interest and terms of up to 30 years. Such loans
may be secured by one- to four-family residential properties and are
underwritten using modified underwriting guidelines. Berkshire Bank also
participates in the Good Samaritan Home Ownership Program, which is a non-profit
venture established to advise and assist low- and middle-income families in the
purchase of their first home in Berkshire County. Qualified individuals can
obtain a 30-year fixed-rate mortgage loan on a one- to four-family, owner
occupied property.
Construction and Land Development Loans. At December 31, 2003,
construction and land development loans totaled $34.7 million, or 4.4% of
Berkshire Bank's total loan portfolio, of which $10.6 million were residential
construction loans, $15.4 million were commercial construction loans and $8.7
million were commercial land development loans. At December 31, 2003, the
unadvanced portion of construction and land development loans totaled $18.1
million.
Berkshire Bank originates construction and land development loans to
individuals for the construction and acquisition of personal residences.
Berkshire Bank's residential construction and land development loans generally
provide for the payment of interest only during the construction phase, which is
usually twelve months. At the end of the construction phase, the loan converts
to a permanent mortgage loan. Loans can be made with a maximum loan to value
ratio of 85%, provided that the borrower obtains private mortgage insurance if
the loan balance exceeds 80% of the appraised value or sales price, whichever is
less, of the secured property. At December 31, 2003, the largest outstanding
residential construction and land development loan commitment was for $2.5
million. Construction and land development loans to individuals are generally
made on the same terms as Berkshire Bank's one- to four-family mortgage loans.
Before making a commitment to fund a residential construction and land
development loan, Berkshire Bank requires an appraisal of the property and
planned improvements by an independent licensed appraiser. Berkshire Bank also
reviews and inspects each property before disbursement of funds during the term
of the construction and land development loan. Loan proceeds are disbursed after
inspection based on the percentage of completion method.
Berkshire Bank also makes construction and land development loans for
commercial development projects, including multi-family commercial properties,
single-family subdivisions and condominiums. These loans generally have an
interest only phase during construction then convert to permanent financing.
Disbursement of funds is at the sole discretion of Berkshire Bank and is based
on the progress of construction. The maximum loan to value ratio for these loans
depends upon the type of commercial development project being undertaken, but
generally will not exceed 80%. At December 31, 2003, the largest commercial
construction and land development commitment was $4.5 million, of which $4.5
million was outstanding, to a locally headquartered company that develops
residential subdivisions on a national scale, and is a long-time Berkshire Bank
borrower. This loan is secured by a 1,075 acre, 892 lot residential subdivision
in the Austin-San Antonio, Texas corridor. This loan was performing according to
its terms at December 31, 2003.
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Berkshire Bank also originates land loans to local contractors and
developers for the purpose of making improvements thereon, or for the purpose of
holding or developing the land for sale. Such loans are secured by a lien on the
property, have loan to value ratios that are limited to 75% of the value of the
land used for residential development and 80% of the value of the land used for
commercial development (based on the lower of the acquisition price or the
appraised value of the land). Land loans are offered with a term of three years
in which only interest is required to be paid each month. A balloon payment for
the principal plus any accrued interest is due at the end of the three-year
period. Berkshire Bank's land loans are generally secured by property in its
primary market area. Berkshire Bank generally requires title insurance and, if
applicable, either a hazardous waste survey or environmental insurance coverage.
Construction and land development financing is generally considered to
involve a higher degree of credit risk than long-term financing on improved,
owner-occupied real estate. Risk of loss on a construction loan is dependent
largely upon the accuracy of the initial estimate of the property's value at
completion of construction compared to the estimated cost (including interest)
of construction and other assumptions. If the estimate of construction cost
proves to be inaccurate, Berkshire Bank may be required to advance funds beyond
the amount originally committed to protect the value of the property.
Additionally, if the estimate of value proves to be inaccurate, Berkshire Bank
may be confronted with a completed project, having a value insufficient to
assure full repayment.
Multi-Family and Commercial Real Estate Loans. Berkshire Bank originates
multi-family and commercial real estate loans that are generally secured by five
or more unit apartment buildings and properties used for business purposes such
as small office buildings, industrial, healthcare, lodging or retail facilities
predominantly located in Berkshire Bank's primary market area. Berkshire Bank's
multi-family and commercial real estate loans may be made in amounts of up to
80% of the appraised value of the property or the selling price, whichever is
less. Loans secured by single-family subdivisions and condominium projects may
be made in amounts of up to 75% and 70%, respectively, of the appraised value of
the property or selling price, whichever is less. Berkshire Bank's multi-family
and commercial real estate loans may be made with terms of up to 20 years and
substantially all of which are originated with interest rates that adjust
periodically and are generally indexed to Berkshire Bank's base rate. In
reaching its decision on whether to make a multi-family or commercial real
estate loan, Berkshire Bank considers the net operating income and value of the
property and the borrower's expertise, credit history and profitability. In
addition, with respect to commercial real estate rental properties, Berkshire
Bank will also consider the term of the lease and the quality of the tenants.
Berkshire Bank generally requires that the properties securing these real estate
loans have debt service coverage ratios (the ratio of available cash flows
before debt service to debt service) of at least 1.25x. Environmental surveys or
environmental insurance coverage are generally required for commercial real
estate loans. Additionally, in larger real estate projects, it is recommended
that a feasibility study be obtained. A feasibility study is particularly
important with respect to multi-family housing projects, hotel/motel
construction and health care facilities. Generally, multi-family and commercial
real estate loans made to corporations, partnerships and other business entities
require personal guarantees by the principals. The largest multi-family or
commercial real estate loan relationship in Berkshire Bank's portfolio at
December 31, 2003 consisted of four loans to related health care facilities in
Massachusetts totaling $8.5 million. All loans were performing according to
their terms at December 31, 2003.
Loans secured by multi-family and commercial real estate properties
generally involve larger principal amounts and a greater degree of risk than
one- to four-family residential mortgage loans. Because payments on loans
secured by multi-family and commercial real estate properties are 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.
Consumer Lending
Automobile Lending. At December 31, 2003, automobile loans totaled $103.7
million, or 13.1% of Berkshire Bank's total loans and 67.3% of consumer loans.
The Bank offers fixed-rate automobile loans on a direct and indirect basis with
terms of up to 72 months for new and recent model used cars and up to 66 months
for older model used cars. Berkshire Bank generally will make such loans up to
100% of the retail value shown in the NADA Used Car Guide. The interest rates
offered differ depending on the age of the automobile and current interest rates
offered by competitors.
Berkshire Bank began offering indirect automobile loans through automobile
dealers over ten years ago. Currently, Berkshire Bank maintains contractual
relationships with over 90 new and used car dealers throughout western
Massachusetts, northern Connecticut, eastern New York and southern Vermont. In
2001, management determined to decrease the Bank's emphasis on lower quality or
sub-prime automobile loans and attempt to reduce the overall size of the
automobile loan portfolio. This process was accelerated through the sale of
$69.7 million of sub-prime automobile loans in 2002 and the sale of an
additional $9.9 million of sub-prime automobile loans in 2003. At December 31,
2003, $1.4 million of lower quality or sub-prime automobile loans, representing
1.3% of automobile loans, or 0.2% of total loans, remained.
Home Equity Lines of Credit and Other Consumer Loans. Berkshire Bank
offers home equity lines of credit secured by owner-occupied one- to four-family
residences. At December 31, 2003, home equity lines of credit totaled $45.8
million, or 5.8% of Berkshire Bank's total loans and 29.7% of consumer loans.
Additionally, at December 31, 2003, the unadvanced amounts of
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home equity lines of credit totaled $45.5 million. The underwriting standards
employed by Berkshire Bank for home equity lines of credit include a
determination of the applicant's credit history, an assessment of the
applicant's ability to meet existing obligations and payments on the proposed
loan and the value of the collateral securing the loan. Home equity loans will
not be made if the borrower's first mortgage payment, monthly real estate
payment and amortized equity line payment exceed 25% of the borrower's gross
monthly income. Additionally, the borrower's monthly debt service cannot exceed
35% of the borrower's gross monthly income. Home equity lines of credit have
adjustable rates of interest which are indexed to the prime rate as reported in
The Wall Street Journal. Generally, the maximum combined loan-to-value ratio on
home equity lines of credit is 80% for loans up to $200,000 and 60% for loans
greater than $200,000. A home equity line of credit may be drawn down by the
borrower for an initial period of five years from the date of the loan
agreement. During this period, the borrower has the option of paying, on a
monthly basis, either principal and interest or only interest. If not renewed,
the borrower has to pay back the amount outstanding under the line of credit
over a term not to exceed ten years, beginning at the end of the five-year
period.
Other consumer loans at December 31, 2003 amounted to $4.5 million, or
0.6% of Berkshire Bank's total loans and 2.9% of consumer loans. These loans
include education, collateral, personal and unsecured loans, and second mortgage
loans other than home equity lines of credit. Collateral loans are generally
secured by a passbook account, a certificate of deposit or marketable
securities. Unsecured loans generally have a maximum borrowing limitation of
$10,000 and a maximum term of five years. Second mortgages are offered on
owner-occupied primary or secondary residences and are adjustable-rate, either
adjusting annually or with a five-year initial fixed period adjusting annually
thereafter, with terms up to 30 years.
Loans secured by rapidly depreciable assets such as automobiles or that
are unsecured entail greater risks than one- to four-family mortgage loans. In
such cases, repossessed collateral for a defaulted loan may not provide an
adequate source of repayment of the outstanding loan balance, since there is a
greater likelihood of damage, loss or depreciation of the underlying collateral.
The remaining deficiency often does not warrant further substantial collection
efforts against the borrower beyond obtaining a deficiency judgment. Further,
collections on these loans are dependent on the borrower's continuing financial
stability and, therefore, are more likely to be adversely affected by job loss,
divorce, illness or personal bankruptcy. Finally, the application of various
federal and state laws, including federal and state bankruptcy and insolvency
laws, may limit the amount which can be recovered on such loans if a borrower
defaults.
Commercial Lending
Commercial Loans. At December 31, 2003, Berkshire Bank had $166.5 million
in commercial loans which amounted to 21.0% of total loans. In addition, at such
date, Berkshire Bank had $49.4 million of unadvanced commercial lines of credit.
Berkshire Bank makes commercial business loans primarily in its market area to a
variety of professionals, sole proprietorships and small businesses. Berkshire
Bank's largest commercial loan relationship was a $4.4 million loan to a long
time customer secured by various types of business assets located in Berkshire
County. This loan was performing according to its terms at December 31, 2003.
Berkshire Bank offers secured commercial term loans, which have maturities
of greater than one year and the repayment of which is dependent on future
earnings. The term for repayment will normally be limited to the lesser of the
expected useful life of the asset being financed or a fixed amount of time,
generally seven years or less. Berkshire Bank also offers loans originated to
finance a business' equipment and machinery, lines of credit, letters of credit,
time notes and Small Business Administration guaranteed loans. In addition,
Berkshire Bank offers revolving lines of credit called operating loans that are
secured by business assets other than real estate, such as business equipment,
inventory and accounts receivable. Business lines of credit have adjustable
rates of interest and are payable on demand, subject to annual review and
renewal. Time notes are short-term loans, generally limited to 90 days which do
not require payment of principal or interest until maturity.
When making commercial business loans, Berkshire Bank considers the
financial statements of the borrower, the borrower's payment history of both
corporate and personal debt, the debt service capabilities of the borrower, the
projected cash flows of the business, the viability of the industry in which the
customer operates and the value of the collateral. 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.
Depending on the collateral used to secure the loans, commercial loans are
generally made in amounts of up to 95% of the value of the collateral securing
the loan. Berkshire Bank generally does not make unsecured commercial loans.
Unlike residential mortgage loans, which generally are made on the basis
of the borrower's ability to make repayment from his or her employment or other
income, and which are secured by real property whose value tends to be more
easily ascertainable, commercial loans are of higher risk and typically are made
on the basis of the borrower's ability to make repayment from the cash flow of
the borrower's business. As a result, the availability of funds for the
repayment of commercial loans may depend substantially on the success of the
business itself. Further, any collateral securing such loans may depreciate over
time, may be difficult to appraise and may fluctuate in value.
-19-
Loans to One Borrower. The maximum amount that Berkshire Bank may lend to
one borrower is limited by statute. At December 31, 2003, Berkshire Bank's
statutory limit on loans to one borrower was $21.0 million. At that date,
Berkshire Bank's largest amount of loans to one borrower, including the
borrower's related interests, was approximately $10.3 million and consisted of
ten loans secured by various types of business and real estate assets. These
loans were performing according to their terms at December 31, 2003.
Maturity of Loan Portfolio. The following table shows the remaining
contractual maturity of Berkshire Bank's total loans at December 31, 2003,
excluding the effect of future principal prepayments, and contractual repricing.
At December 31, 2003
-------------------------------------------------------------------------------------------------------------
Construction Home Equity
One- to Four- and Land Commercial and Lines Other
Family Development Multi-Family of Credit Automobile Consumer Commercial Total
------------- ------------ -------------- ----------- ---------- -------- ---------- --------
(In thousands)
Amounts due in:
One year or less $ 620 $25,017 $ 8,373 $ 1,767 $ 2,420 $ 544 $ 49,627 $ 88,368
More than one
year to five
years 7,781 7,079 10,598 11,823 81,305 1,641 26,296 146,523
More than 5 years 258,352 2,623 150,787 32,193 19,949 2,321 90,528 556,753
-------- ------- -------- ------- -------- ------ -------- --------
Total amount due $266,753 $34,719 $169,758 $45,783 $103,674 $4,506 $166,451 $791,644
======== ======= ======== ======= ======== ====== ======== ========
The following table sets forth, at December 31, 2003, the dollar amount of
loans contractually due after December 31, 2004, and whether such loans have
fixed interest rates or adjustable interest rates.
Due After December 31, 2004
----------------------------------------
Fixed Adjustable Total
-------- -------- --------
(In thousands)
Real estate loans:
One- to four-family $130,530 $135,603 $266,133
Construction and land
development -- 9,702 9,702
Commercial and
multi-family 13,170 148,215 161,385
-------- -------- --------
Total real estate loans 143,700 293,520 437,220
Home equity lines of credit -- 44,016 44,016
Automobile 101,254 -- 101,254
Other consumer 1,938 2,024 3,962
Commercial loans 12,470 104,354 116,824
-------- -------- --------
Total loans $259,362 $443,914 $703,276
======== ======== ========
Scheduled contractual principal repayments of loans do not reflect the
actual life of the loans. The average life of a loan is substantially less than
its contractual term because of prepayments. Automobile loans have relatively
short average lives since they are fully amortizing with final maturities
generally no longer than five years. In addition, due-on-sale clauses on loans
generally give Berkshire Bank the right to declare loans immediately due and
payable if, among other things, the borrower sells the real property with the
mortgage and the loan is not repaid. The average life of a mortgage loan tends
to increase, however, when current mortgage loan market rates are substantially
higher than rates on existing mortgage loans and, conversely, tends to decrease
when rates on existing mortgage loans are substantially higher than current
mortgage loan market rates.
Loan Approval Procedures and Authority. Berkshire Bank's lending
activities follow written, non-discriminatory, underwriting standards and loan
origination procedures established by Berkshire Bank's Board of Directors and
management. The Board of Directors has authorized the following persons and
groups of persons to approve loans up to the amounts indicated: several retail
lenders have been delegated authority to approve residential mortgage loans up
to $300,000; home equity lines of
-20-
credit ranging from $50,000 to $300,000; unsecured consumer loans from $5,000 to
$30,000; and secured consumer loans from $20,000 to $50,000. One- to four-family
mortgage loans and home equity loans up to $300,000, secured consumer loans up
to $50,000 and unsecured loans up to $30,000, may be approved by the President
and the Senior Vice President-Retail Lending.
One- to four-family mortgage loans and home equity loans from $300,000 to
$600,000 may be approved by a combination of individual officer authorities,
provided that approval must include either the President or Senior Vice
President-Retail Lending. Approvals from $600,000 to $1.5 million require
approvals of both the President and the Senior Vice President-Retail Lending.
All residential loans in excess of $1.5 million require the approval of the Loan
and Investment Committee of the Board of Directors or the full Board of
Directors.
The Board of Directors has delegated the authority to approve loans to the
President, the Senior Commercial Lender and several commercial loan officers in
amounts ranging up to $300,000 for secured commercial loans and in amounts
ranging up to $175,000 for unsecured commercial loans. Loans in excess of these
amounts require the approval of a majority of the members of Berkshire Bank's
Senior Lending Committee, which consists of the Senior Commercial Lender and all
commercial loan officers. The President, the Credit Administration Officer and
the Loan Review Officer are non-voting members of the Senior Loan Committee.
Delegated approval authorities may be combined. However, individual limits may
be combined only up to $500,000 for commercial loan approvals without requiring
approval of the Senior Lending Committee, provided that commercial loans
approved by a combination of authorities must include the approval of either the
President or the Senior Commercial Lender. All commercial loans in excess of
$1.5 million require the approval of the Loan and Investment Committee of the
Board of Directors or the full Board of Directors.
Loan Originations, Purchases and Sales. Berkshire Bank's lending
activities are conducted by its salaried and commissioned loan personnel and
through its relationships with automobile dealers. Currently, Berkshire Bank has
contractual relationships with over 90 automobile dealers who originate
automobile loans for Berkshire Bank. Such loans are only made following an
underwriting review and acceptance by Berkshire Bank. These loans are closed by
the automobile dealer and immediately assigned to Berkshire Bank, who then
services the loans. On loans originated by its automobile dealers, Berkshire
Bank compensates the originator an amount by which the interest rate paid on the
loan exceeds a specified threshold, up to a maximum of four points. The
compensation is paid at the time the loan is closed and assigned to Berkshire
Bank. For the fiscal years 2003 and 2002, Berkshire Bank originated or purchased
$60.2 million and $54.3 million of automobile loans, respectively, of which
90.6% and 87.4%, respectively, were originated indirectly through the automobile
dealers.
From time to time, Berkshire 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.
Berkshire Bank purchased $57.4 million of loans in 2003, of which $53.8 million
were secured by first mortgage liens on residential real estate. Amounts
outstanding related to loan participation interests purchased by Berkshire Bank
totaled $50.9 million and $13.7 million at December 31, 2003 and December 31,
2002, respectively, and consisted primarily of loans secured by real estate.
At December 31, 2003, Berkshire Bank was servicing $7.2 million of
automobile loans, $8.6 million of one- to four-family mortgage loans and $8.0
million of commercial loans sold to others. Loan servicing includes collecting
and remitting loan payments, accounting for principal and interest, contacting
delinquent borrowers, supervising foreclosures and property dispositions when
there 4are unremedied defaults, making insurance and tax payments on behalf of
the borrowers and generally administering the loans. The gross servicing fee
income from loans sold is generally 25 basis points for one- to four-family
mortgage loans and 100 basis points for automobile loans of the total balance of
the loan being serviced.
Berkshire Bank generally originates loans for its own portfolio but from
time to time will sell or securitize loans 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. Berkshire Bank sold or securitized fixed rate residential one-
to four-family mortgages of $69.4 million in 2003 and has contracted to
securitize an additional $39.6 million in January 2004. In addition, Berkshire
Bank sold $9.9 million of sub-prime automobile loans in 2003.
-21-
The following table presents total loans originated, purchased, sold and
repaid during the years indicated.
For the Years Ended December 31,
----------------------------------
2003 2002 2001
-------- --------- --------
(In thousands)
Loans at beginning of year $723,181 $ 802,985 $793,389
-------- --------- --------
Originations:
Real estate loans:
One-to four-family 113,606 88,770 36,668
Construction and land development 32,246 30,678 22,170
Commercial 48,644 37,564 13,296
Multi-family 2,862 5,242 800
-------- --------- --------
Total real estate loans 197,358 162,254 72,934
-------- --------- --------
Consumer loans:
Home equity lines of credit 15,380 16,361 6,887
Automobile 60,174 54,284 105,124
Other 3,466 4,613 4,527
-------- --------- --------
Total consumer loans 79,020 75,258 116,538
Commercial loans:
Commercial 44,727 48,343 63,456
-------- --------- --------
Total loans originated 321,105 285,855 252,928
-------- --------- --------
Purchases:
Real estate loans:
Residential 53,814 -- --
Commercial real estate 3,041 2,724 4,042
-------- --------- --------
Total real estate loans 56,855 2,724 4,042
Consumer loans:
Automobile -- -- 7,451
Commercial loans:
Commercial 500 -- 2,000
-------- --------- --------
Total loans purchased 57,355 2,724 13,493
-------- --------- --------
Deduct:
Principal loan repayments, prepayments
and other, net 225,528 285,852 226,179
Loan sales 65,400 73,625 24,263
Securitization of loans 16,270 -- --
Net loan charge-offs 2,799 6,906 6,357
Transfers to real estate owned -- 2,000 26
-------- --------- --------
Total deductions 309,997 368,383 256,825
-------- --------- --------
Net increase (decrease) in loans 68,463 (79,804) 9,596
-------- --------- --------
Loans at end of year $791,644 $ 723,181 $802,985
======== ========= ========
Loan Commitments. Berkshire Bank issues loan commitments to its
prospective borrowers conditioned on the occurrence of certain events.
Commitments are made in writing on specified terms and conditions and are
generally honored for up to 60 days from approval. At December 31, 2003,
Berkshire Bank had loan commitments and unadvanced loans and lines of credit
totaling $143.0 million.
Loan Fees. In addition to interest earned on loans, Berkshire Bank
receives income from fees derived from loan originations, loan modifications,
late payments and for miscellaneous services related to its loans. Income from
these activities varies from period to period depending upon the volume and type
of loans made and competitive conditions.
-22-
Berkshire Bank charges loan origination fees which are calculated as a
percentage of the amount borrowed. As required by applicable accounting
principles, loan origination fees, discount points and certain loan origination
costs are deferred and recognized over the contractual remaining lives of the
related loans on a level yield basis. At December 31, 2003, Berkshire Bank had
approximately $110,000 of net deferred loan fees and costs. Berkshire Bank
amortized approximately $34,000 of net deferred loan fees and costs during the
year ended December 31, 2003.
Nonperforming Assets, Delinquencies and Impaired Loans. When a borrower
fails to make a required loan payment, Berkshire Bank attempts to cure the
deficiency by mailing a past due notice on the 10th day after payment is due. In
most cases, delinquencies are cured promptly. If a delinquency continues beyond
the 15th day after the payment is due, the loan will appear on a delinquency
list and the account officer will contact the borrower. If a delinquency
continues beyond the 30th day, the borrower is again contacted and if it is
determined that the late payment is not a short-term cash flow problem, the
account is reported to the Senior Loan Officer. While Berkshire Bank generally
prefers to work with borrowers to resolve problems, Berkshire 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 informs the Board of Directors monthly of the amount of loans
delinquent more than 30 days, all loans in foreclosure, and all foreclosed and
repossessed property that Berkshire Bank owns. Berkshire Bank generally ceases
accruing interest on all commercial and residential loans when principal or
interest payments are delinquent 90 days or more unless management determines
the loan principal and interest to be fully-secured and in the process of
collection. Once management determines that interest is uncollectible, the
accrual of interest income on a loan is discontinued and all interest previously
accrued is reversed against current period interest income. In 2001, to enhance
its risk management practices, the Bank initiated a more conservative policy for
automobile loans whereby all delinquent automobile loans remain on accrual
status until they reach 120 days delinquent. At that time they are charged-off,
except for those customers who are in bankruptcy proceedings with a secured
loan, in which case the loan is transferred to nonaccrual status.
Berkshire Bank has adopted Statements of Financial Accounting Standards
("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan," as amended
by SFAS No. 118 "Accounting by Creditors for Impairment of a Loan--an amendment
to SFAS No. 114." At December 31, 2003 and December 31, 2002, Berkshire Bank had
$388,000 and $727,000, respectively, recorded investment in impaired loans,
which had no specific allowances and $2.0 million and $2.1 million in loans with
specific valuation allowances of $267,000 and $295,000, respectively.
The following table sets forth information regarding nonperforming assets
and loans that were 90 days or more past due and still accruing at the dates
indicated.
At December 31,
--------------------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
(Dollars in thousands)
Nonaccruing loans:
One- to four-family real estate $ 348 $ 230 $ 310 $ 390 $ 450
Commercial real estate 496 -- -- -- --
Commercial 1,887 2,850 2,077 466 1,572
Consumer(1) 468 661 315 2,013 819
------ ------ ------ ------ ------
Total nonperforming loans 3,199 3,741 2,702 2,869 2,841
Real estate owned -- 1,500 -- 50 220
------ ------ ------ ------ ------
Total nonperforming assets $3,199 $5,241 $2,702 $2,919 $3,061
====== ====== ====== ====== ======
Total nonperforming loans as a
percentage of total loans 0.40% 0.52% 0.34% 0.36% 0.42%
Total nonperforming assets as a
percentage of total assets 0.26% 0.50% 0.26% 0.29% 0.36%
Loans 90 days or more past due
and still accruing(2) $ 306 $ 590 $1,306 $ -- $ --
- ----------
(1) Consists primarily of automobile loans.
(2) Reflects Bank's policy on delinquent automobile loans whereby all
delinquent automobile loans remain on accrual status until they reach 120
days delinquent, at which time they are charged off. Previous to 2001,
automobile loans past due 90 days or more were reported as nonaccrual.
-23-
Nonaccruing commercial loans and commercial real estate loans decreased to
$2.4 million at December 31, 2003 from $2.9 million at December 31, 2002
primarily as the result of the return of two loans to accrual status, payments
collected on accounts remaining on nonaccruing status and $157,000 in gross
commercial loan charge-offs. The borrowers with loans in Berkshire Bank's
nonaccruing commercial loan portfolio have been adversely affected by national
and regional economic conditions.
Interest income that would have been recorded for the year ended December
31, 2003, had nonaccruing loans been current according to their original terms,
amounted to $165,000. A total of $14,000 was included in interest income to
reflect payments received on loans that had been paid off or brought up to date
but were still classified as nonaccruing.
The following table sets forth the delinquencies in Berkshire Bank's loan
portfolio as of the dates indicated.
At December 31, 2003 At December 31, 2002
----------------------------------------- ------------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
------------------- ------------------- ------------------- -------------------
Principal Principal Principal Principal
Balance Balance Balance Balance
Number of of Number of of Number of of Number of of
Loans Loans Loans Loans Loans Loans Loans Loans
--------- --------- --------- --------- --------- --------- --------- ---------
(Dollars in thousands)
Real estate loans:
One- to four-
family 3 $ 236 3 $ 220 3 $ 207 4 $ 92
Commercial -- -- -- -- -- -- -- --
Multi-family -- -- -- -- -- -- -- --
Consumer loans:
Home equity lines
of credit -- -- -- -- -- -- -- --
All other(1) 80 460 85 612 120 924 118 893
Commercial loans 1 36 6 215 2 49 4 110
---- ----- ---- ------ ---- ------ ---- ------
Total 84 $ 732 94 $1,047 125 $1,180 126 $1,095
==== ===== ==== ====== ==== ====== ==== ======
Delinquent loans to
total loans 0.42% 0.09% 0.47% 0.13% 0.57% 0.16% 0.57% 0.15%
At December 31, 2001
------------------------------------------
60-89 Days 90 Days or More
------------------- -------------------
Principal Principal
Balance Balance
Number of of Number of of
Loans Loans Loans Loans
--------- --------- --------- ---------
(Dollars in thousands)
Real estate loans:
One- to four-
family 3 $ 144 3 $ 254
Commercial -- -- -- --
Multi-family -- -- -- --
Consumer loans:
Home equity lines
of credit -- -- -- --
All other(1) 323 2,645 217 1,621
Commercial loans 2 381 7 1,234
---- ------ ---- ------
Total 328 $3,170 227 $3,109
==== ====== ==== ======
Delinquent loans to
total loans 0.96% 0.39% 0.66% 0.39%
- ----------
(1) Consists primarily of automobile loans.
Real Estate Owned. Real estate acquired by Berkshire Bank as a result of
foreclosure or by deed in lieu of foreclosure is classified as real estate owned
until sold. When property is acquired it is recorded at fair market value at the
date of foreclosure, establishing a new cost basis. Holding costs and declines
in fair value after acquisition are expensed. At December 31, 2003, Berkshire
Bank had no foreclosed property.
Asset Classification. Regulators have adopted various regulations and
practices regarding problem assets of financial institutions. Under such
regulations, federal and state examiners have authority to identify problem
assets during examinations and, if appropriate, require them to be classified.
Berkshire 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. In addition, Berkshire
Bank regularly analyzes the losses inherent in its loan portfolio and its
nonperforming loans to determine the appropriate level of the allowance for loan
losses.
There are four classifications for problem assets: loss, doubtful,
substandard and special mention. An asset classified as loss is considered
uncollectible and of such little value that continuance as an asset of the
institution is not warranted. If an asset or portion thereof is classified as
loss, the insured institution establishes specific allowances for loan losses
for the full amount of the portion of the asset classified as loss. 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. 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. All or
a portion of general loan loss allowances established to cover probable losses
related to assets classified as substandard or doubtful can be included in
determining an institution's regulatory capital, while specific valuation
allowances for loan losses generally do not qualify as regulatory capital.
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."
-24-
The following table sets forth Berkshire Bank's classified assets at
December 31, 2003.
Loss Doubtful Substandard Special Mention
----------------------- ----------------------- ----------------------- -----------------------
Number of Principal Number of Principal Number of Principal Number of Principal
Loans Balance Loans Balance Loans Balance Loans Balance
--------- --------- --------- --------- --------- --------- --------- ---------
(Dollars in thousands)
Real estate loans:
One- to four-family -- $ -- -- $ -- 9 $ 476 3 $ 236
Commercial -- -- -- -- 7 1,618 2 2,560
Multi-family -- -- -- -- -- -- 1 549
Construction and land
development -- -- -- -- -- -- 1 4,106
Consumer loans:
Home equity lines of
credit -- -- -- -- -- -- -- --
Automobile -- -- -- -- 123 800 77 410
All other -- -- -- -- 3 2 3 50
Commercial loans -- -- 1 194 36 4,146 45 9,423
------- ------- ------- ------- ------- ------- ------- -------
Total -- $ -- 1 $ 194 178 $ 7,042 132 $17,334
======= ======= ======= ======= ======= ======= ======= =======
At December 31, 2003, Berkshire Bank had four outstanding commercial loans
with one borrower, which were adversely classified or identified as a problem
credit, totaling $1.5 million. These loans were classified as substandard and
were secured by a lien on the borrower's commercial real estate, accounts
receivable, inventory and other commercial business assets. Based on
management's collateral value estimates, $459,000 of Berkshire Bank's December
31, 2003 allowance for loan losses have been allocated to this borrowing
relationship. Management believes that the current allocation is adequate. The
aforementioned loans were not performing according to their terms on December
31, 2003. Berkshire Bank had no other classified loans greater than $500,000
which were not performing according to their terms on December 31, 2003.
Allowance for Loan Losses. In originating loans, Berkshire Bank recognizes
that losses will be experienced on loans and that the risk of loss will vary
with, among other things, the type of loan being made, the creditworthiness of
the borrower over the term of the loan, general economic conditions and, in the
case of a secured loan, the quality of the security for the loan. Berkshire Bank
maintains an allowance for loan losses to absorb losses inherent in the loan
portfolio. The allowance for loan losses represents management's estimate of
probable losses based on information available as of the date of the financial
statements. The allowance for loan losses is based on management's evaluation of
the collectibility of the loan 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 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 all of Berkshire Bank's commercial loan
relationships exceeding $1.0 million, all material credits on Berkshire Bank's
watch list or classified as substandard and a random sampling of new loans. 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.
In assessing the allowance for loan losses, loss factors are applied to
various pools of outstanding loans and certain unused commitments. Berkshire
Bank segregates the loan portfolio according to risk characteristics (i.e.,
mortgage loans, home equity, other consumer, commercial). Loss factors are
derived using Berkshire Bank's historical loss experience and may be adjusted
for significant factors that, in management's judgment, affect the
collectibility of the portfolio as of the evaluation date.
All classified loans are reviewed for adequacy of their estimated
supporting collateral values and guarantees. If a loan is determined to have a
recovery value less than the loan balance after deducting the general reserve
assigned to that loan based upon its classification, an additional specific
reserve is assigned in an amount equal to the projected shortfall.
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 concentration 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 for the imprecision
necessarily inherent in estimates of expected credit losses.
-25-
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. Furthermore, while Berkshire Bank believes it has
established its existing allowance for loan losses in conformity with accounting
principles generally accepted in the United States of America, there can be no
assurance that regulators, in reviewing Berkshire Bank's loan portfolio, will
not request Berkshire Bank to increase its allowance for loan losses. In
addition, because future events affecting borrowers and collateral cannot be
predicted 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 loans deteriorate as a result of the factors discussed above. Any
material increase in the allowance for loan losses may adversely affect
Berkshire Bank's financial condition and results of operations.
The following table presents an analysis of Berkshire Bank's allowance for
loan losses for the years indicated.
At or For the Years Ended December 31,
-------------------------------------------------------
2003 2002 2001 2000 1999
------- ------- ------- ------- -------
(Dollars in thousands)
Allowance for loan losses, beginning of
year $10,308 $11,034 $10,216 $ 8,534 $ 7,589
------- ------- ------- ------- -------
Charged-off loans:
One- to four-family real estate -- -- 2 -- 117
Multi-family -- -- 222 -- --
Commercial real estate -- 510 -- 19 297
Consumer(1) 4,175 9,074 5,989 1,422 731
Home equity lines of credit 32 -- 52 -- --
Commercial 157 444 797 469 1,208
------- ------- ------- ------- -------
Total charged-off loans 4,364 10,028 7,062 1,910 2,353
Recoveries on loans previously
charged off 1,565 3,122 705 422 268
------- ------- ------- ------- -------
Net loans charged off 2,799 6,906 6,357 1,488 2,085
Provision for loan losses 1,460 6,180 7,175 3,170 3,030
------- ------- ------- ------- -------
Allowance for loan losses, end of year $ 8,969 $10,308 $11,034 $10,216 $ 8,534
======= ======= ======= ======= =======
Ratios:
Net loans charged off to interest-earning
loans 0.36% 0.96% 0.79% 0.19% 0.31%
Allowance for loan losses to total loans 1.13% 1.43% 1.37% 1.29% 1.27%
Allowance for loan losses to
nonperforming loans 280.37% 275.54% 408.36% 356.08% 300.39%
Net loans charged off to allowance
for loan losses 31.21% 67.00% 57.61% 14.57% 24.43%
Recoveries to charged-off loans 35.86% 31.13% 9.98% 22.09% 11.39%
- ----------
(1) Consists primarily of automobile loans.
-26-
The following table presents the approximate allocation of the allowance
for loan losses by loan categories at the dates indicated and the percentage of
such amounts to the total allowance and to total loans. 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.
At December 31,
-------------------------------------------------------------------------------------------------
2003 2002 2001
------------------------------- ------------------------------- -------------------------------
Percent of Percent of Percent of Percent of Percent of Percent of
Allowance Loans Allowance Loans Allowance Loans
in Each in Each in Each in Each in Each in Each
Category Category Category Category Category Category
to Total to Total to Total to Total to Total to Total
Amount Allowance Loans Amount Allowance Loans Amount Allowance Loans
------- ---------- ---------- ------- ---------- ---------- ------- ---------- ----------
(Dollars in thousands)
Real estate loans $ 3,436 38.31% 59.54% $ 2,289 22.21% 55.13% $ 2,347 21.27% 45.07%
Consumer loans 2,171 24.21 19.45 4,650 45.11 21.99 4,217 38.22 33.72
Commercial loans 3,362 37.48 21.01 3,369 32.68 22.88 4,470 40.51 21.21
------- ------ ------ ------- ------ ------ ------- ------ ------
Total allowance for
loan losses $ 8,969 100.00% 100.00% $10,308 100.00% 100.00% $11,034 100.00% 100.00%
======= ====== ====== ======= ====== ====== ======= ====== ======
At December 31,
----------------------------------------------------------------
2000 1999
------------------------------- -------------------------------
Percent of Percent of Percent of Percent of
Allowance Loans Allowance Loans
in Each in Each in Each in Each
Category Category Category Category
to Total to Total to Total to Total
Amount Allowance Loans Amount Allowance Loans
------- ---------- ---------- ------- ---------- ----------
(Dollars in thousands)
Real estate loans $ 2,337 22.88% 43.27% $ 2,322 27.20% 47.34%
Consumer loans 4,528 44.32 35.69 2,867 33.60 30.97
Commercial loans 3,351 32.80 21.04 3,345 39.20 21.69
------- ------ ------ ------- ------ ------
Total allowance for
loan losses $10,216 100.00% 100.00% $ 8,534 100.00% 100.00%
======= ====== ====== ======= ====== ======
Investment Securities Activities
General. Under Massachusetts law, Berkshire Bank has authority to purchase
a wide range of investment securities. As a result of changes in federal banking
laws, however, financial institutions such as Berkshire Bank may not engage as
principals in any activities that are not permissible for a national bank,
unless the Federal Deposit Insurance Corporation has determined that the
investments would pose no significant risk to the Bank Insurance Fund and
Berkshire Bank is in compliance with applicable capital standards. In 1993, the
Regional Director of the Federal Deposit Insurance Corporation approved a
request by Berkshire Bank to acquire and retain certain listed stocks and/or
registered stocks subject to certain conditions. The Company makes its
investments through Berkshire Bank or one of the Bank's securities corporation
subsidiaries and is generally not subject to any such restrictions on its
investment authority. See "Regulation and Supervision."
Berkshire Bank's main source of income has been and will continue to be
derived from its loan portfolio. The investment securities portfolio is
primarily used to provide for Berkshire Bank's cash flow needs, to provide
adequate liquidity to protect the safety of customer deposits and to earn a
reasonable return on investment. The structure of the investment securities
portfolio is based upon the composition and quality of the loan portfolio and
Berkshire Bank's liquidity position and deposit structure.
Berkshire Bank's investment policy divides investments into two
categories, fixed income and equity portfolios. The primary objectives of the
fixed income portfolio are to: (1) maintain an adequate source of liquidity
sufficient to meet regulatory and operating requirements, including funding for
loans; (2) safeguard against deposit outflows, reduced loan amortization and
increased loan demand; and (3) manage interest rate risk. The fixed income
securities portfolio primarily consists of debt issues, including corporate and
municipal bonds, U.S. Government and Agency obligations and mortgage-backed and
asset-backed securities, including collateralized mortgage obligations and real
estate mortgage investment conduits. A collateralized mortgage obligation is a
mortgage-backed bond that separates mortgage pools into different maturities
called "tranches." Tranches pay different rates of interest and can mature in a
few months, or a few years. In return for a lower yield, collateralized mortgage
obligations provide increased security over the life of the investment. However,
in a declining interest rate risk environment, collateralized mortgage
obligations tend to be repaid before their expected maturities as prepayments
increase. This may result in Berkshire Bank having to reinvest the funds at a
lower interest rate. Real estate mortgage investment conduits, a type of
-27-
collateralized mortgage obligation, are similar in that securities representing
an undivided interest in such mortgages are issued. However, real estate
mortgage investment conduits have more flexibility than other types of
collateralized mortgage obligations as issuers can separate mortgage pools not
only into different maturity classes but also into different risk classes. At
present, 99.8% of Berkshire Bank's mortgage-backed securities are issued or
guaranteed by agencies of the U.S. Government, which carry lower credit risk
than mortgage-backed securities of a private issuer. Other types of asset-backed
securities in which Berkshire Bank invests are typically collateralized by the
cash flow from a pool of automobile loans, credit card receivables, consumer
loans and other similar obligations. Both mortgage-backed and asset-backed
securities carry the risk that changing market interest rates may cause a change
in market value.
The marketable equity securities portfolio is currently managed to produce
capital gains through price appreciation and lowering taxable income through
deductions permitted for a portion of dividends received. However, Berkshire
Bank continued restructuring its investment portfolio by placing less emphasis
on equity securities. The marketable equity securities portfolio consists
primarily of bank, utility and industrial stocks and is currently limited by the
investment policy to 100% of Tier I capital. Berkshire Bank had $93.8 million of
Tier 1 capital at December 31, 2003. Equities totaling $7.0 million were sold in
2003, resulting in a gain of $2.7 million. At December 31, 2003, equities,
excluding Federal Home Loan Bank and Savings Bank Life Insurance stock,
comprised 4.3% of the investment portfolio compared to 9.0% at December 31,
2002. The gross unrealized gains associated with the marketable equity
securities portfolio were $8.4 million at December 31, 2003. At such date, there
were no gross unrealized losses. The marketable equity securities portfolio
carries equity price risk in that, if equity prices decline due to unfavorable
market conditions or other factors, Berkshire Bank's capital would decrease.
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities," requires that securities be categorized as "held-to-maturity,"
"trading securities" or "available-for-sale," based on management's intent as to
the ultimate disposition of each security. SFAS No. 115 allows debt securities
to be classified as "held-to-maturity" and reported in financial statements at
amortized cost only if the reporting entity has the positive intent and ability
to hold those securities to maturity. Securities that might be sold in response
to changes in market interest rates, changes in the security's prepayment risk,
increases in loan demand, or other similar factors cannot be classified as
"held-to-maturity." Debt and equity securities held for current resale are
classified as "trading securities." These securities are reported at fair value,
and unrealized gains and losses on the securities would be included in earnings.
Berkshire Bank does not currently use or maintain a trading account. Debt and
equity securities not classified as either "held-to-maturity" or "trading
securities" are classified as "available-for-sale." These securities are
reported at fair value, and unrealized gains and losses on the securities are
excluded from earnings and included in accumulated other comprehensive income,
net of taxes.
The Loan and Investment Committee of the Board of Directors is responsible
for developing and reviewing Berkshire Bank's investment policy. Investment
decisions are made in accordance with Berkshire Bank's investment policy and are
based upon the quality of a particular investment, its inherent risks, Berkshire
Bank's liquidity needs, prospects for yield and/or appreciation and the
potential tax consequences. While general investment strategies are developed
and authorized by the Loan and Investment Committee, the execution of specific
investment actions and the day-to-day oversight of Berkshire Bank's investment
portfolio rests with the President and the Treasurer. These officers are
authorized to execute investment transactions up to specified limits based on
the type of security without the prior approval of the Loan and Investment
Committee. However, such purchases require a review of the Loan and Investment
Committee at their next scheduled meeting. The Board of Directors receives a
monthly report of all securities transactions made during the previous month.
Berkshire Bank's investment policy allows the use of certain hedging
strategies, including the purchase of options in an effort to increase the
return and decrease the risk on the securities portfolio. Berkshire Bank has
used covered call option strategies in the past and may continue to do so in the
future. Berkshire Bank has not used interest rate futures or options on futures
as part of its interest rate hedging strategies.
-28-
The following table presents the amortized cost and fair value of
Berkshire Bank's available-for-sale securities, by type of security, at the
dates indicated.
At December 31,
--------------------------------------------------------------------------
2003 2002 2001
---------------------- ---------------------- ----------------------
Amortized Amortized Amortized
Cost Fair Value Cost Fair Value Cost Fair Value
--------- ---------- --------- ---------- --------- ----------
(In thousands)
Investment securities:
Obligations of U.S. Treasury and
U.S. Government Agencies $ 20,840 $ 20,969 $ 98,058 $ 98,719 $ 13,876 $ 14,017
Corporate bonds and notes 17,102 17,310 31,284 31,637 31,017 31,251
Municipal notes 12,294 12,282 -- -- -- --
Asset-backed securities 2,566 2,106 6,956 6,772 1,484 1,496
Marketable equity securities(1) 6,515 14,888 11,132 19,581 11,447 39,803
-------- -------- -------- -------- -------- --------
Total investment securities 59,317 67,555 147,430 156,709 57,824 86,567
-------- -------- -------- -------- -------- --------
Mortgage-backed securities:
Freddie Mac 53,883 53,638 3,558 3,605 3,292 3,335
Fannie Mae 185,018 185,551 3,066 3,051 2,774 2,845
Private label REMICs 653 648 9,761 9,750 11,555 11,619
Ginnie Mae 32 33 52 54 78 80
-------- -------- -------- -------- -------- --------
Total mortgage-backed securities 239,586 239,870 16,437 16,460 17,699 17,879
-------- -------- -------- -------- -------- --------
Total available for sale securities $298,903 $307,425 $163,867 $173,169 $ 75,523 $104,446
======== ======== ======== ======== ======== ========
- ----------
(1) Includes mutual funds.
The following table presents the amortized cost and fair value of
Berkshire Bank's held for maturity securities, by type of security, at the dates
indicated.
At December 31,
--------------------------------------------------------------------------
2003 2002 2001
---------------------- ---------------------- ----------------------
Amortized Amortized Amortized
Cost Fair Value Cost Fair Value Cost Fair Value
--------- ---------- --------- ---------- --------- ----------
(In thousands)
Investment securities:
Municipal notes and other
obligations $ 20,545 $ 20,545 $ 14,480 $ 14,480 $ 11,241 $ 11,241
-------- -------- -------- -------- -------- --------
Total investment securities 20,545 20,545 14,480 14,480 11,241 11,241
-------- -------- -------- -------- -------- --------
Mortgage-backed securities:
Freddie Mac 10,163 10,146 17,120 17,164 9,790 9,851
Fannie Mae 3,743 3,742 11,657 11,688 11,177 11,253
Ginnie Mae 2,452 2,435 1,010 1,016 1,055 1,064
-------- -------- -------- -------- -------- --------
Total mortgage-backed securities 16,358 16,323 29,787 29,868 22,022 22,168
-------- -------- -------- -------- -------- --------
Total held to maturity securities $ 36,903 $ 36,868 $ 44,267 $ 44,348 $ 33,263 $ 33,409
======== ======== ======== ======== ======== ========
At December 31, 2003, Berkshire Bank did not own any investment or
mortgage-backed securities of a single issuer, other than U.S. Treasury and U.S.
Government Agency securities, which had an aggregate book value in excess of 10%
of Berkshire Bank's capital at that date.
-29-
The following table presents the activity in the investment securities and
mortgage-backed securities portfolios for the years indicated.
For the Years Ended December 31,
---------------------------------------
2003 2002 2001
--------- --------- ---------
(In thousands)
Investment securities:
Investment securities, beginning of year $ 171,189 $ 97,808 $ 97,023
--------- --------- ---------
Purchases 83,227 195,005 49,212
Sales (12,133) (13,112) (3,697)
Loss on impairment of securities -- (673) --
Maturities and calls (147,286) (84,606) (39,559)
Repayments and prepayments (5,140) (3,191) (2,395)
Net (premium) (994) (578) (1,225)
(Decrease) in unrealized gain (763) (19,464) (1,551)
--------- --------- ---------
Net increase/(decrease) in investment securities (83,089) 73,381 785
--------- --------- ---------
Investment securities, end of year 88,100 171,189 97,808
--------- --------- ---------
Mortgage-backed securities:
Mortgage-backed securities, beginning of year 46,247 39,901 34,524
--------- --------- ---------
Purchases 266,586 63,065 43,853
Securitized mortgages 16,270 -- --
Repayments and prepayments (66,918) (56,037) (39,477)
Sales (5,139) -- --
Net (premium) discount (801) (525) 955
Increase /(decrease) in unrealized gain (17) (157) 46
--------- --------- ---------
Net increase in mortgage-backed securities 209,981 6,346 5,377
--------- --------- ---------
Mortgage-backed securities, end of year 256,228 46,247 39,901
--------- --------- ---------
Total securities, end of year $ 344,328 $ 217,436 $ 137,709
========= ========= =========
The following table presents certain information regarding the amortized
cost, weighted average yields and estimated maturities or periods to repricing
of Berkshire Bank's debt securities at December 31, 2003.
At December 31, 2003
---------------------------------------------------------------------------
More than One Year More than Five Years
One Year or Less to Five Years to Ten Years
--------------------- --------------------- ---------------------
Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield
--------- -------- --------- -------- --------- --------
(Dollars in thousands)
Investment securities:
Obligations of U.S. Treasury and
U.S. Government Agencies $ 15,696 2.73% $ 5,144 3.10% $ -- --%
Mortgage-backed securities 2,777 2.11 226,086 3.90 27,080 4.73
Municipal notes 8,088 1.42 5,073 4.13 3,052 4.27
Corporate bonds and notes 10,049 2.63 3,975 2.17 -- --
Asset-backed securities 268 0.21 2,298 6.18 -- --
-------- -------- --------
Total $ 36,878 2.35% $242,576 3.88% $ 30,132 4.68%
======== ======== ========
At December 31, 2003
------------------------------------------------
More than Ten Years Total
--------------------- ---------------------
Weighted Weighted
Amortized Average Amortized Average
Cost Yield Cost Yield
--------- -------- --------- --------
(Dollars in thousands)
Investment securities:
Obligations of U.S. Treasury and
U.S. Government Agencies $ -- --% $ 20,840 2.82%
Mortgage-backed securities -- -- 255,943 3.97
Municipal notes 16,627 4.90 32,840 3.86
Corporate bonds and notes 3,078 4.36 17,102 2.84
Asset-backed securities -- -- 2,566 5.55
-------- --------
Total $ 19,705 4.82% $329,291 3.84%
======== ========
-30-
Deposit Activities and Other Sources of Funds
General. Deposits are the major source of funds for Berkshire Bank's
lending and other investment activities. In addition, Berkshire Bank also
generates funds internally from loan repayments, prepayments and sales and
maturing investment securities. Scheduled loan repayments are a relatively
stable source of funds, while deposit inflows and outflows and loan prepayments
are influenced significantly by general interest rates and money market
conditions. Berkshire Bank uses borrowings from the Federal Home Loan Bank of
Boston as an additional source of funding for loan and securities investment
activity.
Deposit Accounts. Substantially all of Berkshire Bank's deposits are
generated from the areas surrounding its branch offices. Berkshire Bank offers a
wide variety of deposit accounts with a range of interest rates and terms.
Berkshire Bank may periodically offer special 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 certificates of deposit. The initial maturities of Berkshire
Bank's certificate of deposit accounts range from three months to ten years. In
addition, Berkshire Bank offers retirement accounts, including Traditional IRAs,
Roth IRAs, Simple IRAs, Self-Directed IRAs and Keogh accounts, simplified
employee pension plan, profit-sharing qualified plan and money purchase pension
plan accounts.
Berkshire Bank also offers a variety of deposit accounts designed for the
businesses operating in its market area. Deposit account terms vary with the
principal differences being the minimum balance deposit, early withdrawal
penalties, limits on the number of transactions and the interest rate. Berkshire
Bank's business banking deposit products include a commercial checking account
that provides an earnings credit to offset monthly service charges and a
checking account specifically designed for small businesses. Additionally,
Berkshire Bank offers sweep accounts and money market accounts for businesses
and IOLTA interest checking and escrow accounts. Berkshire Bank has sought to
increase its commercial deposits through the offering of these products,
particularly to its commercial borrowers and to the municipalities that
participate in its government banking program.
Berkshire Bank reviews its deposit mix and pricing on a weekly basis and
believes it offers competitive interest rates on its deposit products. Berkshire
Bank determines the rates paid based on a number of factors, including rates
paid by competitors, Berkshire Bank's need for funds and cost of funds,
Berkshire Bank's current asset/liability structure, the amount of maturing
deposits and movements of market interest rates. Berkshire Bank currently does
not utilize brokers to obtain deposits but may choose to do so in the future.
In the unlikely event Berkshire Bank is liquidated, depositors will be
entitled to full payment of their deposit accounts before any payment is made to
Berkshire Hills as the sole stockholder of Berkshire Bank.
The following table presents the deposit activity of Berkshire Bank for
the years indicated.
For the Years Ended December 31,
--------------------------------
2003 2002 2001
-------- -------- --------
(In thousands)
Increase/(decrease) before interest credited $ 34,022 $ 21,854 $(13,550)
Interest credited 13,862 17,777 26,685
-------- -------- --------
Net increase $ 47,884 $ 39,631 $ 13,135
======== ======== ========
At December 31, 2003, Berkshire Bank had certificate of deposit accounts
in amounts of $100,000 or more maturing as follows:
Weighted
Maturity Average
Period Amount Rate
-----------------------------------------------------------
(Dollars in thousands)
Three months or less $ 30,702 1.90%
Over 3 months through 6 months 28,273 2.14
Over 6 months through 12 months 31,730 2.71
Over 12 months 50,388 4.75
--------
Total $141,093 3.14%
========
-31-
The following table presents information concerning average balances and
weighted average interest rates on Berkshire Bank's deposit accounts for the
years indicated.
For the Years Ended December 31,
-------------------------------------------------------------------------------
2003 2002
-------------------------------------- ------------------------------------
Percent of Percent of
Total Weighted Total Weighted
Average Average Average Average Average Average
Balance Deposits Rate Balance Deposits Rate
-------- ---------- -------- -------- ---------- --------
(Dollars in thousands)
Money market accounts $132,497 16.25% 1.24% $117,950 15.48% 1.69%
NOW accounts 90,170 11.06 0.17 83,399 10.95 0.75
Savings(1) 170,749 20.95 1.01 157,444 20.66 1.70
Certificates of deposit 330,116 40.50 3.13 320,418 42.05 3.91
Demand accounts 91,627 11.24 -- 82,752 10.86 --
-------- ------ -------- ------
Total $815,159 100.00% 1.70% $761,963 100.00% 2.33%
======== ====== ======== ======
For the Years Ended December 31,
-------------------------------------
2001
-------------------------------------
Percent of
Total Weighted
Average Average Average
Balance Deposits Rate
-------- ---------- --------
(Dollars in thousands)
Money market accounts $112,434 15.31% 3.30%
NOW accounts 77,276 10.52 1.04
Savings(1) 142,150 19.36 2.88
Certificates of deposit 325,633 44.34 5.55
Demand accounts 76,912 10.47 --
-------- ------
Total $734,405 100.00% 3.63%
======== ======
- ----------
(1) Includes mortgagors' escrow accounts.
Certificates of Deposit by Rates and Maturities. The following table
presents the amount of certificate accounts categorized by rates and maturities,
for the periods and years indicated.
Period to Maturity from December 31, 2003
------------------------------------------------- Total at December 31,
Less than One to Two Two to Three Over Three ----------------------------------
One Year Years Years Years 2003 2002 2001
--------- --------- ------------ ---------- -------- -------- --------
(In thousands)
0.00-4.00% $210,485 $ 24,073 $ 6,817 $ 5,661 $247,036 $236,829 $107,984
4.01-5.00% 2,457 14,629 1,239 21,788 40,113 43,019 79,635
5.01-6.00% 3,967 1,327 1,913 9,740 16,947 20,196 50,726
6.01-7.00% 2,621 2,802 550 9,455 15,428 28,423 70,223
7.01% and above 92 1,734 -- -- 1,826 1,722 8,669
-------- -------- -------- -------- -------- -------- --------
Total $219,622 $ 44,565 $ 10,519 $ 46,644 $321,350 $330,189 $317,237
======== ======== ======== ======== ======== ======== ========
Borrowings. Berkshire Bank utilizes advances from the Federal Home Loan
Bank of Boston to supplement its supply of lendable funds and to meet deposit
withdrawal requirements. The Federal Home Loan Bank of Boston functions as a
central reserve bank providing credit for savings banks and certain other member
financial institutions. As a member of the Federal Home Loan Bank of Boston,
Berkshire Bank is required to own capital stock in the Federal Home Loan Bank of
Boston and may apply for advances on the security of the capital stock and
certain of its mortgage loans and other assets, principally securities that are
obligations of, or guaranteed by, the U.S. Government or its Agencies, provided
certain creditworthiness standards have been met. Advances are made under
several different credit programs. Each credit program has its own interest rate
and range of maturities. Depending on the program, limitations on the amount of
advances are based on the financial condition of the member institution and the
adequacy of collateral pledged to secure the credit. At December 31, 2003,
Berkshire Bank had the ability to borrow a total of approximately $374.8 million
from the Federal Home Loan Bank of Boston. At that date, Berkshire Bank had
outstanding advances of $251.5 million. In addition, Berkshire Bank had a $2.0
million repurchase agreement line of credit to be secured by securities or other
assets of Berkshire Bank with the Depositors Insurance Fund, and a $50.0 million
repurchase agreement line of credit with a nationally recognized broker-dealer.
At December 31, 2003, Berkshire Bank had no outstanding borrowings against
either of these agreements.
-32-
The following tables present certain information regarding Berkshire
Bank's Federal Home Loan Bank advances during the periods and at the dates
indicated.
For the Years Ended December 31,
------------------------------------
2003 2002 2001
-------- -------- --------
(Dollars in thousands)
Maximum amount of advances
outstanding at any month end $251,465 $143,053 $140,115
Average advances outstanding 167,621 140,406 127,990
Weighted average rate paid
on advances 2.91% 4.01% 5.17%
At December 31,
------------------------------------
2003 2002 2001
-------- -------- --------
(Dollars in thousands)
Balance outstanding at end of year $251,465 $133,002 $133,964
Weighted average rate on advances
at end of year 2.61% 3.27% 4.26%
Berkshire Bank offers retail repurchase agreements to selected higher
balance customers and certain municipalities. These agreements are direct
obligations of Berkshire Bank to repay at maturity or on demand the purchase
price of an undivided interest in a U.S. Government or agency security owned by
Berkshire Bank. Since these agreements are not deposits, they are not insured by
the Federal Deposit Insurance Corporation. At December 31, 2003, there were no
such retail repurchase agreements.
The following tables represent certain information regarding Berkshire
Bank's retail repurchase agreements during the years and at the dates indicated.
For the Years Ended December 31,
------------------------------------
2003 2002 2001
-------- -------- --------
(Dollars in thousands)
Maximum amount of retail repurchase
agreements outstanding at any month end $ 500 $ 1,830 $ 2,340
Average retail repurchase agreements
outstanding 88 1,349 1,584
Weighted average rate paid on retail
repurchase agreements 1.24% 1.72% 3.78%
At December 31,
------------------------------------
2003 2002 2001
-------- -------- --------
(Dollars in thousands)
Balance outstanding at end of year -- $ 700 $ 1,890
Weighted average rate on retail repurchase
agreements at end of year --% 1.59% 1.74%
Trust Services
Berkshire Bank maintains the Asset Management/Trust Group as a department
within Berkshire Bank which primarily provides trust and investment services to
individuals, partnerships, corporations and institutions and also acts as a
fiduciary of estates and conservatorships and as a trustee under various wills,
trusts and other plans. The trust department allows Berkshire Bank to provide
investment opportunities and fiduciary services to both current and prospective
customers. Consistent with Berkshire Bank's operating strategy, Berkshire Bank
will continue to emphasize the growth of its trust service operations to grow
assets and increase fee-based income. Berkshire Bank has implemented several
policies governing the practices and procedures of the trust department,
including policies relating to maintaining confidentiality of trust records,
investment of trust property, handling conflicts of interest, and maintaining
impartiality. At December 31, 2003, the trust department managed 792 accounts
with aggregate assets of $287.7 million, of which the largest relationship
totaled $20.0 million, or 7.0%, of the trust department's total assets. Trust
fees totaled $2.1 million for 2003 and $1.8 million for 2002.
-33-
Government Banking
Berkshire Bank offers full-service government banking for cities, towns
and municipal school districts in western Massachusetts and southern Vermont.
Berkshire Bank offers municipalities all aspects of financial advisory services
for the sale of notes and bonds, actively working with bond counsel, rating
agencies, consulting agencies and bond buyers. Additionally, Berkshire Bank
offers a wide range of municipal deposit products and checking accounts, as well
as the origination of payroll accounts. At December 31, 2003, Berkshire Bank was
working with approximately 63 municipal entities. For 2003, government banking
generated $56,000 of net fee income compared to $180,000 for 2002.
Personnel
As of December 31, 2003, Berkshire Bank had 230 full-time employees and 34
part-time employees. The employees are not represented by a collective
bargaining unit and the Bank will strive to continue its strong relationship
with its employees.
Subsidiary Activities
The following are descriptions of Berkshire Bank's active subsidiaries,
all of which are wholly-owned. All subsidiaries are incorporated in
Massachusetts and are indirectly owned by Berkshire Hills.
North Street Securities Corporation. North Street Securities Corporation,
("North Street") originally named GBSB Leasing Corporation, was established in
January 1984 to acquire and hold investment securities of a type that are
permissible for banks to hold under applicable law. North Street is qualified as
a "securities corporation" for Massachusetts income tax purposes. Income earned
by a qualifying securities corporation is generally entitled to special tax
treatment from Massachusetts income tax. As of December 31, 2003, North Street
had assets totaling $105.6 million, consisting primarily of municipal bonds,
corporate bonds, private label REMICs and common and preferred equity
securities.
Gold Leaf Investment Services, Inc. Gold Leaf Investment Services, Inc.,
established in May 2000, began operations during the first quarter of 2001. Gold
Leaf Investment Services offers access to a full range of security brokerage
services, including financial planning, professional money management, stocks,
bonds, mutual funds and annuities. These services are available through a
partnership with UVEST Investment Services, a registered securities
broker-dealer and member NASD/SIPC and are available in all of the Bank's
branches.
Gold Leaf Insurance Agency, Inc. Gold Leaf Insurance Agency, Inc.,
established in May 2000, began operations during the third quarter of 2000. Gold
Leaf Insurance Agency offers a full line of products including automobile, home,
business and life insurance.
Gold Leaf Securities Corporation. Gold Leaf Securities Corporation was
established in May 2003 to acquire and hold investment securities of a type that
are permissible for banks to hold under applicable law. Gold Leaf Securities
Corporation is qualified as a "securities corporation" for Massachusetts income
tax purposes. As of December 31, 2003, Gold Leaf Securities Corporation had
assets totaling $5.1 million, consisting primarily of Industrial Revenue Bonds.
Woodland Securities, Inc. Woodland Securities, Inc. ("Woodland"),
originally named Woodland Realty, Inc., was established in April 1995 to
purchase, own, sell, develop and lease real property and personal property of
all types. Inactive for a number of years, Woodland converted to a Massachusetts
"securities corporation" for Massachusetts income tax purposes in 2002. As of
December 31, 2003, Woodland had assets of $210.0 million consisting primarily of
agency mortgage-backed, callable agency securities and agency REMICs. The Bank
has pledged all of its shares of Woodland to the Federal Home Loan Bank of
Boston to secure its borrowing facility.
Excluding Berkshire Bank, the following are descriptions of Berkshire
Hills' wholly-owned active subsidiaries. All of Berkshire Hills' subsidiaries,
including Berkshire Bank, are incorporated in Massachusetts.
Berkshire Hills Funding Corporation. Berkshire Hills Funding Corporation
was established in May 2000 as a general purpose funding vehicle for Berkshire
Hills. Outside of cash, its sole asset is a loan to Berkshire Bank's Employee
Stock Ownership Plan ("ESOP"). The proceeds of such loan were used to fund the
ESOP trustee's purchase of Berkshire Hills common stock.
Berkshire Hills Technology, Inc. Berkshire Hills Technology, Inc. was
established in May 2001 to invest, own and sell any type of business enterprise
including, but not limited to, corporations and limited liability companies. In
June 2001, along with a consortium of five other financial institutions,
Berkshire Hills Technology, Inc. announced its investment of $4.7 million in
EastPoint Technologies, LLC ("EastPoint"). The Company's equity interest in
EastPoint equals 60.3%. EastPoint, headquartered in Bedford, New Hampshire, is a
software and data processing provider for financial institutions.
-34-
Segment Reporting
Through its wholly-owned subsidiary, Berkshire Hills Technology, Inc., the
Company owns a 60.3% equity interest in EastPoint. Prior to the acquisition of
EastPoint, management monitored the revenue streams of the various products and
services in evaluating the Company's operations and financial performance.
Accordingly, all of the Company's operations were considered by management to be
aggregated in one reportable operating segment. Subsequent to the acquisition of
EastPoint, the Company's operations continue to be aggregated in one reportable
segment, the Bank, except Berkshire Hills Technology, Inc., which is evaluated
on a stand-alone basis.
Information about reportable segments, and the reconciliation of such
information to the consolidated financial statements as of and for the years
ended December 31, 2003, 2002 and 2001 follows:
At December 31, 2003
---------------------------------------------
Berkshire Hills Consolidated
Bank Technology, Inc. Totals
----------- ---------------- ------------
(In thousands)
Net interest income $ 37,566 $ -- $ 37,566
Depreciation and amortization 1,412 695 2,107
Provision for loan losses 1,460 -- 1,460
License fees -- 7,262 7,262
Minority interest -- (186) (186)
Profit (loss) 9,247 (282) 8,965
Assets 1,210,890 7,658 1,218,548
Expenditures for additions to
premises and equipment 1,386 80 1,466
At December 31, 2002
---------------------------------------------
Berkshire Hills Consolidated
Bank Technology, Inc. Totals
----------- ---------------- ------------
(In thousands)
Net interest income $ 40,700 $ -- $ 40,700
Depreciation and amortization 1,813 601 2,414
Provision for loan losses 6,180 -- 6,180
License fees -- 6,991 6,991
Minority interest -- (685) (685)
Profit (loss) 3,937 (1,040) 2,097
Assets 1,037,376 8,571 1,045,947
Expenditures for additions to
premises and equipment 1,044 424 1,468
At December 31, 2001
---------------------------------------------
Berkshire Hills Consolidated
Bank Technology, Inc. Totals
----------- ---------------- ------------
(In thousands)
Net interest income $ 42,236 $ -- $ 42,236
Depreciation and amortization 1,769 312 2,081
Provision for loan losses 7,175 -- 7,175
License fees -- 3,465 3,465
Minority interest -- (119) (119)
Profit (loss) 8,868 43 8,911
Assets 1,021,623 9,078 1,030,701
Expenditures for additions to
premises and equipment 735 1,609 2,344
The Company does not allocate income taxes to its segments, but rather,
assigns all taxes to the Bank.
-35-
REGULATION AND SUPERVISION
General
As a savings and loan holding company, Berkshire Hills is required to file
reports with, and otherwise comply with the rules and regulations of, the Office
of Thrift Supervision ("OTS"). As a savings bank chartered by the Commonwealth
of Massachusetts, Berkshire Bank is subject to extensive regulation, examination
and supervision by the Massachusetts Commissioner of Banks, as its primary
regulator, and the Federal Deposit Insurance Corporation, as the deposit
insurer. Berkshire Bank is a member of the Federal Home Loan Bank system and,
with respect to deposit insurance, of the Bank Insurance Fund managed by the
Federal Deposit Insurance Corporation. Berkshire Bank must file reports with the
Commissioner of Banks and the Federal Deposit Insurance Corporation 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 of Banks and /or
the Federal Deposit Insurance Corporation conduct periodic examinations to test
Berkshire Bank's safety and soundness and compliance with various regulatory
requirements. This regulation and supervision establishes a comprehensive
framework of activities in which an institution can engage and is intended
primarily for the protection of the insurance fund and depositors. The
regulatory structure also 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
of Banks, the Federal Deposit Insurance Corporation or Congress, could have a
material adverse impact on the Company, the Bank and their operations. Certain
regulatory requirements applicable to Berkshire Bank and to the Company 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.
Massachusetts Banking Laws and Supervision
Massachusetts savings banks are regulated and supervised by the
Massachusetts Commissioner of Banks. The Massachusetts Commissioner of Banks is
required to regularly examine each state-chartered bank. The approval of the
Massachusetts Commissioner of Banks is required to establish or close branches,
to merge with another bank, to form a holding company, to issue stock or to
undertake many other activities. Any Massachusetts bank that does not operate in
accordance with the regulations, policies and directives of the Massachusetts
Commissioner of Banks may be sanctioned. The Massachusetts Commissioner of Banks
may suspend or remove directors or officers of a bank who have violated the law,
conducted a bank's business in a manner that is unsafe, unsound or contrary to
the depositors' interests, or been negligent in the performance of their duties.
In addition, the Massachusetts Commissioner of Banks has the authority to
appoint a receiver or conservator if it is determined that the bank is
conducting its business in an unsafe or unauthorized manner, and under certain
other circumstances.
All Massachusetts-chartered savings banks are required to be members of
the Depositors Insurance Fund, a private deposit insurer, which insures all
deposits in member banks in excess of Federal Deposit Insurance Corporation
deposit insurance limits. Member banks are required to pay the assessments of
the fund. 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.
The powers that Massachusetts-chartered savings banks can exercise under
these laws are summarized below.
Lending Activities. A Massachusetts-chartered savings bank may make a wide
variety of mortgage loans including fixed-rate loans, adjustable-rate loans,
variable-rate loans, participation loans, graduated payment loans, construction
and development loans, condominium and co-operative loans, second mortgage loans
and other types of loans that may be made in accordance with applicable
regulations. Commercial loans may be made to corporations and other commercial
enterprises with or without security. Consumer and personal loans may also be
made with or without security. Loans to individual borrowers generally must be
limited to 20% of the total of a bank's capital accounts and stockholders'
equity.
Investments Authorized. Massachusetts-chartered savings banks have broad
investment powers under Massachusetts law, including so-called "leeway"
authority for investments that are not otherwise specifically authorized. The
investment powers authorized under Massachusetts law are restricted by federal
law to permit, in general, only investments of the kinds that would be permitted
for national banks. Berkshire Bank has authority to invest in all of the classes
of loans and investments that are permitted by its existing loan and investment
policies.
Payment of Dividends. A savings bank may only pay dividends on its capital
stock if such payment would not impair the bank's capital stock. 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
Massachusetts Commissioner of Banks may restrict the payment of dividends by a
bank if it is determined that such payment would result in safety and soundness
concerns.
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Parity Regulation. Effective November 19, 2002, Massachusetts law was
amended to increase the powers of Massachusetts banks under certain conditions.
As a result of such amendment, a Massachusetts bank may engage in any activity
or offer any product or service if the activity, product or service is engaged
in or offered in accordance with regulations promulgated by the Massachusetts
Commissioner of Banks and has been authorized for national banks, federal
thrifts or state banks in a state other than Massachusetts; provided that the
activity is permissible under applicable federal and Massachusetts law and
subject to the same limitations and restrictions imposed on the national bank,
federal thrift or out-of-state bank that had previously been granted the power.
Assessments. Savings banks are required to pay assessments to the
Commissioner of Banks to fund operations. Assessments paid by Berkshire Bank for
the fiscal year ended December 31, 2003 totaled $150,254.
Federal Regulations
Capital Requirements. Under Federal Deposit Insurance Corporation
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 Federal Deposit Insurance Corporation 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 assets 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 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.
Berkshire Bank must also comply with the Federal Deposit Insurance
Corporation risk-based capital guidelines. The Federal Deposit Insurance
Corporation guidelines require state non-member banks to maintain certain levels
of regulatory capital in relation to regulatory risk-weighted assets. The ratio
of regulatory capital to regulatory risk-weighted assets is referred to as
Berkshire Bank's "risk-based capital ratio." 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. For
example, under the Federal Deposit Insurance Corporation's risk-weighting
system, cash and securities backed by the full faith and credit of the U.S.
Government are given a 0% risk weight, loans secured by one- to four-family
residential properties generally have a 50% risk weight and commercial loans
have a risk weighting of 100%.
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.
The Federal Deposit Insurance Corporation Improvement Act required each
federal banking agency to revise its risk-based capital standards for insured
institutions to ensure that those standards take adequate account of interest
rate risk, concentration of credit risk, and the risk of nontraditional
activities, as well as to reflect the actual performance and expected risk of
loss on multi-family residential loans. The Federal Deposit Insurance
Corporation, along with the other federal banking agencies, has adopted a
regulation providing that the agencies will take into account the exposure of a
bank's capital and economic value to changes in interest rate risk in assessing
a bank's capital adequacy.
As a savings and loan holding company regulated by the Office of Thrift
Supervision, Berkshire Hills is not, under current law, subject to any separate
regulatory capital requirements.
The following is a summary of Berkshire Bank's regulatory capital at
December 31, 2003:
GAAP Capital to Total Assets 10.11%
Total Capital to Risk-Weighted Assets 12.57%
Tier I Leverage Ratio 7.87%
Tier I to Risk-Weighted Assets 11.07%
Standards for Safety and Soundness. The federal banking agencies adopted
regulations and Interagency Guidelines Establishing Standards for Safety and
Soundness to implement safety and soundness standards. The guidelines set forth
the safety and soundness standards that the federal banking agencies use to
identify and address problems at insured depository institutions before capital
becomes impaired. The guidelines address internal controls and information
systems, an internal audit system, credit underwriting, loan documentation,
interest rate risk exposure, asset growth, asset quality, earnings and
compensation, and fees and benefits. If the appropriate federal banking agency
determines that an institution fails to meet any standard prescribed by the
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guidelines, the agency may require the institution to submit to the agency an
acceptable plan to achieve compliance with the standard.
Investment Activities
Under federal law, all state-chartered Federal Deposit Insurance
Corporation insured banks, including savings banks, have generally been limited
to activities as principal and equity investments of the type and in the amount
authorized for national banks, notwithstanding state law. The Federal Deposit
Insurance Corporation Improvement Act and the Federal Deposit Insurance
Corporation permit exceptions to these limitations. For example, state chartered
banks, such as Berkshire Bank, may, with Federal Deposit Insurance Corporation
approval, continue to exercise grandfathered state authority to invest in common
or preferred stocks listed on a national securities exchange or the NASDAQ
National Market and in the shares of an investment company registered under
federal law. In addition, the Federal Deposit Insurance Corporation is
authorized to permit such institutions to engage in state authorized activities
or investments that do not meet this standard (other than non-subsidiary equity
investments) for institutions that meet all applicable capital requirements if
it is determined that such activities or investments do not pose a significant
risk to the Bank Insurance Fund. All non-subsidiary equity investments, unless
otherwise authorized or approved by the Federal Deposit Insurance Corporation,
must have been divested by December 19, 1996, under a Federal Deposit Insurance
Corporation-approved divestiture plan, unless such investments were
grandfathered by the Federal Deposit Insurance Corporation. Berkshire Bank
received grandfathering authority from the Federal Deposit Insurance Corporation
in February 1993 to invest in listed stocks and/or registered shares. The
maximum permissible investment is 100% of Tier 1 capital, as specified by the
Federal Deposit Insurance Corporation's regulations, or the maximum amount
permitted by Massachusetts Banking Law, whichever is less. The Federal Deposit
Insurance Corporation also required that Berkshire Bank provide prior notice to
the agency if it increases the holdings of listed stock and/or registered shares
as a percentage of Tier 1 equity capital by 25%. Such grandfathering authority
may be terminated upon the Federal Deposit Insurance Corporation's determination
that such investments pose a safety and soundness risk to Berkshire Bank or if
Berkshire Bank converts its charter or undergoes a change in control. As of
December 31, 2003, Berkshire Bank had marketable equity securities including
money market preferred stocks with a market value of $14.9 million which were
held under such grandfathering authority.
Interstate Banking and Branching
Beginning June 1, 1997, the Interstate Banking Act permitted the
responsible federal banking agencies to approve merger transactions between
banks located in different states, regardless of whether the merger would be
prohibited under the law of the two states. The Interstate Banking Act also
permitted a state to "opt in" to the provisions of the Interstate Banking Act
before June 1, 1997, and permitted a state to "opt out" of the provisions of the
Interstate Banking Act by adopting appropriate legislation before that date.
Accordingly, beginning June 1, 1997, the Interstate Banking Act permitted a
bank, such as Berkshire Bank, to acquire an institution by merger in a state
other than Massachusetts unless the other state had opted out of the Interstate
Banking Act. The Interstate Banking Act 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.
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 five
capital categories: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized.
The Federal Deposit Insurance Corporation 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, 2003, Berkshire Bank met
the conditions to be classified 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 plan is required to be guaranteed by any company
that controls the undercapitalized institution in an amount equal to the lesser
of 5% of the institution's total assets when deemed undercapitalized or the
amount necessary to achieve the status of adequately capitalized. 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 Federal Deposit
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Insurance Corporation to sell sufficient voting stock to become adequately
capitalized, requirements to reduce total 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
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" 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. The term "covered transaction"
includes, among other things, the making of loans or other extensions of credit
to an affiliate and the purchase of assets from an affiliate. Section 23A also
establishes specific collateral requirements for loans or extensions of credit
to, or guarantees, acceptances on letters of credit issued on behalf of an
affiliate. Section 23B requires that covered transactions and a broad list of
other specified transactions be on terms substantially the same, or 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.
Enforcement
The Federal Deposit Insurance Corporation 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, to 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 Federal Deposit Insurance Corporation has authority under federal law
to appoint a conservator or receiver for an insured bank under limited
circumstances. The Federal Deposit Insurance Corporation is required, with
certain exceptions, to appoint a receiver or conservator for an insured state
non-member bank if that bank was "critically undercapitalized" on average during
the calendar quarter beginning 270 days after the date on which the institution
became "critically undercapitalized." See "Prompt Corrective Regulatory Action."
The Federal Deposit Insurance Corporation may also appoint itself as conservator
or receiver for an insured state non-member institution under specific
circumstances on the basis of the institution's financial condition or upon the
occurrence of other events, including: (1) insolvency; (2) substantial
dissipation of assets or earnings through violations of law or unsafe or unsound
practices; (3) existence of an unsafe or unsound condition to transact business;
and (4) insufficient capital, or the incurring of losses that will deplete
substantially all of the institution's capital with no reasonable prospect of
replenishment without federal assistance.
Insurance of Deposit Accounts
The Federal Deposit Insurance Corporation has adopted a risk-based
insurance assessment system. The Federal Deposit Insurance Corporation assigns
an institution to one of three capital categories based on the institution's
financial information consisting of (1) well capitalized, (2) adequately
capitalized or (3) undercapitalized, and one of three supervisory subcategories
within each capital group. The supervisory subgroup to which an institution is
assigned is based on a supervisory evaluation provided to the Federal Deposit
Insurance Corporation by the institution's primary federal regulator and
information which the Federal Deposit Insurance Corporation determines to be
relevant to the institution's financial condition and the risk posed to the
deposit insurance funds. An institution's assessment rate depends on the capital
category and supervisory category to which it is assigned. Assessment rates for
insurance fund deposits currently range from 0 basis points for the strongest
institution to 27 basis points for the weakest. Bank Insurance Fund members are
also required to assist in the repayment of bonds issued by the Financing
Corporation in the late 1980s to recapitalize the Federal Savings and Loan
Insurance Corporation. Effective January 1, 2000, full pro rata sharing of the
payments between Bank Insurance Fund and Savings Association Insurance Fund
members commenced. The Federal Deposit Insurance Corporation is authorized to
raise the assessment rates. The Federal Deposit Insurance Corporation has
exercised this authority several times in the past and may raise insurance
premiums in the future. If the Federal Deposit Insurance Corporation takes such
action, it could have an adverse effect on the earnings of Berkshire Bank.
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The Federal Deposit Insurance Corporation may terminate insurance of
deposits if it finds that the institution is in an unsafe or unsound condition
to continue operations, has engaged in unsafe or unsound practices, or has
violated any applicable law, regulation, rule, order or condition imposed by the
Federal Deposit Insurance Corporation. The management of the Bank does not know
of any practice, condition or violation that might lead to termination of
deposit insurance.
Berkshire Bank, as a member of the Depositors Insurance Fund, is also
subject to its assessments. See "- Massachusetts Banking Laws and Supervision."
Federal Reserve System
The Federal Reserve Board regulations require depository institutions to
maintain noninterest-earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The Federal Reserve Board
regulations currently require that reserves be maintained against aggregate
transaction accounts as follows: for that portion of transaction accounts
aggregating $45.4 million less an exemption of $6.6 million (which may be
adjusted by the Federal Reserve Board) the reserve requirement is 3%; and for
accounts greater than $45.4 million, the reserve requirement is 10% (which may
be adjusted by the Federal Reserve Board between 8% and 14%) of the portion in
excess of $45.4 million. Berkshire Bank is in compliance with these
requirements.
Community Reinvestment Act
Under the Community Reinvestment Act, as implemented by Federal Deposit
Insurance Corporation regulations, a state non-member bank has a continuing and
affirmative obligation consistent with its safe and sound operation to help meet
the credit needs of its entire community, including low and moderate-income
neighborhoods. The Community Reinvestment Act neither establishes specific
lending requirements or programs for financial institutions nor limits an
institution's discretion to develop the types of products and services that it
believes are best suited to its particular community. The Community Reinvestment
Act requires the Federal Deposit Insurance Corporation, in connection with its
examination of an institution, to assess the institution's record of meeting the
credit needs of its community and to consider such record when it evaluates
applications made by such institution. The Community Reinvestment Act requires
public disclosure of an institution's Community Reinvestment Act rating.
Berkshire Bank's latest Community Reinvestment Act rating received from the
Federal Deposit Insurance Corporation was "Outstanding."
Berkshire Bank is also subject to similar obligations under Massachusetts
Law, which has an additional CRA rating category. The Massachusetts Community
Reinvestment Act requires the Massachusetts Banking Commissioner to consider a
bank's Massachusetts Community Reinvestment Act rating when reviewing a bank's
application to engage in certain transactions, including mergers, asset
purchases and the establishment of branch offices or automated teller machines,
and provides that such assessment may serve as a basis for the denial of such
application. Berkshire Bank's latest Massachusetts Community Reinvestment Act
rating received from the Massachusetts Division of Banks was "Outstanding."
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. The Federal Home Loan Bank provides a
central credit facility primarily for member institutions. Berkshire Bank, as a
member of the Federal Home Loan Bank of Boston, is required to acquire and hold
shares of capital stock in the Federal Home Loan Bank of Boston in an amount
equal to at least 1% of the aggregate principal amount of its unpaid residential
mortgage loans and similar obligations at the beginning of each year, or 1/20 of
its advances (borrowings) from the Federal Home Loan Bank of Boston, whichever
is greater. Berkshire Bank was in compliance with this requirement with an
investment in Federal Home Loan Bank of Boston stock at December 31, 2003 of
$12.9 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 ended 2003,
2002, 2001, 2000, and 1999, cash dividends from the Federal Home Loan Bank of
Boston to Berkshire Bank amounted to approximately $249,211, $283,300, $303,600,
$332,700 and $180,900, respectively. Further, there can be no assurance that the
impact of recent or future legislation on the Federal Home Loan Banks will not
also cause a decrease in the value of the Federal Home Loan Bank stock held by
the Bank.
Holding Company Regulation
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 Office of Thrift Supervision rather than as a bank
holding company by the Federal Reserve Board. Berkshire Bank made such election
and the Company is a non-
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diversified unitary savings and loan holding company within the meaning of
federal law. As such, the Company is registered with the Office of Thrift
Supervision and has adhered to the Office of Thrift Supervision's regulations
and reporting requirements. In addition, the Office of Thrift Supervision may
examine and supervise the Company and the Office of Thrift Supervision has
enforcement authority over the Company and its non-savings institution
subsidiaries. Among other things, this authority permits the Office of Thrift
Supervision 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 Office of Thrift Supervision at least 30 days before
declaring any dividend to the Company. By regulation, the Office of Thrift
Supervision may restrict or prohibit the Bank from paying dividends.
As a unitary savings and loan holding company, the Company is generally
not restricted under existing laws as to the types of business activities in
which it may engage. The Gramm-Leach-Bliley Act of 1999 expanded the authority
of bank holding companies to affiliate with other financial services companies
such as insurance companies and investment banking companies. The
Gramm-Leach-Bliley Act, however, provided that unitary savings and loan holding
companies may only engage in activities permitted to a financial holding company
under the 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.
Upon any non-supervisory acquisition by the Company of another savings
association as a separate subsidiary, the Company would become a multiple
savings and loan holding company. Federal law limits the activities of a
multiple savings and loan holding company and its non-insured institution
subsidiaries primarily to activities permissible for bank holding companies
under Section 4(c)(8) of the Bank Holding Company Act, provided the prior
approval of the Office of Thrift Supervision is obtained, to other activities
authorized by Office of Thrift Supervision regulation and to those permitted for
financial holding companies. Multiple savings and loan holding companies are
generally prohibited from acquiring or retaining more than 5% of a
non-subsidiary company engaged in activities other than those permitted by
federal law.
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 Office of Thrift Supervision. In
evaluating applications by holding companies to acquire savings associations,
the Office of Thrift Supervision 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 funds, the convenience
and needs of the community and competitive factors.
The Office of Thrift Supervision is prohibited from approving any
acquisition that would result in a multiple savings and loan holding company
controlling savings institutions in more than one state, except for (1)
interstate supervisory acquisitions by savings and loan holding companies, and
(2) the acquisition of a savings institution in another state if the laws of the
state of the target savings institution specifically permit such acquisitions.
To be regulated as a savings and loan holding company by the Office of
Thrift Supervision (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, 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 mortgages and related investments, including certain mortgage-backed
and related securities) in at least 9 months out of each 12 month period. As of
December 31, 2003, Berkshire Bank maintained 93.1% 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 Office of Thrift Supervision 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 Office of Thrift
Supervision has found that the acquisition will not result in a change of
control of the Company. Under the Change in Bank Control Act, the Office of
Thrift Supervision has 60 days from the filing of a complete notice to act,
taking into consideration certain factors, including the financial and
managerial resources of the acquirer and the anti-trust effects of the
acquisition. Any company that acquires control would then be subject to
regulation as a savings and loan holding 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 any regulation under the Massachusetts law.
The term "bank holding company," for the purposes 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 associations 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
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company may become a bank holding company; any bank holding company acquires
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 merges 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. The Company has no current plan or arrangement to acquire
ownership or control, directly or indirectly, of 25% or more of the voting stock
of another banking institution.
Federal Securities Laws
The Company's common stock is registered with the Securities and Exchange
Commission under the Exchange Act. The Company is subject to the information,
proxy solicitation, insider trading restrictions and other requirements under
the Exchange Act.
The registration under the Securities Act of shares of common stock does
not cover the resale of such shares. Shares of the common stock purchased by
persons who are not affiliates of the Company may be resold without
registration. The resale restrictions of Rule 144 under the Securities Act
govern shares purchased by an affiliate of the Company. If the Company meets the
current public information requirements of Rule 144 under the Securities Act,
each affiliate of the Company who complies with the other conditions of Rule 144
(including those that require the affiliate's sale to be aggregated with those
of other persons) would be able to sell in the public market, without
registration, a number of shares not to exceed, in any three-month period, the
greater of (1) 1% of the outstanding shares of the Company or (2) the average
weekly volume of trading in such shares during the preceding four calendar
weeks. Future provision may be made by the Company to permit affiliates to have
their shares registered for sale under the Securities Act under specific
circumstances.
FEDERAL AND STATE TAXATION ON INCOME
Federal Income Taxation
General. The Company and Berkshire 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 to other
corporations with some exceptions, including particularly Berkshire Bank's
reserve for bad debts discussed below. The following discussion of tax matters
is intended only as a summary and does not purport to be a comprehensive
description of the tax rules applicable to Berkshire Bank or the Company.
Berkshire Bank's federal income tax returns have been either audited or closed
under the statute of limitations through tax year 1999. For its 2003 tax year,
Berkshire Bank's maximum federal income tax rate was 34%.
Bad Debt Reserves. For fiscal years beginning before December 31, 1995,
thrift institutions which qualified under certain definitional tests and other
conditions of the Internal Revenue Code of 1986, as amended, were permitted to
use certain favorable provisions to calculate their deductions from taxable
income for annual additions to their bad debt reserve. A reserve could be
established for bad debts on qualifying real property loans, generally secured
by interests in real property improved or to be improved, under the percentage
of taxable income method or the experience method. The reserve for
non-qualifying loans was computed using the experience method.
Federal legislation enacted in 1996 repealed the reserve method of
accounting for bad debts and the percentage of taxable income method for tax
years beginning after 1995 and required savings institutions to recapture or
take into income certain portions of their accumulated bad debt reserves.
Approximately $844,000 of the Bank's accumulated bad debt reserves will not be
recaptured into taxable income unless the Bank makes a "nondividend
distribution" to the Company as described below.
Distributions. If the Bank makes "nondividend distributions" to the
Company, they will be considered to have been made from the Bank's unrecaptured
tax bad debt reserves, including the balance of its reserves as of December 31,
1987, to the extent of the "nondividend distributions," and then from the Bank's
supplemental reserve for losses on loans, to the extent of those reserves, and
an amount based on the amount distributed, but not more than the amount of those
reserves, will be included in the Bank's taxable income. Nondividend
distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete
liquidation. Dividends paid out of the Bank's current or accumulated earnings
and profits will not be included in the Bank's taxable income.
The amount of additional taxable income triggered by a nondividend
distribution is an amount that, when reduced by the tax attributable to the
income, is equal to the amount of the distribution. Therefore, if the Bank makes
a nondividend distribution to the Company, approximately one and one-half times
the amount of the distribution not in excess of the amount of the reserves would
be includable in income for federal income tax purposes, assuming a 35% federal
corporate income tax rate. The Bank does not intend to pay dividends that would
result in a recapture of any portion of its bad debt reserves.
-42-
State Taxation
Massachusetts Taxation. The Massachusetts excise tax rate for savings
banks is currently 10.5% of federal taxable income, adjusted for certain items.
Taxable income includes gross income as defined under the Internal Revenue Code,
plus interest from bonds, notes and evidences of indebtedness of any state,
including Massachusetts, less deductions, but not the credits, allowable under
the provisions of the Internal Revenue Code, except no deduction is allowed for
taxes paid to the state which are based on income. Carryforwards and carrybacks
of net operating losses are not allowed.
A financial institution or business corporation is generally entitled to
special tax treatment as a "securities corporation," provided that: (a) its
activities are limited to buying, selling, dealing in or holding securities on
its own behalf and not as a broker; and (b) it has applied for, and received,
classification as a "securities corporation" by the Commissioner of the
Massachusetts Department of Revenue. A securities corporation that is also a
bank holding company under the Code must pay a tax equal to 0.33% of its gross
income. A securities corporation that is not a bank holding company under the
Code must pay a tax equal to 1.32% of its gross income. Three of the Bank's
subsidiaries, North Street Securities Corporation, Gold Leaf Securities
Corporation and Woodland Securities, Inc., are Massachusetts securities
corporations.
In June 2003, the Company reached a settlement with the Massachusetts
Department of Revenue (the "DOR") with respect to the DOR's tax assessment
resulting from the DOR's disallowance of the Company's deduction of certain
dividend distributions received by the Bank from Gold Leaf Capital Corporation,
its majority-owned real estate investment trust (the "REIT"). As a result, the
Company paid approximately $398,000 to the DOR representing one-half of the
assessment plus interest and obtained the DOR's release from liability for the
remaining half assessed. The Company dissolved the REIT during the third quarter
of 2003.
Delaware Taxation. As a Delaware holding company not earning income in
Delaware, the Company is exempt from Delaware corporate income tax but is
required to file an annual report with and pay an annual franchise tax to the
State of Delaware.
-43-
ITEM 1A. EXECUTIVE OFFICERS OF THE REGISTRANT
- --------------------------------------------------------------------------------
The following table sets forth certain information regarding the executive
officers of Berkshire Hills and Berkshire Bank.
Name Age(1) Position
---- ------ --------
Michael P. Daly 42 President and Chief Executive Officer
Wayne F. Patenaude 43 Senior Vice President, Chief Financial Officer and Treasurer
Gayle P. Fawcett 51 Senior Vice President of Retail Banking and Operations
- --------------------
(1) As of December 31, 2003
The executive officers are elected annually and hold office until their
successors have been elected and qualified or until they are removed or
replaced.
Biographical Information
Michael P. Daly serves as President and Chief Executive Officer of the
Company and Berkshire Bank. Prior to this position, Mr. Daly served as
Executive Vice President of the Company and Bank from January 2000 to
October 2002 and as Senior Vice President of Commercial Lending from
October 1997 until January 2000.
Wayne F. Patenaude has served as Senior Vice President, Chief Financial
Officer and Treasurer of the Company and Berkshire Bank since February
2003. Mr. Patenaude served as Executive Vice President, Chief Financial
Officer and Treasurer of American Savings Bank, located in New Britain,
Connecticut, from 1999 until American Savings Bank's acquisition by
Banknorth, N.A. on February 14, 2003. Mr. Patenaude served as Chief
Financial Officer of Bancorp Connecticut from December 1998 to 1999 when
he joined American Savings Bank.
Gayle P. Fawcett has been Senior Vice President of Retail Banking and
Operations of the Company and Berkshire Bank since October 2002. Prior to
this position, Ms. Fawcett served as Senior Vice President of Systems and
Operations of Berkshire Bank since May 1999.
-44-
ITEM 2. PROPERTIES
- --------------------------------------------------------------------------------
The Company and the Bank currently conduct their business through the main
office located in Pittsfield, Massachusetts, and 11 other full service banking
offices and one other facility listed below. The Company and the Bank believe
their facilities are adequate to meet their present and immediately foreseeable
needs.
Net Book Value
of Property
Lease Original Year Date of or Leasehold
Or Leased Lease Improvements at
Location Own or Acquired Expiration December 31, 2003
- ------------- --------------- ------------------- --------------- ----------------------------
(In thousands)
Main Office
24 North Street
Pittsfield, Massachusetts Own 1898 -- $1,637
Banking Offices
244 Main Street
Great Barrington, Massachusetts Own 1950 -- 695
103 North Main Street
Sheffield, Massachusetts Own 1966 -- 180
Old Town Hall
43 East Street Lease 1969 2030 454
Pittsfield, Massachusetts
2 Depot Street
West Stockbridge, Massachusetts Own 1975 -- 318
165 Elm Street
Pittsfield, Massachusetts Own 1977 -- 216
255 Stockbridge Road
Great Barrington, Massachusetts Own 1985 -- 223
37 Main Street
North Adams, Massachusetts Lease 1985 2005(1) 330
1 Park Street
Lee, Massachusetts Own 1991 -- 191
32 Main Street
Stockbridge, Massachusetts Own 1991 -- 261
66 West Street
Pittsfield, Massachusetts Lease 1998 2009(2) 157
Allendale Shopping Center
39 Cheshire Road Lease 2001 2021(3) 1,205
Pittsfield, Massachusetts
Other Office
66 Allen Street(4) Own 1999 -- 2,136
Pittsfield, Massachusetts
- --------------
(1) Berkshire Bank has one option to renew for ten years.
(2) Berkshire Bank has two options to renew, each for an additional five-year
period.
(3) Berkshire Bank has four options to renew, each for an additional five-year
period.
(4) This facility houses Berkshire Bank's Commercial Lending Division, Asset
Management/Trust Division and Government Banking Department.
-45-
ITEM 3. LEGAL PROCEEDINGS
- --------------------------------------------------------------------------------
Periodically, there have been various claims and lawsuits involving
Berkshire 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 would have a material adverse effect
on the financial condition or operations of the Company, taken as a whole.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- --------------------------------------------------------------------------------
None.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
- --------------------------------------------------------------------------------
The common stock is traded on the American Stock Exchange under the symbol
"BHL." As of February 26, 2004, the Company had approximately 951 holders of
record. The following table sets forth, for the quarters indicated, the daily
closing high and low sales price for the common stock and the dividends paid.
The Company 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.
For the Year Ended December 31, 2003
-----------------------------------------------------
4th Quarter 3rd Quarter 2nd Quarter 1st Quarter
----------- ----------- ----------- -----------
High $ 37.40 $ 33.90 $ 28.40 $ 24.00
Low $ 33.55 $ 28.10 $ 23.10 $ 21.86
Dividend Paid $ 0.12 $ 0.12 $ 0.12 $ 0.12
For the Year Ended December 31, 2002
-----------------------------------------------------
4th Quarter 3rd Quarter 2nd Quarter 1st Quarter
----------- ----------- ----------- -----------
High $ 25.25 $ 27.25 $ 26.20 $ 22.08
Low $ 22.94 $ 20.99 $ 21.98 $ 19.65
Dividend Paid $ 0.12 $ 0.12 $ 0.12 $ 0.12
-46-
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------------------------------------------------------
The Company has derived the following selected consolidated financial and
other data of the Company and Berkshire Bank in part from the consolidated
financial statements and notes appearing elsewhere in this Form 10-K. The data
as of and for the years ended December 31, 2003, 2002, 2001 and 2000 are derived
from the audited consolidated financial statements for Berkshire Hills and
Berkshire Bank. The data as of and for the year ended December 31, 1999 is
derived from the audited consolidated financial statements of Berkshire Bancorp
and Berkshire Bank.
At or For the Years Ended December 31,
------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ----------- ---------- ---------- ----------
(In thousands, except per share data)
Selected Financial Data:
Total assets $ 1,218,548 $ 1,045,947 $1,030,701 $1,011,340 $ 841,651
Loans, net 783,258 712,714 791,920 783,405 665,554
Investment securities:
Available-for-sale 307,425 173,169 104,446 99,309 93,084
Held-to-maturity 36,903 44,267 33,263 32,238 17,014
Federal Home Loan Bank stock 12,923 7,440 7,027 5,651 3,843
Savings Bank Life Insurance stock 2,043 2,043 2,043 2,043 2,043
Deposits(1) 830,244 782,360 742,729 729,594 680,767
Federal Home Loan Bank advances 251,465 133,002 133,964 101,386 58,928
Repurchase agreements -- 700 1,890 2,030 1,120
Total stockholders' equity 123,175 120,569 139,323 161,322 88,352
Real estate owned -- 1,500 -- 50 220
Nonperforming loans 3,199 3,741 2,702 2,869 2,841
Selected Operating Data:
Total interest and dividend income $ 56,308 $ 64,128 $ 75,796 $ 71,018 $ 58,468
Total interest expense 18,742 23,428 33,560 33,468 26,922
----------- ----------- ---------- ---------- ----------
Net interest income 37,566 40,700 42,236 37,550 31,546
Provision for loan losses 1,460 6,180 7,175 3,170 3,030
----------- ----------- ---------- ---------- ----------
Net interest income afer provision
for loan losses 36,106 34,520 35,061 34,380 28,516
----------- ----------- ---------- ---------- ----------
Noninterest income:
Service charges and fees 4,776 4,469 4,187 3,743 3,405
Gain on sales and dispositions of
securities, net 3,077 14,470 268 423 491
Loss on sale of loans (1,854) (10,702) -- -- --
Other(2) 7,711 5,181 6,093 580 402
----------- ----------- ---------- ---------- ----------
Total noninterest income 13,710 13,418 10,548 4,746 4,298
----------- ----------- ---------- ---------- ----------
Total noninterest expense 35,786 45,310 32,349 32,184 25,196
----------- ----------- ---------- ---------- ----------
Income before income taxes 14,030 2,628 13,260 6,942 7,618
Income taxes 5,065 531 4,349 2,360 1,995
----------- ----------- ---------- ---------- ----------
Net income $ 8,965 $ 2,097 $ 8,911 $ 4,582 $ 5,623
=========== =========== ========== ========== ==========
Dividends per share $ 0.48 $ 0.48 $ 0.43 $ 0.10 N/A
Earnings per share
Basic $ 1.70 $ 0.39 $ 1.42 N/A N/A
Diluted $ 1.57 $ 0.36 $ 1.35 N/A N/A
-47-
At or For the Years Ended December 31,
--------------------------------------------------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
Selected Operating Ratios and Other Data(3):
Performance Ratios:
Average yield on interest-earning assets 5.35% 6.49% 7.80% 8.04% 7.65%
Average rate paid on interest-bearing
liabilities 2.10 2.85 4.25 4.64 4.15
Interest rate spread(4) 3.25 3.64 3.55 3.40 3.50
Net interest margin(5) 3.57 4.12 4.35 4.25 4.13
Interest-bearing assets to interest-bearing
liabilities 118.01 120.33 123.04 122.53 117.75
Net interest income after provision for loan
losses to noninterest expense 100.89 75.36 108.39 106.82 113.18
Noninterest expense as a percent of
average assets 3.21 4.31 3.13 3.44 3.09
Return on average assets(6) 0.80 0.20 0.86 0.49 0.69
Return on average equity(7) 7.28 1.54 5.74 3.72 6.51
Average equity to average assets 11.04 12.96 15.00 13.15 10.59
Dividend payout ratio(8) 28.19 145.45 30.28 N/A N/A
Efficiency ratio(9) 70.96 77.32 61.60 76.86 71.27
Regulatory Capital Ratios:
Tier 1 capital to average assets 8.97 10.04 11.02 14.54 7.91
Total capital to risk-weighted assets 14.10 15.18 15.73 20.15 12.90
Asset Quality Ratios:
Nonperforming loans as a percent of total
loans(10) 0.40 0.52 0.34 0.36 0.42
Nonperforming assets as a percent of total
assets(11) 0.26 0.36 0.26 0.29 0.36
Allowance for loan losses as a percent of
total loans 1.13 1.43 1.37 1.29 1.27
Allowance for loan losses as a percent of
nonperforming loans 280.37 275.54 408.36 356.08 300.39
Net loans charged-off as a percent of
interest-earning loans 0.11 0.09 0.79 0.19 0.31
- ----------------
(1) Includes mortgagors' escrow accounts.
(2) Consists primarily of Berkshire Hills Technology's revenues in 2003, 2002
and 2001. Berkshire Hills Technology was formed in May 2001.
(3) Regulatory Capital and Asset Quality Ratios are end of period ratios.
Performance Ratios are based on daily averages.
(4) Difference between weighted average yield on interest-earning assets and
weighted average cost of interest-bearing liabilities.
(5) Net interest income as a percentage of average interest-earning assets.
(6) Net income divided by average total assets.
(7) Net income divided by average total equity.
(8) Dividends per share divided by basic earnings per share. Comparable
figures for 2000 and 1999 are not available as the Company began paying
dividends in the fourth quarter of 2000.
(9) Operating expenses divided by net interest income plus other income, less
gain on sale of securities plus losses on sale of sub-prime loans. For
purposes of the 2002 computation, severance payments of $6.9 million were
deducted from operating expenses.
(10) Nonperforming loans consist of nonaccrual loans.
(11) Nonperforming assets consist of nonaccrual loans and real estate owned.
-48-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
- --------------------------------------------------------------------------------
General
Management's discussion and analysis of financial condition and results of
operations is intended to assist in understanding the financial condition and
results of operations of the Company. The information contained in this section
should be read in conjunction with the consolidated financial statements and
accompanying notes contained in this report.
Forward-Looking Statements
This Annual Report on Form 10-K contains certain forward-looking
statements that are based on certain assumptions and describe future plans,
strategies and expectations of the Company. These forward-looking statements are
generally identified by use of the words "believe," "expect," "intend,"
"anticipate," "estimate," "project" or similar expressions. The Company's
ability to predict results or the actual effect of future plans or strategies is
inherently uncertain. Factors which could have a material adverse effect on the
operations of the Company and its subsidiaries include, but are not limited to,
changes in interest rates, general economic conditions, legislative/regulatory
changes, monetary and fiscal policies of the U.S. Government, including policies
of the U.S. Treasury and the Federal Reserve Board, the quality or composition
of the loan or investment portfolios, demand for loan products, deposit flows,
competition, demand for financial services in the Company's market area and
accounting principles and guidelines. These risks and uncertainties should be
considered in evaluating forward-looking statements and undue reliance should
not be placed on such statements. The Company does not undertake -- and
specifically disclaims any obligation -- to publicly release the result of any
revisions which may be made to any forward-looking statements to reflect events
or circumstances after the date of such statements or to reflect the occurrence
of anticipated or unanticipated events.
Critical Accounting Policies
The Company has established various accounting policies, which govern the
application of generally accepted accounting principles in the preparation of
the financial statements. Certain accounting policies involve significant
judgments and assumptions by management that have a material impact on the
carrying value of certain assets and liabilities. Management considers such
accounting policies to be critical accounting policies. The judgments and
assumptions used by management are based on historical experience and other
factors, which are believed to be reasonable under the circumstances. Because of
the nature of the judgments and assumptions made by management, actual results
could differ from these judgments and estimates that could have a material
impact on the carrying values of assets and liabilities and the results of
operations of the Company. The Company believes the allowance for loan losses is
a critical accounting policy that requires the most significant judgments and
estimates used in the preparation of the Consolidated Financial Statements.
Refer to Footnote 1 to the Consolidated Financial Statements, "Summary of
Significant Accounting Policies" and the allowance for loan loss discussion in
Item 1. Business, for a detailed description of the estimation processes and
methodology related to the allowance for loan losses.
Operating Strategy
The Bank is an independent, community-oriented savings bank, delivering
quality customer service and offering a wide range of deposit, loan and
investment products to its customers. In recent years, the Bank's strategy has
been to enhance profitability through controlled balance sheet growth by
emphasizing the origination of real estate mortgages, commercial loans and home
equity loans, increasing sources of noninterest income and by improving
operating efficiencies while managing its capital position and limiting its
credit and interest rate risk exposure. The Company has established
profitability goals of a return on assets of 1.0%, a return on equity of 10.0%
and an efficiency ratio of under 60%, which it expects to achieve by 2005.
Earnings growth is always a priority for a public company and good balance of
this with community involvement and employee retention is paramount to the
Company's management.
The Bank is primarily a lending institution, which does a good job of
cross-selling products in an effort to "own" the "whole customer." While it does
not overpay for deposits, it has still achieved strong growth in its core
deposit base. In addition, being vigilant in expense control through efficiency
efforts, including the implementation of Six Sigma, is critical and we believe
those efforts will help earnings. To accomplish these objectives, the Bank has
sought to:
o Operate as a full-service community bank by expanding the services
and products it offers.
o Provide superior customer service through an attention to detail and
a focus on building customer relationships.
o Provide innovative products by increasing the functionality of its
ATM network and expanding the capability of its call center.
o Increase fee income by broadening non-depository product offerings
and services.
-49-
o Continue to increase its emphasis on high quality consumer and
commercial loans.
o Control credit risk by continuing to employ conservative
underwriting standards to minimize the level of new problem assets.
o Improve asset quality by exiting the indirect sub-prime automobile
loan business.
o Manage interest rate risk by emphasizing investments in shorter-term
loans and investment securities, engaging in the sale,
securitization and purchase of loans and by managing the Company's
sources of borrowed funds, such as, its ability to borrow from the
FHLB of Boston.
o Limit equity price risk and reductions to capital with decreases in
its equity securities portfolio by selling a portion of its
marketable equity securities portfolio.
o Operate more efficiently by: (1) increasing core deposits through
aggressive cross-selling of products and using a disciplined
approach to deposit pricing; and (2) utilizing "Six Sigma" process
improvement infrastructure, which is designed to improve the
Company's operating efficiencies.
o Invest primarily in debt instruments that provide adequate liquidity
to meet cash flow needs and to earn a reasonable return on
investment.
As global and local economies continue to improve, the Company will strive
to take advantage of growth opportunities, both organic and through non-dilutive
acquisitions. While industry consolidation continues to increase acquisition
multiples making them increasingly more difficult to achieve, the Company will
prudently continue to explore opportunities that will improve its franchise and
be accretive to shareholders.
-50-
Fourth Quarter Events and Recent Developments
In December 2003, as part of the Bank's effort to improve its credit risk
profile, the Bank accelerated its strategy to exit the sub-prime automobile loan
business by selling $9.9 million of such loans, which resulted in the reversal
of approximately $1.0 million of previously provided loan loss provision. At
December 31, 2003, the Bank held $1.4 million of sub-prime automobile loans. The
Bank will continue to invest in automobile loans, but will no longer originate
or acquire sub-prime automobile loans.
To prepare for a volatile and potentially rising interest rate
environment, $55.0 million of one- to four-family fixed rate residential
mortgages were securitized, of which $16.3 million settled in December 2003, and
the remaining $38.7 million settled in January 2004.
Total commercial loans increased $20.1 million, or at an annualized rate
of 22.8%, from September 30, 2003. The majority of this increase was in
commercial real estate loans, which increased $22.3 million from September 30,
2003 as several new loans were added to the portfolio, of which the largest loan
was $2.5 million, while commercial loans declined $2.2 million for the same
period.
Core deposits, which the Company considers to be all deposits other than
certificates of deposit, increased $8.5 million, or at an annualized rate of
6.8%, from September 30, 2003. The Bank had the largest increase in demand
deposits, which increased $6.3 million, or 6.5%. NOW accounts increased $2.9
million, or 3.2%, and money market accounts increased $1.4 million, or 1.0%. The
Bank continues to aggressively pursue deposits through customer cross-selling
efforts and other marketing campaigns.
Comparison of Financial Condition at December 31, 2003 and 2002
Total assets were $1.22 billion at December 31, 2003, an increase of
$172.6 million, or 16.5%, from $1.05 billion at December 31, 2002. The Company's
investment portfolio, excluding FHLB and SBLI stock, increased 58.4% to $344.3
million at the end of 2003 from $217.4 million at the end of 2002 as the Company
purchased securities with attractive yields relative to the rates paid on a
corresponding increase in borrowings from the Federal Home Loan Bank of Boston.
These purchases were primarily in securities with durations averaging three to
five years. Short-term investments totaled $1.9 million at December 31, 2003, a
decrease of $41.5 million from December 31, 2002, reflecting the investment of
the proceeds from the December 2002 sale of sub-prime automobile loans in
purchased one-to four-family residential mortgage loans. Loans totaled $783.2
million at December 31, 2003, an increase of $70.5 million, or 9.9%, from the
year ended December 31, 2002. Organic loan growth, which excludes purchases,
securitization and sales of loans, increased $88.1 million, or 12.2%, from
December 31, 2002. Automobile loans decreased $9.6 million, or 8.5%, to $104.0
million at December 31, 2003 from December 31, 2002 as the Bank sold $9.9
million of its sub-prime automobile loans to a third party. At December 31,
2003, $1.4 million of sub-prime automobile loans remained with an allocated
reserve of $623,000, or 44.8%. Construction and land development loans increased
$17.1 million, or 97.0%, to $34.7 million at December 31, 2003 from $17.6
million at December 31, 2002. Commercial real estate totaled $154.2 million at
December 31, 2003, an increase of $35.0 million, or 29.4%, from December 31,
2002, while residential one- to four-family loans increased $19.8 million, or
8.0%, to $266.8 million at December 31, 2003 from December 31, 2002. The
increases reflect the Bank's expansion into new commercial loan markets,
primarily in the eastern New York area, and a strong local real estate loan
market primarily driven by a low interest rate environment. Commercial loans
remained relatively flat with an increase of $1.0 million, or 0.6%, to $166.5
million at December 31, 2003 from $165.4 million at December 31, 2002.
Nonperforming loans totaled $3.2 million at December 31, 2003, a decrease
of $542,000, or 14.5%, from $3.7 million at December 31, 2002. Commercial and
commercial real estate nonaccruing loans totaled $2.4 million at the end of 2003
compared to $2.9 million at the end of 2002, primarily as the result of the
return of two loans to accrual status, payments collected on accounts remaining
on nonaccruing status and $156,000 in gross commercial loan charge-offs.
Nonaccruing consumer loans totaled $468,000 at the end of 2003, down from
$661,000 at the end of 2002. Automobile loans of $306,000 were 90 days or more
past due and still accruing interest at the end of 2003, compared to $590,000 at
the end of 2002. The ratio of nonperforming loans to total loans at December 31,
2003 and 2002 was 0.40% and 0.52%, respectively.
The Bank executed a single premium Bank Owned Life Insurance ("BOLI")
contract in June of 2003, totaling $7.5 million. This transaction is expected to
earn a tax-equivalent return in excess of other earning assets with similar risk
characteristics. The income earned on BOLI is recorded as an increase in
noninterest income. BOLI totaled $7.7 million at December 31, 2003.
Interest-bearing liabilities increased $150.7 million, or 18.2%, to $978.9
million at December 31, 2003 from $828.2 million at December 31, 2002, primarily
due to a $118.5 million, or 89.1%, increase in FHLB borrowings. Borrowings
totaled $251.5 million at December 31, 2003, increasing from $133.0 million at
December 31, 2002, as the Bank utilized lower cost borrowings to fund asset
growth. Interest-bearing deposits increased $32.2 million, or 4.6%, to $727.5
million at the end of 2003 from $695.2 million at the end of 2002. Money market
and NOW accounts increased $27.9 million and savings accounts
-51-
increased $13.3 million, while certificates of deposit decreased $8.8 million.
Noninterest bearing demand deposits grew $15.6 million to $102.8 million at
December 31, 2003 from $87.1 million at December 31, 2002.
Stockholders' equity totaled $123.2 million at December 31, 2003, an
increase of $2.6 million, or 2.2%, from December 31, 2002. This increase was
primarily due to net income of $9.0 million, partially offset by the repurchase
of 285,116 shares at a cost of $7.1 million, the exercise of 71,064 shares of
stock options and the payment of cash dividends of $0.48 per share amounting to
$2.6 million.
Comparison of Operating Results for the Years Ended December 31, 2003 and 2002
Net Income. Net income totaled $9.0 million for the year ended December
31, 2003, an increase of $6.9 million, or 327.5%, from $2.1 million for the year
ended December 31, 2002. Net income for 2003 includes $437,000 in charges
related to a non-recurring retirement benefit while net income for 2002 includes
$8.3 million in charges in connection with the restructuring of the Company's
senior management and the reorganizing of the Company's long-term business
strategy. Basic and diluted earnings per share for the year ended December 31,
2003 were $1.70 and $1.57, respectively, compared to basic and diluted earnings
of $0.39 and $0.36 for the year ended December 31, 2002.
Net Interest Income. Net interest income is the largest component of the
Company's revenue stream and is the difference between the interest and
dividends earned on the loan and investment portfolios and the interest paid on
the Company's funding sources, primarily customer deposits and advances from the
Federal Home Loan Bank of Boston. Net interest income decreased $3.1 million, or
7.7%, to $37.6 million in 2003 from $40.7 million in 2002 as the relatively low
market interest rate environment led to a high number of loan prepayments and
refinancings, which had a negative impact on earnings, and due to the
reinvestment of the proceeds from the December 2002 sale of sub-prime automobile
loans in lower yielding loans. Average earning assets increased $63.9 million,
or 6.5%, to $1.05 billion in 2003 from $987.9 million in 2002, while the yield
on average earnings assets declined to 5.35% from 6.49% for the twelve-month
period ended December 31, 2003. Partially offsetting the decline in the yield on
average earning assets was a 75 basis point decrease in the rate paid on average
interest-bearing liabilities from the same period last year. As a result, the
Company's net interest margin for the twelve months ended December 31, 2003 and
2002 were 3.57% and 4.12%, respectively.
Interest and dividend income declined $7.8 million, or 12.2%, to $56.3
million for 2003 from $64.1 million for 2002 as interest earned on the Bank's
loan portfolio decreased $9.2 million, or 16.2%, from $56.9 million for 2002 due
to the sale of $69.7 million of higher rate sub-prime automobile loans in
December 2002 and the impact of lower market interest rates resulting from
comparatively stronger loan refinance activity. The lower loan interest income
also reflects the forfeiture of $65,000 in accrued interest and a write-down of
$180,000 of dealer reserve related to the December 2003 sale of $9.9 million of
sub-prime automobile loans. Interest and dividend income on the Company's
investment portfolio, including FHLB and SBLI stock, equaled $8.5 million in
2003, an increase of $1.8 million, or 25.9%, from $6.8 million earned in 2002 as
higher average balances were able to offset lower average yields earned.
The decrease in interest and dividend income was partially offset by a
decrease in interest expense which decreased $4.7 million, or 20.0%, to $18.7
million for the year ended December 31, 2003 from $23.4 million for the year
ended December 31, 2002 due to lower rates paid, particularly on the Bank's
deposit accounts. Interest expense on deposits totaled $13.9 million for the
twelve months ended December 31, 2003, a decrease of $3.9 million, or 22.0%,
from $17.8 million for the twelve months ended December 31, 2002. Average
interest-bearing deposit balances increased $44.3 million to $723.5 million in
2003 from $679.2 million in 2002, but were more than offset by a lower average
rate of 1.92% paid in 2003 compared to 2.62% in 2002. Interest expense on FHLB
advances and other borrowings totaled $4.9 million this year, a decrease of
$771,000, or 13.7%, from $5.7 million last year, due to lower rates paid, as new
lower-cost borrowings replaced maturing higher cost advances and as a result of
the Bank's prepayment of higher cost advances in December 2002.
Provision for Loan Losses. The provision for loan losses decreased $4.7
million, or 76.4%, to $1.5 million in 2003 from $6.2 million in 2002. The sale
of $9.9 million of sub-prime automobile loans in December 2003 resulted in the
reversal of approximately $1.0 million of previously provided loan loss
provision. In assessing the provision for the twelve months ended December 31,
2003, management took into consideration an $18.2 million decrease in sub-prime
automobile loans from December 31, 2002. The Company also considered net loan
charge-offs which decreased $4.1 million, to $2.8 million in 2003, from $6.9
million last year. Foremost in this decrease were gross consumer loan
charge-offs which declined $4.9 million in 2003 and consisted mainly of
sub-prime automobile loans. Additionally, management considered the level of
delinquent loans, which declined from 1.40% of total loans at December 31, 2002,
to 0.67% at December 31, 2003.
At December 31, 2003, the allowance for loan losses was $9.0 million and
represented 1.13% of total loans and 280.37% of nonperforming loans compared to
$10.3 million, 1.43% and 275.54%, respectively, at December 31, 2002. The
decline in the allowance is consistent with improvement in the Company's credit
risk profile, particularly in consideration of the significant reduction in
sub-prime automobile loans.
-52-
Provisions for loan losses are charges to earnings to bring the total
allowance for loan losses to a level considered by management as adequate to
provide for estimated loan losses based on management's evaluation of the
collectibility of the loan portfolio. Management assesses the adequacy of the
allowance for loan losses based on known and inherent risks in the loan
portfolio and upon management's continuing analysis of the factors underlying
the quality of the loan portfolio. While management believes that, based on
information currently available, Berkshire Bank's allowance for loan losses is
sufficient to cover losses inherent in the Bank's loan portfolio at this time,
no assurances can be given that Berkshire Bank's level of allowance for loan
losses will be sufficient to cover future loan losses incurred by the Bank or
that future adjustments to the allowance for loan losses will not be necessary
if economic and other conditions differ substantially from the economic and
other conditions used by management to determine the current level of the
allowance for loan losses. Management may increase its level of allowance for
loan losses as a percentage of total loans and nonperforming loans if the level
of commercial real estate, multi-family, commercial, construction and
development or consumer loans as a percentage of its total loan portfolio
increases. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review Berkshire Bank's allowance for
loan losses. These agencies may require Berkshire Bank to provide additions to
the allowance based upon judgments different from management.
Noninterest Income. Noninterest income totaled $13.7 million for the
twelve months ended December 31, 2003, an increase of $292,000, or 2.2%, over
$13.4 million for 2002. Noninterest income for 2003 includes a $3.1 million gain
on the sale of securities, which was nearly offset by $2.4 million in charges
relating to the sale of sub-prime automobile loans and the valuation adjustment
in repossessed automobiles. EastPoint license maintenance and processing fees
and license sales and other fees increased $271,000, or 3.9%, to $7.3 million
for the twelve months ended December 31, 2003 as compared to $7.0 million for
the same period last year. Noninterest income for 2002 includes several items
related to the reorganizing of the Company's long-term business strategy that
took place in the fourth quarter of 2002. A $14.8 million gain on the sale of
equity securities was nearly offset by $13.4 million in charges relating to the
sale of sub-prime automobile loans, the write-down of one security, the
write-down of repossessed automobiles, and the prepayment penalty on FHLB
advances. In addition, trust department fees increased $294,000, or 16.4%, in
2003 due to an increase of $42.0 million, or 17.0%, in trust assets under
management.
Noninterest Expenses. Noninterest (operating) expenses totaled $35.8
million for the year ended December 31, 2003 compared to $45.3 million for the
year ended December 31, 2002. Salaries and benefits expense declined $7.3
million for the twelve months ended December 31, 2003 compared to the same
period last year, as expenses for 2002 included $6.9 million of severance
payments for three executive officers and one senior vice president, and the
retirement of seven directors. Expenses for EastPoint, which are recorded in
various noninterest expense categories, totaled $7.8 million for the twelve
months ended December 31, 2003 as compared to $8.2 million for the same period
last year, a decrease of $464,000, or 5.6%. This decrease from 2002 was
attributable to a $500,000 increase in EastPoint's allowance for uncollectible
debt in December 2002. EastPoint had no such increases in 2003. Expenses
pertaining to foreclosed real estate and other loans decreased $2.2 million to
$1.0 million for the year ended December 31, 2003 compared to $3.3 million for
the year ended December 31, 2002, primarily due to a decrease in the expenses
associated with the inventory and sale of repossessed automobiles.
Income Taxes. Income taxes for the year ended December 31, 2003 were $5.1
million, an increase of $4.5 million from $531,000 for the year ended December
31, 2002, due to increased income before taxes as well as an increase in the
effective tax rate to 36.1% for 2003 from 20.2% for 2002. The increase in the
effective tax rate for 2003 was largely due to the disallowance by Massachusetts
of the dividend received deduction from the Bank's REIT. The lower rate paid in
2002 was primarily due to a higher level of qualifying dividends received to
pretax income in 2002 compared to 2003.
Comparison of Operating Results for the Years Ended December 31, 2002 and 2001
Net Income. Net income totaled $2.1 million for the year ended December
31, 2002, a decrease of $6.8 million, or 80.1%, from $8.9 million for the year
ended December 31, 2001. Net income for 2002 includes $8.3 million in charges in
connection with the restructuring of the Company's senior management and the
reorganizing of the Company's long-term business strategy while net income for
2001 includes a one-time gain of $2.2 million from the dissolution of the Bank's
defined benefit pension plan. Basic and diluted earnings per share for the year
ended December 31, 2002 were $0.39 and $0.36, respectively, compared to basic
and diluted earnings of $1.42 and $1.35 for the year ended December 31, 2001.
Net Interest Income. Net interest income decreased $1.5 million, or 3.6%,
to $40.7 million in 2002 from $42.2 million in 2001 as the relatively low market
interest rate environment led to a high number of loan prepayments and
refinancings which had a negative impact on earnings. The average yield on
interest bearing assets declined 131 basis points to 6.49% for the year ended
December 31, 2002 compared to 7.80% for the year ended December 31, 2001 and
more than offset a $16.2 million increase in average interest bearing assets to
$987.9 million for 2002 compared to $971.7 million for 2001. Average interest
bearing liabilities increased $31.3 million to $821.0 million in 2002 from
$789.7 million in 2001, but were more than offset by a lower average rate paid
of 2.85% in 2002 compared to 4.25% in 2001 reflecting the low market interest
rate environment. As a result, the Company's net interest margin for the twelve
months ended December 31, 2002 and 2001 were 4.12% and 4.35%, respectively.
-53-
Interest and dividend income fell $11.7 million, or 15.4%, to $64.1
million for 2002 from $75.8 million for 2001 as interest earned on the Bank's
loan portfolio dropped $11.4 million, or 16.7%, from $68.3 million for 2001 as
the average balance of the Bank's loans fell to $791.3 in 2002 from $815.1 for
last year and the average rate earned equaled 7.19% in 2002 compared to 8.38%
for 2001. The lower loan interest income also reflects the forfeiture of
$492,000 in accrued interest related to the December sale of sub-prime
automobile loans. Interest and dividend income on the Company's investment
portfolio, including FHLB and SBLI stock, equaled $6.8 million in 2002, a
decrease of $330,000, or 4.7%, from $7.1 million earned in 2001. Higher average
balances were not enough to offset the decrease in average rate earned on the
investment portfolio. The average balance of the investment portfolio increased
$24.0 million to $168.7 million in 2002 while the average rate earned dropped 89
basis points to 4.01% in 2002.
The decrease in interest and dividend income was mostly offset by a
decrease in interest expense as interest expense dropped $10.1 million, or
30.2%, to $23.4 million for the year ended December 31, 2002 from $33.6 million
for the year ended December 31, 2001 due to lower rates paid, particularly on
the Bank's deposit accounts. Interest paid on deposits totaled $17.8 million for
the twelve months ended December 31, 2002, a decrease of $8.9 million, or 33.4%,
from $26.7 million for the twelve months ended December 31, 2001. Average
interest bearing deposit balances increased $21.7 million to $679.2 million in
2002 from $657.5 million in 2001, but were more than offset by a lower average
rate paid of 2.62% in 2002 compared to 4.06% in 2001. Interest paid on
borrowings also decreased due to lower interest rates paid as interest on FHLB
advances and securities sold under agreements to repurchase totaled $5.7 million
this year, a decrease of $1.2 million, or 17.8%, from $6.9 million last year,
even though borrowings only declined $2.2 million, or 1.6%, from last year.
Provision for Loan Losses. The provision for loan losses decreased $1.0
million, or 13.9%, to $6.2 million in 2002 from $7.2 million in 2001 as a
greater number of charge-offs in 2002 were more than offset by a higher number
of recoveries and a decrease in the balance of sub-prime automobile loans. Total
charge-offs were $10.0 million in 2002, an increase of $3.0 million, or 42.0%,
from $7.1 million last year. This increase was due to the higher consumer loan
charge-offs which rose $3.1 million in 2002. However, this increase was somewhat
offset by the Bank's strong efforts in 2002 to recover charged-off loans.
Recoveries totaled $3.1 million in 2002, an increase of $2.4 million over
$705,000 in 2001. Net charge-offs were $6.9 million for the year ended December
31, 2002 compared to $6.4 million last year, an increase of $549,000, or 8.6%.
The provision for 2002 also includes $1.5 million added in the fourth
quarter of 2002 to cover losses inherent in the remaining sub-prime automobile
loan portfolio. At December 31, 2002, the allowance for loan losses was $10.3
million and represented 1.43% of total loans and 275.54% of nonperforming loans
compared to $11.0 million at December 31, 2001, which represented 1.37% of total
loans and 408.36% of nonperforming loans.
Noninterest Income. Noninterest income totaled $13.4 million for the
twelve months ended December 31, 2002, an increase of $2.9 million, or 27.2%,
over $10.6 million for 2001. Noninterest income for 2002 includes several items
related to the reorganizing of the Company's long-term business strategy that
took place in the fourth quarter of 2002. A $14.8 million gain on the sale of
equity securities was nearly offset by $13.4 million in charges relating to the
sale of sub-prime automobile loans, the write-down of one security, the
write-down of repossessed automobiles, and the prepayment penalty on FHLB
advances. Noninterest income also increased in 2002 due to the recording of a
full year's worth of fees earned from the operations of EastPoint Technologies,
LLC versus only six months last year, a difference of $3.5 million. In addition,
customer service fees increased $423,000, or 23.4%, due to increased ATM and
checking account fees. Noninterest income for 2001 includes a one-time gain of
$2.2 million on the curtailment of the Bank's defined benefit pension plan.
Noninterest Expense. Noninterest (operating) expenses increased $13.0
million, or 40.1%, to $45.3 million for the year ended December 31, 2002 from
$32.3 million for the year ended December 31, 2001 as expenses for 2002 included
charges related to the restructuring of the Company's senior management and the
retirement of several directors. In the fourth quarter of 2002, the Company and
the Bank restructured their management team, which resulted in $6.6 million of
charges, consisting of the payment to or accrual of severance payments for three
executive officers and one senior vice president under existing contractual
obligations. Additionally, seven directors retired from the Boards of the
Company and the Bank and, as a result, the Company incurred a $300,000 charge in
the fourth quarter to fund retirement plan benefits. Expenses pertaining to
foreclosed real estate and other loans increased $1.0 million to $3.3 million as
the Bank wrote down the value of one commercial property by $500,000. As was the
case with noninterest income, noninterest expenses also increased due to the
recognition of a full year's worth of expenses of EastPoint compared to only six
months last year. The increase attributable to EastPoint totaled $4.8 million.
Income Taxes. Income taxes for the year ended December 31, 2002 were
$531,000, a decrease of $3.8 million from $4.3 million for the year ended
December 31, 2001. The effective tax rate for 2002 and 2001 were 20.2% and
32.8%, respectively. The lower rate paid in 2002 was due to the increase in the
ratio of tax exempt income and qualifying dividends received to pretax income.
-54-
Average Balances, Interest and Average Yields/Cost
The following table presents certain information for the years indicated
regarding average daily balances of assets and liabilities, as well as the total
dollar amounts of interest income from average interest-earning assets and
interest expense on average interest-bearing liabilities and the resulting
average yields and costs. The yields and costs for the years indicated are
derived by dividing income or expense by the average daily balances of assets or
liabilities, respectively, for the years presented. The yields and rates include
fees which are considered adjustments to yields.
For the Years Ended December 31,
----------------------------------------------------------------------------
2003 2002
------------------------------------ ------------------------------------
Average Average Average Average
Balance Interest Yield/Rate Balance Interest Yield/Rate
---------- ---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Interest-earning assets:
Loans(1) $ 800,133 $ 47,683 5.96% $ 791,328 $ 56,910 7.19%
Short-term investments 7,714 109 1.41 27,870 456 1.64
Investment securities 232,998 8,204 3.52 159,318 6,416 4.03
Federal Home Loan Bank stock 8,889 249 2.80 7,303 283 3.88
Savings Bank Life Insurance
stock 2,043 63 3.08 2,043 63 3.08
---------- ---------- ---------- ---------- ---------- ----------
Total interest-earning assets 1,051,777 56,308 5.35 987,862 64,128 6.49
Noninterest-earning assets 64,056 63,948
---------- ----------
Total assets $1,115,833 $1,051,810
========== ==========
Interest-bearing liabilities:
Deposits:
Money market accounts $ 132,497 $ 1,648 1.24% $ 117,950 $ 1,988 1.69%
NOW accounts 90,170 155 0.17 83,399 623 0.75
Savings accounts(2) 170,749 1,731 1.01 157,444 2,669 1.70
Certificates of deposit 330,116 10,328 3.13 320,415 12,497 3.90
---------- ---------- ---------- ----------
Total interest-bearing deposits 723,532 13,862 1.92 679,208 17,777 2.62
Federal Home Loan Bank
advances 167,621 4,878 2.91 140,406 5,628 4.01
Repurchase agreements 88 2 1.14 1,349 23 1.72
---------- ---------- ---------- ----------
Total interest-bearing liabilities 891,241 18,742 2.10 820,963 23,428 2.85
---------- ----------
Noninterest-bearing demand
deposits 91,627 82,751
Other noninterest-bearing
liabilities 9,817 11,935
---------- ----------
Total liabilities 992,685 915,649
Equity 123,148 136,161
---------- ----------
Total liabilities and equity $1,115,833 $1,051,810
========== ==========
Net interest-earning assets $ 160,536 $ 166,899
========== ==========
Net interest income $ 37,566 $ 40,700
========== ==========
Interest rate spread 3.25% 3.64%
Interest margin (net interest
income as a percentage of
total average interest-earning
assets) 3.57% 4.12%
Total average interest-earning
assets to total average
interest-bearing liabilities 118.01% 120.33%
For the Years Ended December 31,
------------------------------------
2001
------------------------------------
Average Average
Balance Interest Yield/Rate
---------- ---------- ----------
(Dollars in thousands)
Interest-earning assets:
Loans(1) $ 815,078 $ 68,291 8.38%
Short-term investments 11,883 413 3.48
Investment securities 136,944 6,725 4.91
Federal Home Loan Bank stock 5,707 304 5.33
Savings Bank Life Insurance
stock 2,043 63 3.08
---------- ---------- ----------
Total interest-earning assets 971,655 75,796 7.80
Noninterest-earning assets 63,207
----------
Total assets $1,034,862
==========
Interest-bearing liabilities:
Deposits:
Money market accounts $ 112,434 $ 3,712 3.30%
NOW accounts 77,276 806 1.04
Savings accounts(2) 142,150 4,087 2.88
Certificates of deposit 325,639 18,080 5.55
---------- ----------
Total interest-bearing deposits 657,499 26,685 4.06
Federal Home Loan Bank
advances 127,990 6,613 5.17
Repurchase agreements 4,215 262 6.22
---------- ----------
Total interest-bearing liabilities 789,704 33,560 4.25
----------
Noninterest-bearing demand
deposits 76,912
Other noninterest-bearing
liabilities 12,968
----------
Total liabilities 879,584
Equity 155,278
----------
Total liabilities and equity $1,034,862
==========
Net interest-earning assets $ 181,951
==========
Net interest income $ 42,236
==========
Interest rate spread 3.55%
Interest margin (net interest
income as a percentage of
total average interest-earning
assets) 4.35%
Total average interest-earning
assets to total average
interest-bearing liabilities 123.04%
- ----------------
(1) Average balances include nonaccrual loans.
(2) Includes mortgagors' escrow accounts.
-55-
Rate/Volume Analysis
The following table presents the effects of changing rates and
volumes on the interest income and interest expense of Berkshire Bank. The rate
column shows the effects attributable to changes in rate (changes in rate
multiplied by prior volume). The volume column shows the effects attributable to
changes in volume (changes in volume multiplied by prior rate). The net column
represents the sum of the prior columns. For purposes of this table, changes
attributable to changes in both rate and volume, which cannot be segregated,
have been allocated proportionately based on the absolute value of the change
due to rate and the change due to volume.
Year Ended December 31, 2003 Year Ended December 31, 2002
Compared to Compared to
Year Ended December 31, 2002 Year Ended December 31, 2001
----------------------------------- -----------------------------------
Increase (Decrease) Due to Increase (Decrease) Due to
----------------------------------- -----------------------------------
Rate Volume Net Rate Volume Net
--------- --------- --------- --------- --------- ---------
(In thousands)
Interest-earning assets:
Loans $ (12,205) $ 2,978 $ (9,227) $ (9,440) $ (1,941) $ (11,381)
Short-term investments (55) (292) (347) (29) 72 43
Investment securities (45) 1,799 1,754 (3,668) 3,338 (330)
--------- --------- --------- --------- --------- ---------
Total interest-earning assets (12,305) 4,485 (7,820) (13,137) 1,469 (11,668)
--------- --------- --------- --------- --------- ---------
Interest-bearing liabilities:
Deposits:
Money market accounts (642) 302 (340) (1,915) 191 (1,724)
NOW accounts (523) 55 (468) (254) 71 (183)
Savings accounts (1,188) 250 (938) (1,922) 504 (1,418)
Certificates of deposit (2,561) 392 (2,169) (5,297) (286) (5,583)
--------- --------- --------- --------- --------- ---------
Total deposits (4,914) 999 (3,915) (9,388) 480 (8,908)
Federal Home Loan Bank
advances (2,564) 1,814 (750) 751 (1,736) (985)
Repurchase agreements (6) (15) (21) (123) (116) (239)
--------- --------- --------- --------- --------- ---------
Total interest-bearing liabilities (7,484) 2,798 (4,686) (8,760) (1,372) (10,132)
--------- --------- --------- --------- --------- ---------
Increase (decrease) in net interest income $ (4,821) $ 1,687 $ (3,134) $ (4,377) $ 2,841 $ (1,536)
========= ========= ========= ========= ========= =========
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations
of a short-term nature. The Bank further defines liquidity as the ability to
respond to the needs of depositors and borrowers, as well as maintaining the
flexibility to take advantage of investment opportunities. The Bank's primary
sources of funds consist of deposit inflows, loan repayments, maturities, loan
sales, paydowns of mortgage-backed securities, sales/calls of investments and
borrowings from the Federal Home Loan Bank of Boston. While maturities and
scheduled amortization of loans and securities are predictable sources of funds,
deposit outflows and mortgage prepayments are greatly influenced by general
interest rates, economic conditions and competition.
The Bank's primary investing activities are: (1) originating residential
one- to four-family mortgage loans, commercial business and real estate loans,
multi-family loans, home equity lines of credit and consumer loans, and (2)
investing in mortgage- and asset-backed securities, U.S. Government and agency
obligations, and debt securities. These activities are funded primarily by
principal and interest payments on loans, proceeds from sales of loans and
investment securities, maturities of securities, deposits and Federal Home Loan
Bank of Boston advances. During the years ended December 31, 2003 and 2002,
Berkshire Bank's loan originations totaled $321.1 million and $285.9 million,
respectively. At December 31, 2003 and 2002, the Bank's investments in
investment securities totaled $344.3 million and $217.4 million, respectively.
The Bank experienced a net increase in total deposits of $47.9 million and $39.6
million for the years ended December 31, 2003 and 2002, respectively. Deposit
flows are affected by the overall level of interest rates, the interest rates
and products offered by the Bank and its local competitors and other factors.
The Bank closely monitors its liquidity position on a daily basis. If the Bank
should require funds beyond its ability to generate them internally, additional
sources of funds are available through advances or a line of credit with the
Federal Home Loan Bank and through repurchase agreement lines of credit with the
Depositors Insurance Fund and a nationally recognized broker-dealer.
-56-
Outstanding commitments for all loans and unadvanced construction loans
and lines of credit totaled $139.6 million at December 31, 2003. Management of
Berkshire Bank anticipates that it will have sufficient funds available to meet
its current loan commitments. Certificates of deposit that are scheduled to
mature in one year or less from December 31, 2003 totaled $219.6 million. The
Bank relies primarily on competitive rates, customer service and long-standing
relationships with customers to retain deposits. Occasionally, the Bank will
also offer special competitive promotions to its customers to increase retention
and promote deposit growth. Based upon the Bank's historical experience with
deposit retention, management believes that, although it is not possible to
predict future terms and conditions upon renewal, a significant portion of such
deposits will remain with the Bank.
The Bank must satisfy various regulatory capital requirements administered
by the federal and state banking agencies including a risk-based capital
measure. The risk-based capital guidelines include both a definition of capital
and a framework for calculating risk-weighted assets by assigning balance sheet
assets and off-balance sheet items to broad risk categories. At December 31,
2003, Berkshire Bank exceeded all of its regulatory capital requirements with
Tier 1 capital to average assets of $93.8 million, or 7.87% of average assets,
which is above the required level of $47.7 million, or 4.0%, and total capital
to risk-weighted assets of $106.6 million, or 12.57% of risk-weighted assets,
which is above the required level of $67.8 million, or 8.0%. The Bank meets the
conditions to be considered "well capitalized" under regulatory guidelines.
The primary source of funding for Berkshire Hills is dividend payments
from Berkshire Bank, and, to a lesser extent, earnings on deposits held by
Berkshire Hills. Dividend payments by Berkshire Bank have primarily been used to
fund stock repurchase programs and pay dividends to Berkshire Hills'
shareholders. The Bank's ability to pay dividends and other capital
distributions to Berkshire Hills is generally limited by the Massachusetts
banking regulations and regulations of the Federal Deposit Insurance
Corporation. See "Regulation and Supervision - Massachusetts Regulation."
Additionally, the Massachusetts Commissioner of Banks and Federal Deposit
Insurance Corporation may prohibit the payment of dividends which are otherwise
permissible by regulation for safety and soundness reasons. Any dividend by the
Bank beyond its current year's earnings and prior two years' retained net income
would require the approval of the Massachusetts Commissioner of Banks, and
notification to or approval of the Federal Deposit Insurance Corporation and the
Office of Thrift Supervision. To the extent the Bank were to apply for a
dividend distribution to Berkshire Hills in excess of the regulatory permitted
dividend amount, no assurances can be made such application would be approved by
the regulatory authorities.
Berkshire Hills is currently engaged in its sixth stock repurchase
program. To date, all purchases have been open market purchases. In the current
program, 112,700 shares out of an announced 300,000 have been purchased at a
cost of $3.1 million through December 31, 2003. The Company has sufficient funds
available to complete the repurchase program without having a material adverse
effect on liquidity.
Contractual Obligations. The following table sets forth, at December 31,
2003, the dollar amount of the Bank's contractual obligations and their
subsequent time period.
Commitments by Period
-----------------------------------------------------------------
Less than One One to Three Three to Five After Five
Total Year Years Years Years
-------- ------------- ------------ ------------- ----------
(In thousands)
Contractual Obligations
Long-term debt obligations (1) $251,465 $125,000 $ 43,297 $ 39,397 $ 43,771
Operating lease obligations (2) 4,790 474 781 705 2,830
Purchase obligations (3) 1,390 1,390 -- -- --
-------- -------- -------- -------- --------
Total Contractual Obligations $257,645 $126,864 $ 44,078 $ 40,102 $ 46,601
======== ======== ======== ======== ========
- ---------------------
(1) Consists of borrowings from the Federal Home Loan Bank. The maturities
extend through 2022 and the rates vary by borrowing.
(2) Consists of leases of four Bank offices through 2030.
(3) Consists of obligations with multiple vendors to purchase a broad range of
services and contractual estimates of capital renovations to Bank
buildings.
-57-
Off-Balance Sheet Arrangements
For a discussion of the Company's off-balance sheet arrangements, see
Footnote 13, "Off-Balance Sheet Activities" in the Notes to the Consolidated
Financial Statements.
Impact of Inflation and Changing Prices
The consolidated financial statements and related 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. Over short periods of time, interest rates may not
necessarily move in the same direction or in the same magnitude as inflation.
Impact of New Accounting Standards
Accounting for Goodwill and Other Intangible Assets. The Company adopted
SFAS No. 142, "Goodwill and Other Intangible Assets," effective January 1, 2002.
Accordingly, goodwill is no longer subject to amortization over its estimated
useful life, but is subject to at least an annual assessment for impairment by
applying a fair value based test. Additionally, under SFAS No. 142, acquired
intangible assets (such as core deposit intangibles) are separately recognized
if the benefit of the intangible asset is obtained through contractual or other
legal rights, or if the intangible asset can be sold, transferred, licensed,
rented, or exchanged, and amortized over their useful life. Branch acquisition
transactions were outside the scope of SFAS No. 142 and, accordingly, intangible
assets related to such transactions continued to amortize upon the adoption of
SFAS No. 142.
As required by SFAS No. 142, the Company completed the annual impairment
test on goodwill assets and has concluded that the amount of recorded goodwill
was not impaired as of December 31, 2003. On October 31, 2002, the Company
adopted SFAS No. 147, "Acquisitions of Certain Financial Institutions." This
Statement amends (except for transactions between two or more mutual
enterprises) previous interpretive guidance on the application of the purchase
method of accounting to acquisitions of financial institutions, and requires the
application of SFAS No. 141, "Business Combinations" and SFAS No. 142 to branch
acquisitions if such transactions meet the definition of a business combination.
This Statement amends SFAS No. 144, "Accounting for the Impairment or Disposal
of Long-Lived Assets," to include in its scope core deposit intangibles of
financial institutions. Accordingly, such intangibles are subject to a
recoverability test based on undiscounted cash flows, and to the impairment
recognition and measurement provisions that are required for other long-lived
assets that are held and used. SFAS No. 141 requires that the Company evaluate
its intangible assets and goodwill that were acquired in a prior purchase
business combination, and to make any necessary reclassifications in order to
conform with the new criteria for recognition apart from goodwill. No
reclassifications or adjustments were made as a result of adopting this
statement.
Consolidation of Variable Interest Entities. In January 2003, the
Financial Accounting Standards Board (FASB) issued Interpretation No. 46,
"Consolidation of Variable Interest Entities," (FIN 46) which establishes
guidance for determining when an entity should consolidate another entity that
meets the definition of a variable interest entity. FIN 46 requires a variable
interest entity to be consolidated by a company if that company will absorb a
majority of the expected losses, will receive a majority of the expected
residual returns, or both. Transferors to qualified special-purpose entities
("QSPEs") and certain other interests in a QSPE are not subject to the
requirements of FIN 46. On December 17, 2003, the FASB deferred the effective
date of FIN 46 to no later than the end of the first reporting period that ends
after March 15, 2004, however, for special-purpose entities the Company would be
required to apply FIN 46 as of December 31, 2003. The interpretation had no
effect on the Company's consolidated financial statements.
-58-
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------------------
Management of Interest Rate Risk and Market Risk Analysis
Qualitative Aspects of Market Risk. The Bank's most significant form of
market risk is interest rate risk. The principal objectives of Berkshire Bank's
interest rate risk management are to evaluate the interest rate risk inherent in
certain balance sheet accounts, determine the level of risk appropriate given
its business strategy, operating environment, capital and liquidity requirements
and performance objectives, and manage the risk consistent with its established
policies. Berkshire Bank maintains an Asset/Liability Committee that is
responsible for reviewing its asset/liability policies and interest rate risk
position, which meets quarterly and reports trends and interest rate risk
position to the Board of Directors on a quarterly basis. The Asset/Liability
Committee consists of six senior officers of the Bank and the Senior Financial
Analyst. The extent of the movement of interest rates is an uncertainty that
could have a negative impact on the earnings of Berkshire Bank.
In recent years, Berkshire Bank has managed interest rate risk by:
o emphasizing the origination and purchase of adjustable-rate loans
and, from time to time, selling a portion of its longer term
fixed-rate loans as market interest rate conditions dictate;
o securitizing a portion of the Bank's long-term, fixed rate
mortgages;
o originating shorter-term commercial and consumer loans;
o investing in high quality liquid investment securities that provide
adequate liquidity and flexibility to take advantage of
opportunities that may arise from fluctuations in market interest
rates, the overall maturity and duration of which is monitored in
relation to the repricing of its loan and funding portfolios;
o promoting lower cost liability accounts such as core deposits; and
o using Federal Home Loan Bank advances to better structure maturities
of its interest rate sensitive liabilities.
Berkshire Bank's market risk also includes equity price risk. Berkshire
Bank's marketable equity securities portfolio had gross unrealized gains of $8.4
million at December 31, 2003 and no gross unrealized losses which are included,
net of taxes, in accumulated other comprehensive income, a separate component of
Berkshire Bank's shareholders' equity. If equity securities prices decline due
to unfavorable market conditions or other factors, Berkshire Bank's and
Berkshire Hills' capital would decrease. Management decided to decrease the
amount of equity securities it holds by selling a portion of its existing
portfolio each quarter during 2003.
Quantitative Aspects of Market Risk. Berkshire Hills uses a simulation
model to measure the potential change in net interest income, incorporating
various assumptions regarding the shape of the yield curve, the pricing
characteristics of loans, deposits and borrowings, prepayments on loans and
securities and changes in the balance sheet mix. The model assumes the yield
curve is derived from the interpolated Treasury yield curve and that an
instantaneous increase or decrease of market interest rates would cause a
simultaneous parallel shift along the entire yield curve. Loans, deposits and
borrowings are expected to reprice at the new market rate on the contractual
review or maturity date. The Company closely monitors its loan prepayment trends
and uses prepayment guidelines set forth by Freddie Mac and Fannie Mae and other
market sources, as well as Company generated data where applicable. All
prepayments are assumed to roll over into new loans originated in the same loan
category at the new market rate. Berkshire Hills further assumes that its
securities' cash flows, especially its mortgage-backed securities cash flows,
are such that they will generally follow industry standards and that prepayments
will be reinvested in the same category at the prevailing market rate. Finally,
the model assumes that its balance sheet mix will remain relatively unchanged
throughout the next calendar year.
-59-
The tables below set forth, as of December 31, 2003 and 2002, estimated
net interest income and the estimated changes in Berkshire Hills' net interest
income for the next twelve-month period which may result given instantaneous
increases or decreases in market interest rates of 100 and 200 basis points.
Increase/(Decrease) in At December 31, 2003
Market Interest Rates in --------------------------------------
Basis Points (Rate Shock) Amount $ Change % Change
- ------------------------- -------- -------- ---------
(Dollars in thousands)
200 $ 37,144 $ (1,757) (4.52%)
100 38,162 (739) (1.90)
Static 38,901 -- --
(100) 39,478 577 1.48
(200) 37,116 (1,785) (4.59)
Increase/(Decrease) in Market At December 31, 2002
Interest Rates in Basis Points --------------------------------------
(Rate Shock) Amount $ Change % Change
- ------------------------------ -------- -------- ---------
(Dollars in thousands)
200 $ 34,583 $ (1,027) (2.88%)
100 34,741 (869) (2.44)
Static 35,610 -- --
(100) 35,162 (448) (1.26)
(200) 32,908 (2,702) (7.59)
In the event of a sudden and sustained decrease in prevailing market
interest rates of 100 and 200 basis points, the December 31, 2003 table
indicates that net interest income would be expected to increase $577,000 and
decrease $1.8 million, respectively. This result is due to the fact that the
Company is slightly liability sensitive and in a 100 basis point decrease many
non-maturity deposit account rates would decrease significantly and reach
Company determined floors. In a negative 200 basis point scenario, many of these
deposit accounts would have reached their floors and the Company would become
asset sensitive. These results compare to the December 31, 2002 table, which
indicates that in the event of a sudden and sustained decrease of 100 and 200
basis points in prevailing market interest rates, net interest income would be
expected to decrease by $448,000 and $2.7 million, respectively. The primary
reason for the differences between the models for the two years is that many
deposit accounts have lower Company determined floors now than they did one year
ago.
In the event of a sudden and sustained increase in prevailing market
interest rates of 100 and 200 basis points, the December 31, 2003 table
indicates that net interest income would be expected to decrease $739,000 and
$1.8 million, respectively, compared to the December 31, 2002 table, which
indicates that net interest income would decrease by $869,000 and $1.0 million,
respectively. The primary reason for the difference in the up 200 basis point
scenario was that at December 31, 2002, the Company had a larger amount of
securities, including overnight federal funds, repricing or maturing in the next
year than it had on December 31, 2003. Partially offsetting this was
Management's expectation that the rates paid on the Company's interest-bearing
non-maturity deposits were less sensitive to changes in prevailing market
interest rates at year-end 2003 than at year-end 2002. After examining the
historic rates paid on interest-bearing non-maturity deposits compared to the
then prevailing market interest rates, Management determined during 2003 that
the rates paid or the cost of these deposits would not have to increase as much
in a rising interest rate environment than what was anticipated at year-end
2002.
Computation of prospective effects of hypothetical interest rate changes
are based on a number of assumptions including the level of market interest
rates, the degree to which certain assets and liabilities with similar
maturities or periods to repricing react to changes in market interest rates,
the expected prepayment rates on loans and investments, the degree to which
early withdrawals occur on certificates of deposit and other deposit flows. As a
result, these computations should not be relied upon as indicative of actual
results. Further, the computations do not reflect any actions that management
may undertake in response to changes in interest rates.
-60-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE
INDEPENDENT AUDITORS' REPORT 62
CONSOLIDATED BALANCE SHEETS AS OF 63
DECEMBER 31, 2003 AND 2002
CONSOLIDATED STATEMENTS OF INCOME FOR THE 64
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
CONSOLIDATED STATEMENTS OF CHANGES IN 65
STOCKHOLDERS' EQUITY FOR THE YEARS ENDED
DECEMBER 31, 2003, 2002 AND 2001
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR 66
THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 68
-61-
WOLF Certified Public Accountants
& COMPANY, P.C. and Business Consultants
- --------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT
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, 2003 and 2002, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 2003.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Berkshire Hills
Bancorp, Inc. and subsidiaries as of December 31, 2003 and 2002 and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2003 in conformity with accounting principles
generally accepted in the United States of America.
/s/ Wolf & Company, P.C.
Boston, Massachusetts
January 23, 2004
99 High Street o Boston, Massachusetts o 02110-2320 o Phone 617-439-9700 o Fax
617-542-0400
1500 Main Street o Suite 1908 o Springfield, Massachusetts o 01115 o Phone
413-747-9042 o Fax 413-739-5149
www.wolfandco.com
-62-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2003 and 2002
2003 2002
----------- -----------
(In thousands)
Assets
Cash and due from banks $ 15,583 $ 17,258
Short-term investments 1,859 43,397
----------- -----------
Total cash and cash equivalents 17,442 60,655
Securities available for sale, at fair value 307,425 173,169
Securities held to maturity (fair value approximates $36,868,000 and
$44,348,000 at December 31, 2003 and 2002, respectively) 36,903 44,267
Federal Home Loan Bank stock, at cost 12,923 7,440
Loans, net of allowance for loan losses of $8,969,000
in 2003 and $10,308,000 in 2002 783,258 712,714
Foreclosed real estate, net -- 1,500
Premises and equipment, net 12,626 13,267
Accrued interest receivable 5,080 5,125
Savings Bank Life Insurance stock 2,043 2,043
Goodwill and other intangibles 10,233 10,436
Net deferred tax asset 1,725 2,016
Bank owned life insurance 7,721 --
Due from broker 7,089 --
Other assets 14,080 13,315
----------- -----------
$ 1,218,548 $ 1,045,947
=========== ===========
Liabilities and Stockholders' Equity
Deposits $ 830,244 $ 782,360
Federal Home Loan Bank advances 251,465 133,002
Loans sold with recourse 473 1,201
Securities sold under agreements to repurchase -- 700
Due to broker 5,646 --
Accrued expenses and other liabilities 5,293 5,677
----------- -----------
Total liabilities 1,093,121 922,940
----------- -----------
Minority Interests 2,252 2,438
----------- -----------
Commitments and contingencies (Notes 6, 13 and 14)
Stockholders' equity:
Preferred stock ($.01 par value; 1,000,000 shares
authorized; no shares issued and outstanding) -- --
Common stock ($.01 par value; 26,000,000 shares authorized; and 7,673,761
shares issued at December 31, 2003 and 2002, respectively, shares
outstanding 5,903,082 and 6,117,134 at December 31, 2003 and 2002, respectively) 77 77
Additional paid-in capital 75,764 74,632
Unearned compensation (8,507) (9,535)
Retained earnings 86,276 80,011
Accumulated other comprehensive income 5,559 5,542
Treasury stock, at cost (1,770,679 and 1,556,627 shares
at December 31, 2003 and 2002, respectively) (35,994) (30,158)
----------- -----------
Total stockholders' equity 123,175 120,569
----------- -----------
Total liabilities and stockholders' equity $ 1,218,548 $ 1,045,947
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
-63-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2003, 2002 and 2001
2003 2002 2001
-------- -------- --------
(In thousands, except per share data)
Interest and dividend income:
Loans, including fees $ 47,683 $ 56,910 $ 68,291
Debt securities:
Taxable 7,298 5,234 5,233
Tax-exempt 262 173 375
Dividends 956 1,355 1,484
Short-term and other investments 109 456 413
-------- -------- --------
Total interest and dividend income 56,308 64,128 75,796
-------- -------- --------
Interest expense:
Deposits 13,862 17,777 26,685
Federal Home Loan Bank advances 4,878 5,628 6,613
Securities sold under agreements to repurchase 2 23 262
-------- -------- --------
Total interest expense 18,742 23,428 33,560
-------- -------- --------
Net interest income 37,566 40,700 42,236
Provision for loan losses 1,460 6,180 7,175
-------- -------- --------
Net interest income, after provision for loan losses 36,106 34,520 35,061
-------- -------- --------
Other income:
Customer service fees 2,300 2,140 1,810
Trust department fees 2,090 1,796 1,782
Loan servicing fees 386 533 595
Gain on sales and dispositions of securities, net 3,077 15,143 268
Loss on impairment of securities -- (673) --
Loss on sale of loans, net (1,854) (10,702) --
Loss on impairment of other assets (206) (1,262) --
Penalty on prepayment of FHLB borrowings -- (1,067) --
License maintenance and processing fees 4,443 4,379 1,322
License sales and other fees 2,819 2,612 2,143
Gain on curtailment of defined benefit pension plan, net -- -- 2,173
Miscellaneous 655 519 455
-------- -------- --------
Total other income 13,710 13,418 10,548
-------- -------- --------
Operating expenses:
Salaries and employee benefits 21,219 28,488 17,590
Occupancy and equipment 5,045 5,288 4,689
Marketing and advertising 678 648 629
Data processing 989 758 1,065
Professional services 1,379 1,384 1,314
Office supplies 695 769 899
Foreclosed real estate and repossessed assets, net 1,047 3,250 2,238
Amortization of goodwill and other intangibles 203 203 827
Minority interests (186) (685) (119)
Other general and administrative expenses 4,717 5,207 3,217
-------- -------- --------
Total operating expenses 35,786 45,310 32,349
-------- -------- --------
Income before income taxes 14,030 2,628 13,260
Provision for income taxes 5,065 531 4,349
-------- -------- --------
Net income $ 8,965 $ 2,097 $ 8,911
======== ======== ========
Earnings per share:
Basic $ 1.70 $ 0.39 $ 1.42
Diluted $ 1.57 $ 0.36 $ 1.35
The accompanying notes are an integral part of these consolidated financial
statements.
-64-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 2003, 2002 and 2001
Accumulated
Additional Other
Common Paid-in Unearned Retained Comprehensive Treasury
Stock Capital Compensation Earnings Income Stock Total
--------- ----------- ------------ --------- ------------- --------- ---------
(In thousands)
Balance at December 31, 2000 $ 77 $ 74,054 $ (7,187) $ 74,555 $ 19,824 $ -- $ 161,323
---------
Comprehensive income:
Net income -- -- -- 8,911 -- -- 8,911
Change in net unrealized gain on
securities available for sale, net
of reclassification adjustment and
tax effects -- -- -- -- (988) -- (988)
---------
Total comprehensive income 7,923
---------
Cash dividends paid ($0.43 per share) -- -- -- (2,808) -- -- (2,808)
Treasury stock purchased -- -- -- -- -- (23,292) (23,292)
Purchase of common stock - stock awards -- -- (5,453) -- -- -- (5,453)
Change in unearned compensation -- 234 1,539 -- -- -- 1,773
Minority interest adjustment -- (142) -- -- -- -- (142)
--------- --------- --------- --------- --------- --------- ---------
Balance at December 31, 2001 77 74,146 (11,101) 80,658 18,836 (23,292) 139,324
---------
Comprehensive income (loss):
Net income -- -- -- 2,097 -- -- 2,097
Change in net unrealized gain on
securities available for sale, net
of reclassification adjustment and
tax effects -- -- -- -- (13,294) -- (13,294)
---------
Total comprehensive loss (11,197)
---------
Cash dividends paid ($0.48 per share) -- -- -- (2,737) -- -- (2,737)
Treasury stock purchased -- -- -- -- -- (6,989) (6,989)
Reissuance of treasury stock under stock
option plan (6,907 shares) -- -- -- (7) -- 123 116
Change in unearned compensation -- 486 1,566 -- -- -- 2,052
--------- --------- --------- --------- --------- --------- ---------
Balance at December 31, 2002 77 74,632 (9,535) 80,011 5,542 (30,158) 120,569
---------
Comprehensive income (loss):
Net income -- -- -- 8,965 -- -- 8,965
Change in net unrealized gain on
securities available for sale, net
of reclassification adjustment and
tax effects -- -- -- -- 17 -- 17
---------
Total comprehensive income 8,982
---------
Cash dividends paid ($0.48 per share) -- -- -- (2,628) -- -- (2,628)
Treasury stock purchased -- -- -- -- -- (7,099) (7,099)
Reissuance of treasury stock under stock
option plan (71,064 shares) -- -- -- (72) -- 1,263 1,191
Change in unearned compensation -- 1,132 1,028 -- -- -- 2,160
--------- --------- --------- --------- --------- --------- ---------
Balance at December 31, 2003 $ 77 $ 75,764 $ (8,507) $ 86,276 $ 5,559 $ (35,994) $ 123,175
========= ========= ========= ========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
-65-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2003, 2002 and 2001
2003 2002 2001
--------- --------- ---------
(In thousands)
Cash flows from operating activities:
Net income $ 8,965 $ 2,097 $ 8,911
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 1,460 6,180 7,175
Net amortizaton of securities 1,795 1,103 270
Depreciation and amortization expense 2,107 2,414 2,081
Amortization of goodwill and other intangibles 203 203 827
Management awards plan expense 1,066 1,165 1,000
Employee stock ownership plan expense 1,094 887 773
Increase in cash surrender value of Bank Owned
Life Insurance (221) -- --
Gain on curtailment of defined benefit pension plan, net -- -- 2,173
Gain on sales and dispositions of securities, net (3,077) (15,143) (268)
Loss on impairment of securities -- 673 --
Loss on sale/writedown of foreclosed real estate, net 44 500 --
Loss on impairment of other assets 206 1,262 --
Loss on sale of equipment -- -- 35
Loss on sale of loans, net 1,854 10,702 --
Deferred income tax provision (benefit) 1,088 (262) 608
Net change in loans held for sale -- 2,540 (2,540)
Minority Interest (186) (685) (119)
Changes in operating assets and liabilities:
Accrued interest receivable and other assets (926) 5,157 1,899
Accrued expenses and other liabilities (384) 747 (2,929)
--------- --------- ---------
Net cash provided by operating activities 15,088 19,540 19,896
--------- --------- ---------
Cash flows from investing activities:
Activity in available-for-sale securities:
Sales 20,349 28,255 3,965
Maturities 130,091 68,232 26,577
Principal payments 33,182 30,096 19,685
Purchases (302,014) (201,258) (56,890)
Activity in held-to-maturity securities:
Maturities 17,195 16,374 12,982
Principal payments 38,876 29,132 22,187
Purchases (49,242) (56,812) (36,175)
Purchase of FHLB stock (5,483) (413) (1,376)
Purchase of Bank Owned Life Insurance (7,500) -- --
Loan originations and purchases, net of
principal payments (153,674) 8,616 (13,176)
(continued)
The accompanying notes are an integral part of these consolidated financial
statements.
-66-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONCLUDED)
Years Ended December 31, 2003, 2002 and 2001
2003 2002 2001
--------- --------- ---------
(In thousands)
Proceeds from sales of loans from portfolio 63,546 66,400 --
Additions to premises and equipment (1,466) (1,468) (2,344)
Proceeds from sales of foreclosed real estate 1,456 -- 76
Proceeds from sale of equipment -- -- 20
Payment for purchase of EastPoint Technologies, LLC -- -- (4,700)
--------- --------- ---------
Net cash used in investing activities (214,684) (30,078) (29,169)
--------- --------- ---------
Cash flows from financing activities:
Net increase in deposits 47,884 39,631 14,638
Net decrease in securities sold under
agreements to repurchase (700) (1,190) (140)
Proceeds from Federal Home Loan Bank advances 252,000 120,172 152,000
Repayments of Federal Home Loan Bank advances (133,537) (121,134) (119,421)
Increase (decrease) in loans sold with recourse (728) 1,201 (7,740)
Treasury stock purchased (7,099) (6,989) (23,292)
Proceeds from reissuance of treasury stock 1,191 116 --
Purchase of common stock in connection with restricted
stock awards under stock based incentive plan -- -- (5,453)
Cash dividends paid (2,628) (2,737) (2,808)
--------- --------- ---------
Net cash provided by financing activities 156,383 29,070 7,784
--------- --------- ---------
Net change in cash and cash equivalents (43,213) 18,532 (1,489)
Cash and cash equivalents at beginning of year 60,655 42,123 43,612
--------- --------- ---------
Cash and cash equivalents at end of year $ 17,442 $ 60,655 $ 42,123
========= ========= =========
Supplemental cash flow information:
Interest paid on deposits $ 13,887 $ 17,835 $ 26,746
Interest paid on borrowed funds 4,696 6,856 6,719
Income taxes paid, net 4,175 1,618 2,882
Transfers from loans to foreclosed real estate -- 2,000 26
Securitization of and transfer of loans to securities 16,270 -- --
Due to broker 5,646 -- --
Due from broker 7,089 -- --
The accompanying notes are an integral part of these consolidated financial
statements.
-67-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2003, 2002 and 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
Basis of presentation and consolidation
Berkshire Hills Bancorp, Inc. (the "Company") is a Delaware corporation and the
holding company for Berkshire Bank (the "Bank"), a state-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 Bank, Berkshire Hills Funding Corporation
and Berkshire Hills Technology, Inc., which was formed during 2001 for the
purpose of acquiring a controlling interest in EastPoint Technologies, LLC. The
Bank's wholly-owned subsidiaries are North Street Securities Corporation, Gold
Leaf Insurance Company, Gold Leaf Investment Services, Gold Leaf Securities
Corporation and Woodland Securities Corporation, Inc. North Street Securities
Corporation, Gold Leaf Securities Corporation, and Woodland Securities
Corporation, Inc. hold title to certain investment securities. Gold Leaf
Insurance Company and Gold Leaf Investment Services were formed in 2000 and
offer insurance and investment products to customers. Berkshire Hills Funding
Corporation was established and funded to loan funds to the Bank's Employee
Stock Ownership Plan. During 2001, the Bank established a majority-owned
subsidiary, Gold Leaf Capital Corporation, which held real estate mortgages
prior to being dissolved during 2003. All significant intercompany balances and
transactions have been eliminated in consolidation.
On June 29, 2001, the Company, through its wholly-owned subsidiary, Berkshire
Hills Technology, Inc., purchased a controlling interest in EastPoint
Technologies, LLC ("EastPoint"), which on the same date acquired all of the
domestic operations and service contracts of M&I EastPoint Technology, Inc.,
Bedford, New Hampshire, a software and data processing provider for financial
institutions, as well as substantially all of the operations and service
contracts of Preferred Financial Systems, Inc., Arden Hills, Minnesota, a data
processing service provider, both of which utilized the EastPoint Technology,
Inc. software. The Company's equity interest in EastPoint at December 31, 2003
and 2002 is 60.3% and represents a total investment of $4.7 million. During 2001
the Company's ownership percentage decreased from 93.6% to 60.3% as other
investor financial institutions obtained regulatory approval to invest in
EastPoint Technologies, LLC. The change in ownership percentage is shown as an
adjustment to additional paid-in capital. This acquisition was accounted for
under the purchase method of accounting.
Business
The Company provides a variety of financial services to individuals,
municipalities and businesses through its offices in Berkshire County. Its
primary deposit products are savings, checking accounts and term certificate
accounts and its primary lending products are residential and commercial
mortgage loans, commercial loans and automobile loans. In addition, trust
services and insurance products are offered to individuals and small businesses
in the Berkshire County area.
Use of estimates
In preparing consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America, 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 sheet 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 and deferred taxes.
Reclassifications
Certain amounts in the 2002 and 2001 consolidated financial statements have been
reclassified to conform to the 2003 presentation.
Cash and cash equivalents
For purposes of the consolidated statements of cash flows, cash and cash
equivalents include cash, balances due from banks and short-term investments,
all of which mature within ninety days.
-68-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Short-term investments
Short-term investments mature within ninety days and are carried at cost, which
approximates fair value.
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.
Securities not classified as held-to-maturity, 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.
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.
Federal Home Loan Bank of Boston ("FHLB") stock is reflected at cost. Savings
Bank Life Insurance Company of Massachusetts ("SBLI") stock was recorded at fair
value at acquisition as determined by an appraisal performed by independent
investment consultants retained by SBLI.
Loans
The Bank grants mortgage, commercial and consumer loans to customers. A
substantial portion of the loan portfolio is represented by mortgage loans in
Berkshire County. The ability of the Bank's debtors to honor their contracts is
dependent upon the local economy and the local real estate market.
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, and any deferred fees or costs on originated loans. Interest income is
accrued on the unpaid principal balance. Loan origination fees, net of certain
direct origination costs, 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 continue accruing to one hundred and twenty days
delinquent at which time they are charged off, unless the customer is in
bankruptcy proceedings. All interest accrued but not collected for loans that
are placed on non-accrual or charged-off is reversed against interest income.
The interest on these 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.
-69-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Allowance for loan losses
The allowance for loan losses is established through a provision for loan losses
charged to earnings as losses are estimated to have occurred. 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's ability to repay,
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 specific, general and unallocated components. The
specific component relates to loans that are classified as either doubtful,
substandard or special mention. For such loans that are also classified as
impaired, an allowance is established when the discounted cash flows (or
collateral value or observable market price) of the impaired loan is lower than
the carrying value of that loan. The general component covers non-classified
loans 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. The unallocated component
of the allowance reflects the margin of imprecision inherent in the underlying
assumptions used in the methodologies for estimating allocated and general
losses in the portfolio.
A loan is considered impaired when, based on current information and events, it
is probable that a creditor will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Impaired loans are generally maintained on a non-accrual basis.
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 Bank'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.
Loans held for sale
Loans originated and intended for sale in the secondary market are carried at
the lower of cost or estimated fair value in the aggregate. Net unrealized
losses, if any, are recognized through a valuation allowance by charges to
income.
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 cost 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 cost to sell. Revenue and expenses from
operations and changes in the valuation allowance are included in net expenses
from foreclosed real estate and repossessed assets.
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 or terms of
the leases, if shorter.
-70-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Goodwill and other intangibles
Goodwill and other intangibles includes goodwill associated with the acquisition
of EastPoint which is evaluated for impairment on an annual basis. Intangible
assets refer to customer relationships acquired in association with the
EastPoint Technologies purchase, which are being amortized on a straight-line
basis over three years, as well as the Company's purchase of two branches from
another financial institution in 1991 and three branches in 1998. The branch
acquisition costs are evaluated for impairment on an annual basis.
Securities sold under agreements to repurchase
The Company enters into repurchase agreements with commercial customers. The
funds are invested in an overnight sweep account and deposited back in
customers' accounts on a daily basis. These agreements are secured by pledged
securities in the Bank's investment portfolio.
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.
Income taxes
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. As changes in tax laws or
rates are enacted, deferred tax assets and liabilities 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.
Stock compensation plans
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for
Stock-Based Compensation," encourages all entities to adopt a fair value based
method of accounting for employee stock compensation plans, whereby compensation
cost is measured at the grant date based on the value of the award and is
recognized over the service period, which is usually the vesting period.
However, it also allows an entity to continue to measure compensation cost for
those plans using the intrinsic value based method of accounting prescribed by
Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued
to Employees," whereby compensation cost is the excess, if any, of the quoted
market price of the stock at the grant date (or other measurement date) over the
amount an employee must pay to acquire the stock. Stock options issued under the
Company's stock option plans have no intrinsic value at the grant date, and
under Opinion No. 25 no compensation cost is recognized for them.
-71-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Stock compensation plans (concluded)
At December 31, 2003, the Company maintains stock-based compensation plans,
which are described more fully in Note 16. The Company has elected to continue
with the accounting methodology in APB No. 25 and, as a result, has provided pro
forma disclosures of net income and earnings per share, as if the fair value
based method of accounting had been applied. The following table illustrates the
effect on net income and earnings per share if the Company had applied the fair
value recognition provisions of SFAS No. 123 to stock-based employee
compensation.
Years Ended December 31,
----------------------------------------
2003 2002 2001
---------- ---------- ----------
(In thousands, except per share data)
Net income, as reported $ 8,965 $ 2,097 $ 8,911
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards, net
of related tax effects (398) (324) (355)
---------- ---------- ----------
Pro forma net income $ 8,567 $ 1,773 $ 8,556
========== ========== ==========
Earnings per share:
Basic-as reported $ 1.70 $ 0.39 $ 1.42
========== ========== ==========
Basic-pro forma $ 1.63 $ 0.33 $ 1.37
========== ========== ==========
Diluted-as reported $ 1.57 $ 0.36 $ 1.35
========== ========== ==========
Diluted-pro forma $ 1.50 $ 0.30 $ 1.30
========== ========== ==========
-72-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Earnings per common share
Basic earnings per share represents income available to common stockholders
divided by the weighted-average number of common shares outstanding during the
period. Diluted earnings per share reflects additional common shares that would
have been outstanding if dilutive potential common shares had been issued.
Potential common shares that may be issued by the Company related to outstanding
stock awards and stock options, and are determined using the treasury stock
method.
Earnings per common share have been computed based upon the following:
2003 2002 2001
---------- ---------- ----------
(In thousands, except per share data)
Net income applicable to common stock $ 8,965 $ 2,097 $ 8,911
========== ========== ==========
Average number of common shares outstanding 5,266 5,435 6,264
Effect of dilutive potential common shares 437 432 340
---------- ---------- ----------
Average number of common shares outstanding
used to calculate diluted earnings per common share 5,703 5,867 6,604
========== ========== ==========
Employee stock ownership plan ("ESOP")
Compensation expense is recognized as ESOP shares are committed to be released.
Allocated and committed to be released ESOP shares are considered outstanding
for earnings per share calculations. Other ESOP shares are excluded from
earnings per share calculations. Dividends declared on allocated ESOP shares are
charged to retained earnings. Dividends declared on unallocated ESOP shares are
used to satisfy debt service. The value of unearned shares to be allocated to
ESOP participants for future services not yet performed is reflected as a
reduction of stockholders' equity.
Stock awards
The fair market value of the stock awards, based on the market price at date of
grant, is recorded as unearned compensation. Unearned compensation is amortized
over the vesting period. Stock award shares are considered outstanding for basic
earnings per share in the period that they vest. Stock award shares not vested
are considered in the calculation of diluted earnings per share.
Advertising costs
Advertising costs are charged to earnings when incurred.
Trust assets
Trust 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.
Comprehensive income
Accounting principles generally require that recognized revenue, expenses, gains
and losses be included in net income. Although certain changes in assets and
liabilities, such as unrealized gains and losses on available-for-sale
securities, are reported as a separate component of the equity section of the
consolidated balance sheet, such items, along with net income, are components of
comprehensive income.
-73-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (concluded)
Comprehensive income (concluded)
The components of other comprehensive income and related tax effects are as
follows for the years ended December 31, 2003, 2002 and 2001:
2003 2002 2001
---------- ---------- ----------
(In thousands)
Change in net unrealized holding gains/losses $ 2,297 $ (5,151) $ (1,237)
on available-for-sale securities
Reclassification adjustment for gains (3,077) (15,143) (268)
realized in income
Reclassification adjustment for impairment
losses recognized in income -- 673 --
---------- ---------- ----------
Net change in unrealized gains/losses (780) (19,621) (1,505)
Tax effects 797 6,327 517
---------- ---------- ----------
Net-of-tax change $ 17 $ (13,294) $ (988)
========== ========== ==========
Accounting changes
The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets,"
effective January 1, 2002. Accordingly, goodwill is no longer subject to
amortization over its estimated useful life, but is subject to at least an
annual assessment for impairment by applying a fair value based test.
Additionally, under SFAS No. 142, acquired intangible assets (such as core
deposit intangibles) are separately recognized if the benefit of the intangible
asset is obtained through contractual or other legal rights, or if the
intangible asset can be sold, transferred, licensed, rented or exchanged, and
amortized over their useful life. Branch acquisition transactions were outside
the scope of SFAS No. 142 and, accordingly, intangible assets related to such
transactions continued to amortize upon the adoption of SFAS No. 142. On October
31, 2002, the Company adopted SFAS No. 147, "Acquisitions of Certain Financial
Institutions." This Statement amends (except for transactions between two or
more mutual enterprises) previous interpretive guidance on the application of
the purchase method of accounting to acquisitions of financial institutions, and
requires the application of SFAS No. 141, "Business Combinations" and SFAS No.
142 to branch acquisitions if such transactions meet the definition of a
business combination. This Statement amends SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," to include in its scope core
deposit intangibles of financial institutions. Accordingly, such intangibles are
subject to a recoverability test based on undiscounted cash flows, and to the
impairment recognition and measurement provisions that are required for other
long-lived assets that are held and used.
SFAS No. 141 requires that the Company evaluate its intangible assets and
goodwill that were acquired in a prior purchase business combination, and to
make any necessary reclassifications in order to conform with the new criteria
for recognition apart from goodwill. No reclassifications or adjustments were
made as a result of adopting this statement. As required by SFAS No. 142 the
Company completed the annual impairment test on goodwill assets and has
concluded that the amount of recorded goodwill was not impaired as of December
31, 2003.
Recent accounting pronouncements
In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46),
which establishes guidance for determining when an entity should consolidate
another entity that meets the definition of a variable interest entity. FIN 46
requires a variable interest entity to be consolidated by a company if that
company will absorb a majority of the expected losses, will receive a majority
of the expected residual returns, or both. Transferors to qualified
special-purpose entities ("QSPEs") and certain other interests in a QSPE are not
subject to the requirements of FIN 46. On December 17, 2003, the FASB deferred
the effective date of FIN 46 to no later than the end of the first reporting
period that ends after March 15, 2004, however, for special-purpose entities the
Company would be required to apply FIN 46 as of December 31, 2003. The
interpretation had no effect on the Company's consolidated financial statements.
-74-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANK
- --------------------------------------------------------------------------------
The Bank is required to maintain cash reserve balances with the Federal Reserve
Bank based upon a percentage of certain deposits. At December 31, 2003 and 2002,
cash and due from banks included $1,129,000 and $972,000, respectively, to
satisfy such reserve requirements.
3. SHORT-TERM INVESTMENTS
- --------------------------------------------------------------------------------
Short-term investments consist of the following at December 31, 2003 and 2002:
2003 2002
------- -------
(In thousands)
Federal funds sold $ -- $17,000
FHLB overnight deposits 1,859 1,397
BIF Liquidity Fund -- 25,000
------- -------
$ 1,859 $43,397
======= =======
-75-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. SECURITIES
- --------------------------------------------------------------------------------
The amortized cost and estimated fair value of securities, with gross unrealized
gains and losses, follows:
December 31, 2003
------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- -----------
(In thousands)
Securities Available-for-Sale
Debt securities:
U.S. Treasury and U.S.
Government agencies $ 20,840 $ 135 $ (6) $ 20,969
Municipal bonds and obligations 12,294 42 (54) 12,282
Other bonds and obligations 17,102 242 (34) 17,310
Mortgaged-backed securities:
FHLMC/FNMA/GNMA 238,066 1,727 (1,470) 238,323
REMIC's and CMO's 1,520 33 (6) 1,547
Asset-backed securities 2,566 -- (460) 2,106
----------- ----------- ----------- -----------
Total debt securities 292,388 2,179 (2,030) 292,537
Marketable equity 6,515 8,373 -- 14,888
----------- ----------- ----------- -----------
Total securities
available-for-sale $ 298,903 $ 10,552 $ (2,030) $ 307,425
=========== =========== =========== ===========
Securities Held-to-Maturity
Debt securities:
Municipal bonds and obligations $ 10,590 $ -- $ -- $ 10,590
Mortgaged-backed securities:
FHLMC/FNMA 5,319 28 (8) 5,339
REMIC's and CMO's 11,039 2 (57) 10,984
Other bonds and obligations 9,955 -- -- 9,955
----------- ----------- ----------- -----------
Total securities
held-to-maturity $ 36,903 $ 30 $ (65) $ 36,868
=========== =========== =========== ===========
-76-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (continued)
December 31, 2002
------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------- ----------- ----------- -----------
(In thousands)
Securities Available-for-Sale
Debt securities:
U.S. Treasury and U.S.
Government agencies $ 98,058 $ 669 $ (8) $ 98,719
Other bonds and obligations 31,284 564 (211) 31,637
Mortgaged-backed securities:
FHLMC/FNMA/GNMA 236 13 -- 249
REMIC's and CMO's 16,201 128 (118) 16,211
Asset-backed securities 6,956 43 (227) 6,772
----------- ----------- ----------- -----------
Total debt securities 152,735 1,417 (564) 153,588
Marketable equity 11,132 8,526 (77) 19,581
----------- ----------- ----------- -----------
Total securities
available-for-sale $ 163,867 $ 9,943 $ (641) $ 173,169
=========== =========== =========== ===========
Securities Held-to-Maturity
Debt securities:
Municipal bonds and obligations $ 7,633 $ -- $ -- $ 7,633
Mortgaged-backed securities:
FHLMC/FNMA 8,648 130 (7) 8,771
REMIC's and CMO's 21,139 46 (88) 21,097
Other bonds and obligations 6,847 -- -- 6,847
----------- ----------- ----------- -----------
Total securities
held-to-maturity $ 44,267 $ 176 $ (95) $ 44,348
=========== =========== =========== ===========
-77-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (continued)
The amortized cost and estimated fair value of debt securities by contractual
maturity at December 31, 2003 was as follows. Expected maturities will differ
from contractual maturities because borrowers may have the right to call or
prepay obligations with or without call or prepayment penalties.
Available-for-Sale Held-to-Maturity
----------------------- -----------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
---------- ---------- ---------- ----------
(In thousands)
Within 1 year $ 13,193 $ 13,310 $ 8,087 $ 8,087
Over 1 year to 5 years 22,728 22,980 4,016 4,016
Over 5 years to 10 years 1,225 1,235 1,827 1,827
Over 10 years 13,090 13,036 6,615 6,615
---------- ---------- ---------- ----------
Total bonds and obligations 50,236 50,561 20,545 20,545
Mortgaged-backed and asset-backed
securities 242,152 241,976 16,358 16,323
---------- ---------- ---------- ----------
Total debt securities $ 292,388 $ 292,537 $ 36,903 $ 36,868
========== ========== ========== ==========
At December 31, 2003 and 2002, the Company has pledged securities with an
amortized cost of $1,000,000 and $6,032,000, respectively, and a fair value of
$1,021,500 and $6,185,000, respectively, as collateral for repurchase
agreements, and for its treasury tax and loan account.
For the years ended December 31, 2003, 2002 and 2001, proceeds from the sales of
securities available-for-sale amounted to $20,349,000, $28,255,000 and
$3,965,000, respectively. Gross realized gains amounted to $3,371,000,
$16,111,000 and $440,000, respectively. Gross realized losses amounted to
$294,000, $968,000 and $172,000, respectively.
-78-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (concluded)
Information pertaining to securities with gross unrealized losses at December
31, 2003, aggregated by investment category and length of time that individual
securities have been in a continuous loss position, follows:
Less Than Twelve Months Over Twelve Months
----------------------- -----------------------
Gross Gross
Unrealized Fair Unrealized Fair
Losses Value Losses Value
---------- ---------- ---------- ----------
(In thousands)
Securities Available-for-Sale
Other bonds and obligations $ 79 $ 8,722 $ 9 $ 402
Mortgaged-backed securities 1,475 113,236 7 144
Asset-backed securities 10 809 450 1,297
---------- ---------- ---------- ----------
Total securities
available-for-sale $ 1,564 $ 122,767 $ 466 $ 1,843
========== ========== ========== ==========
Securities Held-to-Maturity
Mortgaged-backed securities $ 61 $ 12,740 $ 4 $ 195
========== ========== ========== ==========
Management evaluates securities for other-than-temporary impairment at least on
a quarterly basis, and more frequently when economic or market concerns warrant
such evaluation. Consideration is given to (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.
At December 31, 2003, two debt securities, representing 0.11% of total assets,
have unrealized losses with aggregate depreciation of 25.8% from the Company's
amortized cost basis. The unrealized losses are in asset-backed securities that
derive their payment of principal and interest from mortgages on manufactured
housing. At December 31, 2003, these securities had aggregate investment grade
ratings of "A" from nationally recognized rating agencies. Additionally, the
market value on the securities has improved since mid-2003.
-79-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. LOANS
- --------------------------------------------------------------------------------
A summary of the balances of loans follows at December 31, 2003 and 2002:
2003 2002
--------- ---------
(In thousands)
One-to four-family mortgage $ 266,753 $ 246,938
Commercial mortgage 154,244 119,198
Multi-family mortgage 15,514 14,920
Construction and land development 34,719 17,627
Home equity lines of credit 45,783 40,713
Consumer 108,180 118,338
Commercial 166,451 165,447
--------- ---------
Total loans 791,644 723,181
Allowance for loan losses (8,969) (10,308)
Unamortized discount on purchased loans 473 (200)
Net deferred loan costs 110 41
--------- ---------
Loans, net $ 783,258 $ 712,714
========= =========
At December 31, 2003 and 2002, there were no loans held for sale.
An analysis of the allowance for loan losses for the years ended December 31,
2003, 2002 and 2001 follows:
2003 2002 2001
-------- -------- --------
(In thousands)
Balance at beginning of year $ 10,308 $ 11,034 $ 10,216
Provision for loan losses 1,460 6,180 7,175
Loans charged-off (4,364) (10,028) (7,062)
Recoveries 1,565 3,122 705
-------- -------- --------
Balance at end of year $ 8,969 $ 10,308 $ 11,034
======== ======== ========
-80-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
LOANS (concluded)
The following is a summary of information pertaining to impaired and non-accrual
loans at December 31, 2003 and 2002:
2003 2002
-------- --------
(In thousands)
Impaired loans with no valuation allowance $ 388 $ 727
Impaired loans with a valuation allowance 1,994 2,123
-------- --------
Total impaired loans $ 2,382 $ 2,850
======== ========
Specific valuation allowance allocated to impaired loans $ 267 $ 295
======== ========
Non-accrual loans $ 3,199 $ 3,741
======== ========
Total loans past due ninety days or more and
still accruing $ 306 $ 590
======== ========
No additional funds are committed to be advanced in connection with impaired
loans.
For the years ended December 31, 2003, 2002 and 2001, the average recorded
investment in impaired loans amounted to $2,693,000, $2,308,000 and $1,344,000,
respectively. The Company recognized $14,000, $85,000 and $14,000, respectively,
of interest income on impaired loans, during the period that they were impaired,
on the cash basis.
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 $24,878,000 and $3,702,000 at December 31,
2003 and 2002, respectively, which includes $16,270,000 in securitized
mortgages. Consumer loans sold and serviced for others amounted to $7,159,000
and $19,476,000 at December 31, 2003 and 2002, respectively.
Substantially all loans serviced for others were sold without recourse
provisions and are not included in the accompanying consolidated balance sheets.
However, one commercial participation loan sale during 2002 included recourse
provisions amounting to $473,000 and $1,201,000 at December 31, 2003 and 2002.
This loan and the recourse provisions are included in the accompanying
consolidated balance sheets.
-81-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. PREMISES AND EQUIPMENT
- --------------------------------------------------------------------------------
A summary of the cost and accumulated depreciation and amortization of premises
and equipment and their estimated useful lives follows at December 31, 2003 and
2002:
Estimated
2003 2002 Useful Lives
-------- -------- ------------
(In thousands)
Banking premises:
Land $ 1,558 $ 1,558
Buildings and improvements 18,448 17,848 5-50 years
Equipment 11,467 10,948 2-38 years
Construction in process 550 203
-------- --------
32,023 30,557
Accumulated depreciation and
amoritization (19,397) (17,290)
-------- --------
$ 12,626 $ 13,267
======== ========
The majority of construction in process in 2003 related to computer conversion
costs and renovations to the Great Barrington branch. The Company is expecting
additional costs of $262,000 to complete the computer conversion project, of
which $155,000 has been committed. Expected and committed costs to complete
branch renovations are $958,000.
Construction in process in 2002 includes a renovation project at the West
Stockbridge branch. During 2003, this project was completed and costs were
transferred to the applicable categories.
Depreciation and amortization expense for the years ended December 31, 2003,
2002 and 2001 amount to $2,107,000, $2,414,000 and $2,081,000, respectively.
7. OTHER ASSETS
- --------------------------------------------------------------------------------
Other assets consist of the following at December 31, 2003 and 2002:
2003 2002
------- -------
(In thousands)
Prepaid dealer reserves $ 3,196 $ 3,517
Repossessed vehicles 352 838
Cash surrender values, life insurance 5,425 4,952
Other 5,107 4,008
------- -------
Total other assets $14,080 $13,315
======= =======
-82-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. GOODWILL AND OTHER INTANGIBLES
- --------------------------------------------------------------------------------
Goodwill and other intangibles include goodwill associated with the acquisition
of EastPoint, which is evaluated for impairment on an annual basis. Intangible
assets refer to customer relationships acquired in association with the
EastPoint purchase, which are being amortized on a straight-line basis over
three years as well as the Company's purchase of two branches from another
financial institution in 1991 and three branches in 1998. The branch acquisition
costs are being evaluated for impairment on an annual basis.
There have been no changes in carrying amounts of goodwill for the years ended
December 31, 2003 and 2002. The balance is $4,369,000 for both years.
A summary of other intangible assets at December 31 is as follows:
2003 2002
---------------------------- ----------------------------
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
------------ ------------ ------------ ------------
(In thousands)
Branch acquisition $ 5,763 $ (1,700) $ 5,763 $ (1,700)
Customer relationships 101 (507) 304 (304)
------------ ------------ ------------ ------------
$ 5,864 $ (2,207) $ 6,067 $ (2,004)
============ ============ ============ ============
The amortization expense on other intangible assets amounted to $203,000,
$203,000 and $599,000, respectively, for the years ended December 31, 2003, 2002
and 2001. The remaining amortization of customer relationships will be expensed
during 2004.
A reconciliation of reported income before income taxes to adjusted income
before income taxes excluding the impacts of goodwill amortization for the years
ended December 31 are as follows:
2003 2002 2001
-------- -------- --------
(In thousands)
Income before income taxes $ 14,030 $ 2,628 $ 13,260
Add: Goodwill amortization -- -- 228
-------- -------- --------
Adjusted income before income taxes $ 14,030 $ 2,628 $ 13,032
======== ======== ========
The adoption of SFAS 147 in 2002 resulted in increases to goodwill of $497,000,
deferred taxes of $169,000 and $328,000 in retained earnings.
-83-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. DEPOSITS
- --------------------------------------------------------------------------------
A summary of deposit balances, by type, was as follows at December 31, 2003 and
2002:
2003 2002
-------- --------
(In thousands)
Demand $102,788 $ 87,149
NOW 94,606 92,245
Savings 171,139 157,852
Money market 139,897 114,309
Other 464 616
-------- --------
Total non-certificate accounts 508,894 452,171
-------- --------
Term certificates less than $100,000 180,257 194,635
Term certificates of $100,000 or more 141,093 135,554
-------- --------
Total certificate accounts 321,350 330,189
-------- --------
Total deposits $830,244 $782,360
======== ========
A summary of certificate accounts by maturity is as follows at December 31, 2003
and 2002:
2003 2002
--------------------- ----------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
--------- --------- --------- ---------
(Dollars in thousands)
Within 1 year $ 219,622 2.20% $ 215,199 3.07%
Over 1 year to 3 years 55,084 3.61 79,122 4.08
Over 3 years 46,644 5.04 35,868 5.43
--------- ---------
$ 321,350 2.85% $ 330,189 3.57%
========= =========
-84-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. FEDERAL HOME LOAN BANK ADVANCES
- --------------------------------------------------------------------------------
A summary of outstanding advances from the Federal Home Loan Bank of Boston, by
maturity, is as follows at December 31, 2003 and 2002:
2003 2002
---------------------- ----------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
--------- --------- --------- ---------
(Dollars in thousands)
Fixed rate advances maturing:
2003 $ -- --% $ 62,000 1.76%
2004 125,000 1.43 10,000 2.83
2005 17,670 2.68 12,597* 3.02
2006 25,627 2.81 627 5.67
2007 34,397* 3.43 9,000 4.74
2008 5,000 1.25 -- --
2009 7,000 5.40 7,000 5.40
2010 20,000 5.84 20,000 5.84
2011 10,610 4.47 5,610 4.95
2013 6,000 5.18 6,000 5.19
2022 161* 2.00 168* 2.00
--------- ---------
Total FHLB advances $ 251,465 2.61% $ 133,002 3.27%
========= =========
* Amortizing advances requiring monthly principal and interest payments.
Certain FHLB advances are callable in the amount of $52,000,000 during 2004.
The Bank maintains a line-of-credit with the Federal Home Loan Bank of Boston,
which carries interest at a rate that adjusts daily. Borrowings under the line
are limited to 2% of the Bank's total assets. All borrowings from the Federal
Home Loan Bank of Boston are secured by a blanket lien on certain qualified
collateral, defined principally as 75% of the carrying value of certain first
mortgage loans on owner-occupied residential property and 90% of the market
value of U.S. Government and federal agency securities pledged to the Federal
Home Loan Bank. No amounts were outstanding under this line during 2003 and
2002.
-85-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
- --------------------------------------------------------------------------------
Securities sold under agreements to repurchase ("repurchase agreements") are
funds borrowed from customers on an overnight basis that are secured by
investment securities.
A summary of repurchase agreements was as follows for the years ended December
31, 2003 and 2002:
2003 2002
------ ------
(Dollars in thousands)
Balance at year end $ -- $ 700
Fair value of securities underlying the
agreements at year end -- 2,542
Interest rate on year end balance -- 1.59%
Average amount outstanding during year 88 1,349
Maximum amount outstanding at
any month-end 500 1,830
Weighted average interest rate during the year 1.24% 1.72%
The Bank also has a repurchase agreement line of credit with the Depositors
Insurance Fund of up to $2.0 million and a $50.0 million repurchase agreement
line of credit with a major broker-dealer to be secured by securities or other
assets of the Bank. As of December 31, 2003 and 2002, there were no outstanding
borrowings against either agreement.
12. INCOME TAXES
- --------------------------------------------------------------------------------
Allocation of federal and state income taxes between current and deferred
portions is as follows for the years ended December 31, 2003, 2002 and 2001:
2003 2002 2001
-------- -------- --------
(In thousands)
Current tax provision:
Federal $ 3,210 $ 644 $ 3,496
State 767 149 245
-------- -------- --------
3,977 793 3,741
-------- -------- --------
Deferred tax provision (benefit):
Federal 848 (171) 531
State 240 (91) 77
-------- -------- --------
1,088 (262) 608
-------- -------- --------
$ 5,065 $ 531 $ 4,349
======== ======== ========
-86-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
INCOME TAXES (continued)
The reasons for the differences between the statutory federal income tax rate
and the effective tax rates is summarized as follows for the years ended
December 31, 2003, 2002 and 2001:
2003 2002 2001
-------- -------- --------
(In thousands)
Statutory tax rate 34.0% 34.0% 34.0%
Increase (decrease) resulting from:
State taxes, net of federal tax benefit 4.7 1.5 1.6
Dividends received deduction (1.1) (8.1) (1.9)
Tax exempt income (0.9) (6.1) (1.0)
Other, net (0.6) (1.1) 0.1
-------- -------- --------
Effective tax rate 36.1% 20.2% 32.8%
======== ======== ========
The components of the net deferred tax assets are as follows at December 31,
2003 and 2002:
2003 2002
-------- --------
(In thousands)
Deferred tax liability:
Federal $ 3,879 $ 3,587
State 419 1,098
-------- --------
4,298 4,685
-------- --------
Deferred tax asset:
Federal (4,789) (5,332)
State (1,234) (1,369)
-------- --------
(6,023) (6,701)
-------- --------
Net deferred tax asset $ (1,725) $ (2,016)
======== ========
-87-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
INCOME TAXES (concluded)
The tax effects of each type of income and expense item that give rise to
deferred taxes are as follows at December 31, 2003 and 2002:
2003 2002
-------- --------
(In thousands)
Investments:
Net unrealized gain on securities
available for sale $ 2,963 $ 3,760
Other 350 164
Depreciation 7 (9)
Allowance for loan losses (3,671) (3,999)
Employee benefit plans (1,000) (732)
Charitable contribution carryover (824) (1,219)
Other 450 19
-------- --------
Net deferred tax asset $ (1,725) $ (2,016)
======== ========
A summary of the change in the net deferred tax (asset) liability was as follows
for the years ended December 31, 2003, 2002 and 2001:
2003 2002 2001
-------- -------- --------
(In thousands)
Balance at beginning of year $ (2,016) $ 4,573 $ 4,482
Deferred tax (benefit) provision 1,088 (262) 608
Change in deferred tax effects of net unrealized
gains/losses on securities available for sale (797) (6,327) (517)
-------- -------- --------
Balance at end of year $ (1,725) $ (2,016) $ 4,573
======== ======== ========
There is a contribution carryover that was generated during the year ended 2000,
which expires in 2005. Management believes that the deferred tax assets related
to this contribution carryover and other deductible temporary differences will
be realized. As a result, no valuation reserve has been established at December
31, 2003, December 31, 2002 or December 31, 2001.
The federal income tax reserve for loan losses at the Bank's base year is
$844,000. If any portion of the reserve is used for purposes other than to
absorb the losses for which established, approximately 150% of the amount
actually used (limited to the amount of the reserve) would be subject to
taxation in the year in which used. As the Bank intends to use the reserve only
to absorb loan losses, a deferred income tax liability of $346,000 has not been
provided.
In June 2003, the Company reached a settlement with the Massachusetts Department
of Revenue ("DOR") with respect to the DOR's tax assessment resulting from the
DOR's disallowance of the Company's deduction of certain dividend distributions
received by the Bank from its Real Estate Investment Trust majority-owned
subsidiary Gold Leaf Capital Corporation (the "REIT"). As a result, the Company
paid approximately $398,000 to the DOR representing one-half of the assessment
plus interest and obtained the DOR's release from liability for the remaining
half assessed. The Company dissolved the REIT during the third quarter of 2003.
-88-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
13. OFF-BALANCE SHEET ACTIVITIES
- --------------------------------------------------------------------------------
In the normal course of business, there are outstanding commitments and
contingencies that are not reflected in the accompanying consolidated financial
statements.
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.
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 was as
follows at December 31, 2003 and 2002:
2003 2002
-------- --------
(In thousands)
Commitments to grant loans $ 26,854 $ 30,815
Unused funds on commercial lines-of-credit 49,380 47,900
Unadvanced funds on home equity and reddi-cash
lines of credit 46,904 42,671
Unadvanced funds on construction loans 18,069 19,161
Standby letters of credit 1,811 1,894
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 credit
worthiness 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 Bank 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.
-89-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
OFF-BALANCE SHEET ACTIVITIES (concluded)
Operating lease commitments
Pursuant to the terms of noncancelable lease agreements in effect at December
31, 2003, pertaining to premises and equipment, future minimum rent commitments
are as follows:
Years Ending
December 31, (In thousands)
------------
2004 $ 474
2005 428
2006 353
2007 353
2008 352
Thereafter 2,830
-------
$ 4,790
=======
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
ended December 31, 2003, 2002 and 2001 amounted to $371,000, $391,000 and
$375,000, respectively.
Employment and change in control agreements
The Company and the Bank have each entered into an employment agreement with one
senior executive that generally provides for a specified minimum annual
compensation, participation in stock benefit plans and the continuation of
benefits currently received. The original terms of the agreements are for three
years and automatically extend unless either party gives notice to the contrary.
However, such agreements may be terminated for cause, as defined, without
incurring any continuing obligations.
The Bank has also entered into change in control agreements with certain
officers, all of whom are not covered by an employment agreement. The change in
control agreements generally provide a severance payment if the officer is
terminated following a "change in control," as defined in the agreements.
Legal claims
Various legal claims also arise from time to time in the normal course of
business which, in the opinion of management, will have no material effect on
the Company's consolidated financial statements.
Mortgage securitization
On December 2, 2003, the Company entered into an agreement to securitize
mortgages with Fannie Mae in the aggregate of $55,900,000, plus or minus 5% of
total principal balance, which would be securitized and transferred back to the
Company. At December 31, 2003, the Company had an outstanding commitment to
securitize mortgage loans under the agreement of $39,600,000.
-90-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
14. STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
Minimum regulatory capital requirements
The Bank is subject to various regulatory capital requirements administered by
the federal banking agencies. Failure to meet minimum capital requirements can
initiate certain mandatory and possibly additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Company's and the Bank'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. Prompt corrective action
provisions are not applicable to savings and loan holding companies.
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). Management believes, as of December 31, 2003 and 2002, that the Bank
met the capital adequacy requirements.
As of December 31, 2003, 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.
-91-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCKHOLDERS' EQUITY (continued)
The Company and Bank's actual capital amounts and ratios as of December 31, 2003
and 2002 are presented in the following table.
December 31, 2003
----------------------------------------------------------------------
Minimum
To Be Well
Minimum Capitalized Under
Capital Prompt Corrective
Actual Requirement Action Provisions
--------------------- --------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
--------- --------- --------- --------- --------- ---------
(Dollars in thousands)
Total capital to risk weighted assets:
Berkshire Hills Bancorp, Inc. $ 120,120 14.10% N/A N/A N/A N/A
Berkshire Bank 106,564 12.57 $ 67,827 8.00% $ 84,784 10.00%
Tier 1 capital to risk weighted assets:
Berkshire Hills Bancorp, Inc. 107,383 12.60 N/A N/A N/A N/A
Berkshire Bank 93,827 11.07 33,914 4.00 42,392 6.00
Tier 1 capital to average assets:
Berkshire Hills Bancorp, Inc. 107,383 8.97 N/A N/A N/A N/A
Berkshire Bank 93,827 7.87 47,664 4.00 59,580 5.00
-92-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCKHOLDERS' EQUITY (concluded)
Minimum regulatory capital requirements (concluded)
December 31, 2002
----------------------------------------------------------------------
Minimum
To Be Well
Minimum Capitalized Under
Capital Prompt Corrective
Actual Requirement Action Provisions
--------------------- --------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
--------- --------- --------- --------- --------- ---------
(Dollars in thousands)
Total capital to risk weighted assets:
Berkshire Hills Bancorp, Inc. $ 118,124 15.18% N/A N/A N/A N/A
Berkshire Bank 104,087 13.53 $ 61,544 8.00% $ 76,929 10.00%
Tier 1 capital to risk weighted assets:
Berkshire Hills Bancorp, Inc. 104,591 13.45 N/A N/A N/A N/A
Berkshire Bank 90,661 11.78 30,772 4.00 46,158 6.00
Tier 1 capital to average assets:
Berkshire Hills Bancorp, Inc. 104,591 10.04 N/A N/A N/A N/A
Berkshire Bank 90,661 8.76 41,374 4.00 51,718 5.00
Common stock
On March 28, 2001, the Board of Directors approved a dividend reinvestment plan
and authorized its implementation. The plan, which is available to all
shareholders of record of the Company's common stock, permits the reinvestment
of all cash dividends, the deposit of shares for safekeeping and the sale and
gifting of shares held under the plan. Common shares purchased pursuant to this
plan were 7,504 shares. All shares are purchased in open market transactions.
During 2002 and 2001, the Company repurchased approximately 312,516 and
1,249,000 shares of outstanding common stock. The Company announced in July 2003
that its Board of Directors approved a sixth repurchase program for 298,886
shares, or 5%, of its outstanding common stock and at December 31, 2003, the
Company had 186,186 shares remaining to be purchased in the latest 5%
repurchase. During 2003, a total of 112,700 shares were repurchased relating to
the sixth stock repurchase program.
-93-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
15. EMPLOYEE BENEFIT PLANS
- --------------------------------------------------------------------------------
Defined benefit pension plan
The Company terminated its defined benefit pension plan, effective February 24,
2001. During the second quarter of 2001, the Company recorded a loss of $168,000
from the curtailment of its defined benefit pension plan. The final plan
settlement was approved by the IRS in the fourth quarter of 2001. The settlement
gain was $2,341,000.
Defined contribution pension plan
The Company has a qualified savings plan under Section 401(k) of the Internal
Revenue Code. Each employee reaching the age of 21 and having completed at least
1,000 hours of service in a twelve-month period, beginning with such employee's
date of employment, automatically becomes a participant in the 401(k) Plan.
Employees may contribute a portion of their compensation subject to certain
limits based on federal tax laws. The Company made matching contributions which
amounted to $603,000, $640,000 and $528,000, respectively, for the years ended
December 31, 2003, 2002 and 2001.
Supplemental executive retirement plan
The Company has a nonqualified supplemental executive retirement plan for the
benefit of a certain senior executive. Benefits generally commence no earlier
than age sixty and continue for the life of the senior executive. As of December
31, 2003 and 2002, the Company has an accrued expense payable in the amount of
$1,007,000 and $760,000, respectively, representing the present value of future
payments under the supplemental retirement plan. Supplemental retirement expense
for this plan for the year ended December 31, 2003, was $247,000. There was no
expense for the years ended December 31, 2002 and 2001. In some instances, the
Company has also entered into split-dollar life insurance agreements with senior
executives to provide supplemental retirement benefits.
Incentive plan
The Company has an incentive plan (the "Plan") whereby all management and staff
members are eligible to receive a bonus, tied to performance. The structure of
the Plan is to be reviewed on an annual basis by the Corporate Governance
Committee. The Plan year end is December 31. Incentive compensation expense for
the years ended December 31, 2003, 2002 and 2001 amounted to $925,000, $620,000
and $600,000, respectively.
Other benefits
The Company has in the past offered its retirees optional medical insurance
coverage. All participating retirees are required to contribute in part to the
cost of this coverage. The retiree medical plan was terminated on December 31,
1996. Any retiree participating in the plan at that time will continue to be
covered for life, however, no new retirees can participate in this plan. At
December 31, 2003 and 2002, the Company had an accrued liability in the amount
of $428,000 and $487,000, respectively, for payment of future premiums under
this plan.
-94-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
16. STOCK-BASED INCENTIVE PLAN AND EMPLOYEE STOCK OWNERSHIP PLAN
- --------------------------------------------------------------------------------
Stock options
Under the Company's Stock-Based Incentive Plan, the Company may grant options to
its directors, officers and employees for up to 767,366 shares of common stock.
Both incentive stock options and non-statutory stock options may be granted
under the plan. The exercise price of each option equals the market price of the
Company's stock on the date of grant and an option's maximum term is ten years.
Options vest at 20% per year. In 2003, the Company's shareholders approved the
2003 Equity Compensation Plan. Under this Plan the Company may grant up to
300,000 options or stock awards to its directors, officers and employees. No
options or awards were granted under this Plan in 2003.
A summary of the status of the Company's stock options for the years ended
December 31, 2003, 2002 and 2001 are presented below:
2003 2002 2001
---------------------- ---------------------- ---------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- --------- --------- --------- --------- ---------
Fixed options:
Outstanding at beginning of year 600,848 $ 16.75 767,366 $ 16.75 -- $ --
Granted 120,143 22.44 -- -- 767,366 16.75
Exercised (71,064) 16.75 (6,907) 16.75 -- --
Forfeited -- -- (159,611) 16.75 -- --
--------- --------- ---------
Outstanding at end of year 649,927 $ 17.80 600,848 $ 16.75 767,366 $ 16.75
========= ========= =========
Options exercisable at year-end 189,081 $ 16.75 146,573 $ 16.75 -- $ --
Weighted-average fair value of
options granted during the year $ 6.15 $ -- $ 3.44
-95-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCK-BASED INCENTIVE PLAN AND EMPLOYEE STOCK OWNERSHIP PLAN (continued)
Stock options (concluded)
The fair value of each option grant is estimated on the date of grant using the
Modified Roll Geske option-pricing model with the following weighted-average
assumptions:
Years Ended December 31,
-------------------------
2003 2001
-------- --------
Dividend yield 1.85% 2.12%
Expected life in years 10 years 10 years
Expected volatility 20.34% 18.01%
Risk-free interest rate 3.85% 5.12%
No options were granted during the year ended December 31, 2002.
Information pertaining to options outstanding at December 31, 2003 are as
follows:
Options Outstanding Options Exercisable
-------------------------- -------------------------
Weighted
Average Weighted
Remaining Average
Number Contractual Number Exercise
Grant Period Outstanding Life Exercisable Price
- -------------------------- ----------- ----------- -----------
2001 529,784 7.08 years 189,081 $ 16.75
2003 120,143 9.10 years -- 22.44
Stock awards
Under the Company's Stock-Based Incentive Plan, the Company may grant stock
awards to its directors, officers and employees for up to 306,950 shares of
common stock. The Company applies APB Opinion No. 25 and related Interpretations
in accounting for stock awards. The stock awards vest at 20% per year. The fair
market value of the stock allocations, based on the market price at date of
grant, is recorded as unearned compensation. Unearned compensation is amortized
over the periods to be benefited. The Company recorded compensation cost related
to the stock awards of approximately $1,066,000, $1,165,000 and $1,000,000 in
2003, 2002 and 2001, respectively.
-96-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCK-BASED INCENTIVE PLAN AND EMPLOYEE STOCK OWNERSHIP PLAN (continued)
Stock awards (concluded)
A summary of the status of the Company's stock awards is presented below:
Years Ended December 31,
------------------------------
2003 2002 2001
-------- -------- --------
Balance at beginning of year 206,269 306,945 --
Granted 84,166 -- 306,945
Cancelled -- (100,676) --
-------- -------- --------
Balance at end of year 290,435 206,269 306,945
======== ======== ========
Fair value of stock awards granted during the year $ 22.38 $ -- $ 17.76
======== ======== ========
Employee Stock Ownership Plan
The Bank has established an Employee Stock Ownership Plan (the "ESOP") for the
benefit of each employee that has reached the age of 21 and has completed at
least 1,000 hours of service in the previous twelve-month period. As part of the
conversion, Berkshire Hills Funding Corporation provided a loan to the Berkshire
Bank Employee Stock Ownership Plan Trust which was used to purchase 8%, or
613,900 shares, of the Company's outstanding stock in the open market. The loan
bears interest equal to 9.5% and provides for quarterly payments of interest and
principal.
At December 31, 2003, the remaining principal balance is payable as follows:
Years Ending
December 31, (In thousands)
------------
2004 $ 294
2005 325
2006 356
2007 392
2008 429
Thereafter 4,458
-------
$ 6,254
=======
-97-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCK-BASED INCENTIVE PLAN AND EMPLOYEE STOCK OWNERSHIP PLAN (concluded)
Employee Stock Ownership Plan (concluded)
The Bank has committed to make contributions to the ESOP sufficient to support
the debt service of the loan. The loan is secured by the shares purchased, which
are held in a suspense account for allocation among the participants as the loan
is paid. Total compensation expense applicable to the ESOP amounted to
$1,094,000, $887,000 and $773,000 for the years ended December 31, 2003, 2002
and 2001, respectively.
Shares held by the ESOP include the following at December 31, 2003 and 2002:
2003 2002
---------- ----------
Allocated 114,188 83,954
Committed to be allocated 37,853 37,853
Unallocated 454,240 492,093
---------- ----------
606,281 613,900
========== ==========
Cash dividends received on allocated shares are allocated to participants and
cash dividends received on shares held in suspense are applied to repay the
outstanding debt of the ESOP. The fair value of these shares was approximately
$16,443,000 and $11,589,000 at December 31, 2003 and 2002, respectively.
17. RELATED PARTY TRANSACTIONS
- --------------------------------------------------------------------------------
In the ordinary course of business, the Company has granted loans to directors
and officers and their affiliates. All loans and commitments included in such
transactions were made on substantially the same terms, including interest rates
and collateral, as those prevailing at the time for comparable transactions with
other persons. All loans to directors and officers of the Company and their
affiliates are performing in accordance with the contractual terms of the loans
as of December 31, 2003.
An analysis of activity of such loans that aggregate more than $60,000 on an
individual basis to directors and executive officers of the Company and their
affiliates is as follows:
Years Ended December 31,
---------------------------
2003 2002
---------- ----------
(In thousands)
Balance at beginning of year $ 5,740 $ 6,089
Additions 1,127 658
Repayments (4,662) (1,007)
---------- ----------
Balance at end of year $ 2,205 $ 5,740
========== ==========
-98-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
18. RESTRICTIONS ON DIVIDENDS, LOANS AND ADVANCES
- --------------------------------------------------------------------------------
Federal and state banking regulations place certain restrictions on dividends
paid and loans or advances made by the Bank to the Company. The total amount of
dividends which may be paid at any date is generally limited to the retained
earnings of the Bank, and loans or advances are limited to 10% of the Bank's
capital stock and surplus on a secured basis.
At December 31, 2003 and 2002, the Bank's retained earnings available for the
payment of dividends was $67,827,000 and $61,544,000, respectively, and funds
available for loans or advances amounted to $10,656,000 and $10,426,000,
respectively.
In addition, dividends paid by the Bank to the Company would be prohibited if
the effect thereof would cause the Bank's capital to be reduced below applicable
minimum regulatory capital requirements.
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 will 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 be reduced in
an amount proportionate to the reduction in the qualifying deposit accounts.
-99-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
19. FAIR VALUE OF FINANCIAL INSTRUMENTS
- --------------------------------------------------------------------------------
The fair value of a financial instrument is the current amount that would be
exchanged between willing parties, other than in a forced liquidation. 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. In cases where quoted market prices are not available, 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 of future cash flows. Accordingly, the fair value
estimates may not be realized in an immediate settlement of the instrument. SFAS
107 excludes certain financial instruments and all nonfinancial instruments from
its disclosure requirements. Accordingly, the aggregate fair value amounts
presented may not necessarily represent the underlying fair value of the
Company.
The following methods and assumptions were used by the Company in estimating
fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts of these instruments approximate
fair values.
Securities: Fair values for securities, excluding FHLB and SBLI stock, are based
on quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable
instruments. The carrying value of FHLB stock approximates fair value based on
the redemption provisions of the Federal Home Loan Bank and SBLI stock was
recorded at fair value at acquisition as determined by an appraisal performed by
independent investment consultants retained by SBLI.
Loans: For variable-rate loans that reprice frequently and with no significant
change in credit risk, fair values are based on carrying values. Fair values for
all other loans are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to borrowers
of similar credit quality.
Deposits: The fair values for non-certificate accounts and tax escrow are, by
definition, equal to the amount payable on demand at the reporting date which is
their carrying amounts. Fair values for certificates of deposit are estimated
using a discounted cash flow calculation that applies interest rates currently
being offered on certificates to a schedule of aggregated expected monthly
maturities on time deposits.
Federal Home Loan Bank advances: The fair values of Federal Home Loan Bank
advances are estimated using discounted cash flow analyses based on the Bank's
current incremental borrowing rates for similar types of borrowing arrangements.
Securities sold under agreements to repurchase: The carrying amount of
repurchase agreements approximates fair value. Repurchase agreements generally
mature or "roll over" on a daily basis.
Accrued interest: The carrying amounts of accrued interest approximate fair
value.
-100-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FAIR VALUE OF FINANCIAL INSTRUMENTS (concluded)
Off-balance-sheet instruments: Fair values for off-balance-sheet lending
commitments are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
counterparties' credit standing. The fair values of off-balance sheet
instruments are immaterial.
The carrying amounts and estimated fair values of the Company's financial
instruments are as follows at December 31, 2003 and 2002:
2003 2002
---------------------- ----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
--------- --------- --------- ---------
(In thousands)
Financial assets:
Cash and cash equivalents $ 17,442 $ 17,442 $ 60,655 $ 60,655
Securities available for sale 307,425 307,425 173,169 173,169
Securities held to maturity 36,903 36,868 44,267 44,348
Federal Home Loan Bank stock 12,923 12,923 7,440 7,440
Loans, net 783,258 787,490 712,714 725,000
Accrued interest receivable 5,080 5,080 5,125 5,125
Savings Bank Life Insurance stock 2,043 2,043 2,043 2,043
Financial liabilities:
Deposits 830,244 796,623 782,360 759,325
Federal Home Loan Bank advances 251,465 263,218 133,002 146,258
Securities sold under agreement
to repurchase -- -- 700 700
-101-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
20. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
- --------------------------------------------------------------------------------
Condensed financial information pertaining only to the parent company, Berkshire
Hills Bancorp, Inc., is as follows:
CONDENSED BALANCE SHEETS
December 31,
--------------------
2003 2002
-------- --------
(In thousands)
Assets
Cash due from Berkshire Bank $ 6,305 $ 3,075
Securities available for sale, at fair value 31 31
Securities held to maturity -- 3,463
Investment in common stock of Berkshire Bank 105,128 101,996
Investment in common stock of Berkshire Hills
Funding Corporation 6,680 6,690
Investment in common stock of Berkshire
Hills Technology, Inc. 3,421 3,703
Other assets 1,640 1,629
-------- --------
Total assets $123,205 $120,587
======== ========
Liabilities and Stockholders' Equity
Accounts payable $ 30 $ 18
Stockholders' equity 123,175 120,569
-------- --------
Total liabilities and stockholders' equity $123,205 $120,587
======== ========
-102-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (continued)
CONDENSED STATEMENTS OF INCOME
Years Ended December 31,
-------------------------------------------
2003 2002 2001
----------- ----------- -----------
(In thousands)
Income:
Dividends from Berkshire Bank $ 8,000 $ 2,375 $ 13,850
Dividends from Berkshire Hills Funding Corporation 559 577 1,700
Interest on securities 17 273 779
Other 54 44 206
----------- ----------- -----------
Total income 8,630 3,269 16,535
----------- ----------- -----------
Operating expenses 361 405 459
----------- ----------- -----------
Income before income taxes and equity in
undistributed income (loss) of subsidiaries 8,269 2,864 16,076
Applicable income tax (benefit) provision (99) 80 138
----------- ----------- -----------
Income before equity in undistributed
income (loss) of subsidiaries 8,368 2,784 15,938
Equity in undistributed income (loss) of Berkshire Bank 889 612 (5,999)
Equity in undistributed loss of Berkshire Hills
Funding Corporation (10) (259) (1,071)
Equity in undistributed (loss) income of Berkshire Hills
Technology, Inc. (282) (1,040) 43
----------- ----------- -----------
Net income $ 8,965 $ 2,097 $ 8,911
=========== =========== ===========
-103-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (concluded)
CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31,
-------------------------------------------
2003 2002 2001
----------- ----------- -----------
(In thousands)
Cash flows from operating activities:
Net income $ 8,965 $ 2,097 $ 8,911
Adjustments to reconcile net income
to net cash provided by operating activities:
Equity in undistributed (income) loss of Berkshire Bank (889) (612) 5,999
Equity in undistributed loss of Berkshire Hills
Funding Corporation 10 259 1,071
Equity in undistributed income of
Berkshire Hills Technology, Inc. 282 1,040 (43)
Deferred tax benefit -- -- (310)
Net (accretion) amortization of securities -- (4) 5
Other, net (65) 499 591
----------- ----------- -----------
Net cash provided by operating activities 8,303 3,279 16,224
----------- ----------- -----------
Cash flows from investing activities:
Activity in available-for-sale securities:
Sales -- -- 5,666
Maturities -- -- 2,920
Principal payments -- 560 --
Purchases -- -- (4,623)
Activity in held-to-maturity securities:
Maturities 3,463 1,932 12,553
Principal payments -- 169 135
Purchases -- (32) (8,838)
Investment in Berkshire Hills Technology, Inc. -- -- (4,700)
----------- ----------- -----------
Net cash provided by investing activities 3,463 2,629 3,113
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of treasury stock 1,191 116 --
Payments to acquire treasury stock (7,099) (6,989) (23,292)
Dividends paid (2,628) (2,737) (2,808)
----------- ----------- -----------
Net cash used in investing activities (8,536) (9,610) (26,100)
----------- ----------- -----------
Net change in cash and cash equivalents 3,230 (3,702) (6,763)
Cash and cash equivalents at beginning of year 3,075 6,777 13,540
----------- ----------- -----------
Cash and cash equivalents at end of year $ 6,305 $ 3,075 $ 6,777
=========== =========== ===========
-104-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
21. SEGMENT REPORTING
- --------------------------------------------------------------------------------
The Company has one reportable segment, the Bank, and two operating segments,
the Bank and Berkshire Hills Technology, Inc. Each segment is described in Note
1 under business.
Information about reportable segments, and reconciliation of such information to
the consolidated financial statements as of and for the years ended December 31,
follows:
Berkshire Hills
Technology Consolidated
2003 Bank Inc. Totals
- ---- ----------- --------------- ------------
(In thousands)
Net interest income $ 37,566 $ -- $ 37,566
Depreciation and amortization 1,412 695 2,107
Provision for loan losses 1,460 -- 1,460
Licensing fees -- 7,262 7,262
Minority interest -- (186) (186)
Profit(loss) 9,247 (282) 8,965
Assets 1,210,890 7,658 1,218,548
Expenditures for additions
to premises and equipment 1,386 80 1,466
2002
- ----
Net interest income $ 40,700 $ -- $ 40,700
Depreciation and amortization 1,813 601 2,414
Provision for loan losses 6,180 -- 6,180
Licensing fees -- 6,991 6,991
Minority interest -- (685) (685)
Profit(loss) 3,137 (1,040) 2,097
Assets 1,037,376 8,571 1,045,947
Expenditures for additions
to premises and equipment 1,044 424 1,468
2001
- ----
Net interest income $ 42,236 $ -- $ 42,236
Depreciation and amortization 1,769 312 2,081
Provision for loan losses 7,175 -- 7,175
Licensing fees -- 3,465 3,465
Minority interest -- (119) (119)
Profit 8,868 43 8,911
Assets 1,021,623 9,078 1,030,701
Expenditures for additions
to premises and equipment 735 1,609 2,344
The accounting policies of the segments are the same as those described in the
summary of significant accounting policies. The Company evaluates performance
based on profit or loss from operations before income taxes not including
nonrecurring gains or losses.
The Company's operating segments are strategic business units that offer
different products and services. They are managed separately because each
segment appeals to different markets and, accordingly, requires different
technology and marketing strategies.
-105-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEGMENT REPORTING (concluded)
The Company derives a majority of its revenues from interest income and
licensing fees and the chief operating decision maker relies primarily on net
interest revenue and licensing fees to assess the performance of the segments
and make decisions about resources to be allocated to the segment. Therefore,
the segments are reported using net interest income and licensing fees for the
years ended December 31. The Company does not allocate income taxes to the
segments.
The Company does not have a single external customer from which it derives 10
percent or more of its revenues and operates in one geographical area.
22. QUARTERLY DATA (UNAUDITED)
- --------------------------------------------------------------------------------
Quarterly results of operations for the years ended December 31, 2003 and 2002
are as follows:
2003 2002
------------------------------------------- -------------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
--------- --------- --------- --------- --------- --------- --------- ---------
(In thousands, except per share data)
Interest and dividend income $ 14,410 $ 13,858 $ 14,139 $ 13,901 $ 14,549 $ 16,451 $ 16,568 $ 16,560
Interest expense 4,666 4,549 4,706 4,821 5,547 5,892 5,903 6,086
--------- --------- --------- --------- --------- --------- --------- ---------
Net interest income 9,744 9,309 9,433 9,080 9,002 10,559 10,665 10,474
Provision (credit) for loan losses (225) 575 785 325 2,305 1,050 1,315 1,510
Other income (1) 2,494 3,633 4,022 3,561 4,328 3,260 3,086 2,744
Operating expenses (2) 8,773 8,595 9,767 8,651 17,745 9,320 9,144 9,102
Provision (benefit) for
income taxes 1,099 1,358 765 1,843 (2,512) 1,123 1,070 849
--------- --------- --------- --------- --------- --------- --------- ---------
Net income (loss) $ 2,591 $ 2,414 $ 2,138 $ 1,822 $ (4,208) $ 2,326 $ 2,222 $ 1,757
========= ========= ========= ========= ========= ========= ========= =========
Earnings (loss) per share:
Basic $ 0.50 $ 0.46 $ 0.40 $ 0.34 $ (0.79) $ 0.43 $ 0.41 $ 0.32
Diluted 0.45 0.43 0.38 0.32 (0.79) 0.40 0.38 0.29
Note: (1) The decrease in the fourth quarter 2003 other income was due to the
loss on the sale of sub-prime automobile loans.
(2) The increase in the fourth quarter 2002 operating expenses was
primarily due to severance expenses, funding of the retirement plan
benefit for directors and the write-down in value of repossessed
automobiles.
-106-
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
- --------------------------------------------------------------------------------
None.
ITEM 9A. CONTROLS 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. In
addition, based on that evaluation, no change in the Company's internal control
over financial reporting occurred during the quarter ended December 31, 2003
that has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
- --------------------------------------------------------------------------------
For information concerning the directors of the Company, the information
contained under the sections captioned "Proposal 1 -- Election of Directors" in
Berkshire Hills' Proxy Statement for the 2004 Annual Meeting of Stockholders is
incorporated by reference. For information concerning officers of the Company,
reference is made to Part I, Item 1A, "Business--Executive Officers of the
Registrant" in this report. Reference is made to the cover page of this report
and to the section captioned "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 financial expert, reference is made to the section captioned
"Corporate Governance - Committees of the Board of Directors - Audit Committee"
in the Proxy Statement.
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. EXECUTIVE COMPENSATION
- --------------------------------------------------------------------------------
The information contained under the sections captioned "Executive
Compensation" and "Directors Compensation" in the Proxy Statement is
incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER 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.
(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.
(c) 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
-107-
The following table sets forth information, as of December 31, 2003,
about Company common stock that may be issued upon exercise of options under the
Berkshire Hills Bancorp, Inc. 2001 Stock-Based Incentive Plan and the Berkshire
Hills Bancorp, Inc. 2003 Equity Compensation Plan. Each of the plans was
approved by the Company's stockholders.
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 949,927 $17.80 300,000
Equity compensation plans
not approved by security holders -- -- --
Total 949,927 $17.80 300,000
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
- --------------------------------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Transactions with Management" in the Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
- --------------------------------------------------------------------------------
The information required by this item is incorporated herein by reference
to the section captioned "Proposal 2 - Ratification of Independent Auditors" in
the Proxy Statement.
-108-
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
- --------------------------------------------------------------------------------
(a) [1] Financial Statements
o Independent Auditors' Report
o Consolidated Balance Sheets as of December 31, 2003 and
2002
o Consolidated Statements of Income for the Years Ended
December 31, 2003, 2002 and 2001
o Consolidated Statements of Changes in Stockholders'
Equity for the Years Ended December 31, 2003, 2002 and
2001
o Consolidated Statements of Cash Flows for the Years
Ended December 31, 2003, 2002 and 2001
o Notes to Consolidated Financial Statements
[2] Financial Statement Schedules
All financial statement schedules are omitted because they are
not required or applicable. The required information is shown
in the consolidated financial statements or the notes thereto.
-109-
[3] Exhibits
3.1 Certificate of Incorporation of Berkshire Hills Bancorp,
Inc.(1)
3.2 Bylaws of Berkshire Hills Bancorp, Inc.
4.0 Draft Stock Certificate of Berkshire Hills Bancorp,
Inc.(1)
10.1 Employment Agreement between Berkshire Bank and Michael
P. Daly (2)
10.2 Employment Agreement between Berkshire Hills Bancorp,
Inc. and Michael P. Daly (2)
10.3 Severance Agreement, dated October 16, 2002, by and
among James A. Cunningham, Jr., Berkshire Hills Bancorp,
Inc. and Berkshire Bank (3)
10.4 Severance Agreement, dated November 13, 2002, by and
among Charles F. Plungis, Jr., Berkshire Hills Bancorp,
Inc. and Berkshire Bank (4)
10.5 Severance Agreement, dated November 13, 2002, by and
among Susan M. Santora, Berkshire Hills Bancorp, Inc.
and Berkshire Bank (4)
10.6 Change in Control Agreement between Berkshire Bank and
Gayle P. Fawcett
10.7 Change in Control Agreement between Berkshire Hills
Bancorp, Inc. and Gayle P. Fawcett
10.8 Change in Control Agreement between Berkshire Bank and
Wayne F. Patenaude
10.9 Change in Control Agreement between Berkshire Hills
Bancorp, Inc. and Wayne F. Patenaude
10.10 Supplemental Executive Retirement Agreement between
Berkshire Bank and Michael P. Daly
10.11 Berkshire Hills Bancorp, Inc. 2003 Equity Compensation
Plan(5)
10.12 Letter Agreement, dated June 26, 2003, by and among
Berkshire Hills Bancorp, Inc., Berkshire Bank and Robert
A. Wells(2)
10.13 Form of Berkshire Bank Employee Severance Compensation
Plan(1)
10.14 Form of Berkshire Bank Supplemental Executive Retirement
Plan(1)
10.15 Berkshire Hills Bancorp, Inc. 2001 Stock-Based Incentive
Plan(6)
10.16 Retirement Agreement, dated December 4, 2003, by and
among Berkshire Hills Bancorp, Inc., Berkshire Bank and
Robert A. Wells
11.0 Statement re: Computation of Per Share Earnings
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
-110-
- -----------------------------------------------
(1) Incorporated herein by reference into this document from the
Exhibits to Form S-1, Registration Statement and amendments
thereto, initially filed on March 10, 2000, Registration No.
333-32146.
(2) Incorporated herein by reference into this document from the
Exhibits to the Form 10-Q as filed on August 13, 2003.
(3) Incorporated herein by reference into this document from the
Exhibits to the Form 10-K as filed on March 29, 2001.
(4) Incorporated herein by reference into this document from the
Exhibits to the Form 10-Q as filed on November 14, 2003.
(5) Incorporated herein by reference into this document from the
Appendix to the Proxy Statement as filed on March 27, 2003.
(6) Incorporated herein by reference into this document from the
Appendix to the Proxy Statement as filed on December 7, 2000.
(b) Reports on Form 8-K
On October 15, 2003, the Company filed a Form 8-K in which it
announced under Item 5 that it expected to issue its third quarter
earnings release on October 22, 2003. The Company announced that it
would conduct a conference call at 10:00 a.m. on October 23, 2003 to
discuss third quarter results. Instructions on how to access the
call and an investor presentation that supplemented the call were
contained in the press release. The press release announcing this
conference call was attached by exhibit.
On October 23, 2003, the Company furnished a Form 8-K in which
it announced under Item 12 its financial results for the quarter
ended September 30, 2003. The press release announcing financial
results for the quarter ended September 30, 2003 was attached by
exhibit.
-111-
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.
Date: February 26, 2004 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 President, Chief Executive Officer February 26, 2004
- -------------------------------- and Director
Michael P. Daly (principal executive officer)
/s/ Wayne F. Patenaude Senior Vice President, Treasurer February 26, 2004
- -------------------------------- and Chief Financial Officer
Wayne F. Patenaude (principal accounting
and financial officer)
/s/ Lawrence A. Bossidy Non-Executive Chairman February 26, 2004
- --------------------------------
Lawrence A. Bossidy
/s/ Thomas O. Andrews Director February 26, 2004
- --------------------------------
Thomas O. Andrews
/s/ Thomas R. Dawson, CPA Director February 26, 2004
- --------------------------------
Thomas R. Dawson, CPA
/s/ A. Allen Gray Director February 26, 2004
- --------------------------------
A. Allen Gray
/s/ Peter J. Lafayette Director February 26, 2004
- --------------------------------
Peter J. Lafayette
/s/ Edward G. McCormick, Esq. Director February 26, 2004
- --------------------------------
Edward G. McCormick, Esq.
/s/ Catherine B. Miller Director February 26, 2004
- --------------------------------
Catherine B. Miller
/s/ Corydon L. Thurston Director February 26, 2004
- --------------------------------
Corydon L. Thurston
-112-
/s/ Ann H. Trabulsi Director February 26, 2004
- --------------------------------
Ann H. Trabulsi
/s/ Robert A. Wells Director February 26, 2004
- --------------------------------
Robert A. Wells
-113-