Back to GetFilings.com
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, 2004
|_| 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 $205 million, based upon the closing price of $37.10 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
March 14, 2005, was 5,813,053.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2005 Annual Meeting of
Stockholders are incorporated by reference in Part III of this Form 10-K.
-1-
INDEX
- --------------------------------------------------------------------------------
PART I .................................................................................. 3
ITEM 1. BUSINESS ..................................................................... 3
ITEM 2. PROPERTIES ................................................................... 35
ITEM 3. LEGAL PROCEEDINGS ............................................................ 36
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS .......................... 36
PART II ................................................................................. 36
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES ........................................ 36
ITEM 6. SELECTED FINANCIAL DATA ...................................................... 37
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATION .................................................................... 39
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK .................. 49
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA .................................. 51
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE ................................................................... 96
ITEM 9A. CONTROLS AND PROCEDURES ..................................................... 96
ITEM 9B. OTHER INFORMATION ........................................................... 96
PART III ................................................................................ 97
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT .......................... 97
ITEM 11. EXECUTIVE COMPENSATION ...................................................... 97
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS ......................................................... 98
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS .............................. 98
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES ...................................... 98
PART IV ................................................................................. 99
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES .................................. 99
SIGNATURES ........................................................................... 101
-2-
PART I
ITEM 1. BUSINESS
- --------------------------------------------------------------------------------
Forward-Looking Statements
- --------------------------
This report contains forward-looking statements that are based on
assumptions and may describe future plans, strategies and expectations of
Berkshire Hills Bancorp, Inc. (the "Company" or "Berkshire Hills") and Berkshire
Bank (the "Bank"). These forward-looking statements are generally identified by
use of the words "believe," "expect," "intend," "anticipate," "estimate,"
"project" or similar expressions. Berkshire Hills' and Berkshire Bank'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 Berkshire Hills and its subsidiaries include, but are not limited
to, changes in interest rates, national and regional economic conditions,
legislative and 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 and composition of the loan or investment portfolios, demand
for loan products, deposit flows, competition, demand for financial services in
Berkshire Hills' and Berkshire Bank's market area, changes in real estate market
values in Berkshire Hills' and Berkshire Bank's market area, and changes in
relevant 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. Except as required by applicable law or
regulation, Berkshire Hills does not undertake, and specifically disclaims any
obligation, to release publicly the result of any revisions which may be made to
any forward-looking statements to reflect events or circumstances after the date
of the statements or to reflect the occurrence of anticipated or unanticipated
events.
Forward-looking statements also include, with limitation, those statements
relating to the anticipated effects of the Company's proposed merger with
Woronoco Bancorp, Inc. The following factors, among others, could cause the
actual results of the merger to differ materially from expectations: the ability
of the companies to obtain the required stockholder or regulatory approvals of
the merger; the imposition of any regulatory conditions or requirements on the
merger; the ability of the companies to consummate the merger; Berkshire Hills'
ability to successfully integrate Woronoco Bancorp following the merger,
including integration of the data processing system and retention of key
personnel; a materially adverse change in the financial condition, operations,
or projected or actual earnings of either company; the ability to fully realize
the expected cost savings and anticipated revenues; the ability to realize the
expected cost savings and anticipated revenues on a timely basis; and any
material change in the local markets in which each company operates.
General
- -------
Berkshire Hills Bancorp, Inc., a Delaware corporation, was organized in
January 2000 to become the holding company for Berkshire 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 Massachusetts Depositors Insurance Fund (the "DIF"), the
Bank's excess deposit insurer. Berkshire Bank has been a member of the Federal
Home Loan Bank system since 1973.
Founded in 1846, Berkshire Bank is one of Massachusetts' oldest and
largest independent banks and the largest banking institution based in western
Massachusetts. Berkshire Bank is a community bank that accepts retail deposits
from the general public in the areas surrounding its 12 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 adjustable rate loans that it
originates for investment, but occasionally sells or securitizes some of its
loans, including ongoing sales of most newly originated 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, municipal notes and bonds, 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. The Bank also provides
various services, which generate non-interest income. 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.
-3-
Merger Agreement
- ----------------
On December 16, 2004, Berkshire Hills and Woronoco Bancorp, Inc., a
Delaware corporation ("Woronoco"), entered into a definitive merger agreement
(the "Agreement"), pursuant to which Woronoco will merge with and into Berkshire
Hills, with Berkshire Hills being the surviving entity (the "Merger"). Under the
terms of the Agreement, the stockholders of Woronoco will have the right to
elect to receive either $36.00 in cash or one share of Berkshire Hills common
stock in exchange for each Woronoco share held by them, subject to procedures
such that 75% of the outstanding Woronoco common shares are converted into
Berkshire Hills common stock and the balance is converted into cash. Immediately
following the Merger, Woronoco Savings Bank, the wholly-owned subsidiary of
Woronoco, will merge with and into Berkshire Bank, with Berkshire Bank being the
surviving entity.
The completion of the Merger is subject to approval by the stockholders of
both companies and customary regulatory approvals. The Merger is expected to
close in the second quarter of 2005.
The above description of the Agreement does not purport to be a complete
statement of the parties' rights and obligations under the Agreement and the
transactions contemplated thereby. The above description is qualified in its
entirety by reference to the Agreement, a copy of which is attached as Exhibit
99.1 to the current report on Form 8-K filed on December 17, 2004, which is
incorporated herein by reference. A preliminary Registration Statement on Form
S-4 was filed with the Securities and Exchange Commission on February 3, 2005
for the issuance of additional shares of common stock in conjunction with the
Agreement.
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 pursuant to Section 13(a) or 15(d) of the
Securities Exchange Act of 1934 as soon as reasonably practicable after the
Company electronically files such material with the Securities and Exchange
Commission.
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. Additionally, the Bank has expanded its market area
into Eastern New York through the opening of a full-service branch and a
representative office in 2004. The Bank has also announced plans to open
additional full-service offices in eastern New York. Berkshire Bank also makes
loans primarily throughout western Massachusetts, northern Connecticut and
southern Vermont.
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, 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, 2004, according
to information presented on the Federal Deposit Insurance Corporation's website,
the Bank held approximately 33% of the deposits in Berkshire County. This was
the largest share of deposits out of 13 banks in the county, and was about twice
as large as the share of the next highest bank in the county. The Bank generally
competes on the basis of customer service and relationship management, the
pricing of loan and deposit products and wealth management services. 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, which have substantially greater resources and
lending limits. Additionally, Berkshire Bank faces competition for deposits from
several other 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 their funds. 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).
-4-
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,
----------------------------------------------------------------------------------------------------
2004 2003 2002 2001 2000
------------------ ------------------- ------------------ ------------------ ------------------
Percent Percent Percent Percent Percent
of of of of of
Amount Total Amount Total Amount Total Amount Total Amount Total
------------------ ------------------- ------------------ ------------------ ------------------
(Dollars in thousands)
Real estate loans:
One- to four-family $ 232,498 28% $ 266,753 34% $ 246,938 34% $ 240,852 30% $ 249,440 31%
Commercial 207,619 25 154,244 20 119,198 17 84,741 10 63,871 8
Multi-family 16,380 2 15,514 2 14,920 2 13,183 2 15,699 2
Construction and land
development 38,702 5 34,719 4 17,627 2 22,936 3 14,290 2
--------- --- --------- --- --------- --- --------- --- --------- ---
Total real estate loans 495,199 60 471,230 60 398,683 55 361,712 45 343,300 43
--------- --- --------- --- --------- --- --------- --- --------- ---
Consumer loans:
Home equity lines of credit 54,157 6 45,783 5 40,713 6 34,439 4 34,471 4
Automobile 122,830 15 103,674 13 113,321 15 228,412 29 241,862 31
Other 4,292 1 4,506 1 5,017 1 7,792 1 6,800 1
--------- --- --------- --- --------- --- --------- --- --------- ---
Total consumer loans 181,279 22 153,963 19 159,051 22 270,643 34 283,133 36
--------- --- --------- --- --------- --- --------- --- --------- ---
Commercial loans 150,932 18 166,451 21 165,447 23 170,230 21 166,956 21
--------- --- --------- --- --------- --- --------- --- --------- ---
Subtotal 827,410 791,644 723,181 802,585 793,389
Net deferred loan origination
costs 574 110 41 172 232
Unamortized premium/(discount)
on purchased loans 195 473 (200) (203) --
--------- --- --------- --- --------- --- --------- --- --------- ---
Total loans 828,179 100% 792,227 100% 723,022 100% 802,554 100% 793,621 100%
=== === === === ===
Allowance for loan losses (9,337) (8,969) (10,308) (11,034) (10,216)
--------- --------- --------- --------- ---------
Net loans $ 818,842 $ 783,258 $ 712,714 $ 791,520 $ 783,405
========= ========= ========= ========= =========
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, 2004, $232
million, or 28%, 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, 35% were fixed-rate mortgage loans and 65% 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 $359,650.
Berkshire Bank generally originates loans for its own portfolio, but also 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. The Company currently sells most of its
fixed-rate residential mortgage originations on a flow basis to secondary market
investors at the time of origination. Berkshire Bank generally underwrites,
processes and closes its residential mortgages following conforming secondary
market guidelines.
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
-5-
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. At December 31, 2004, the
largest residential mortgage loan totaled $2.6 million. This loan was performing
according to its terms at December 31, 2004.
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, 2004,
construction and land development loans totaled $39 million, or 5% of Berkshire
Bank's total loan portfolio, of which $18 million was residential construction
loans, $13 million was commercial construction loans and $8 million was
commercial land development loans. At December 31, 2004, the unadvanced portion
of construction and land development loans totaled $28 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 fifteen 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, 2004, the largest outstanding
residential construction and land development loan commitment was for $2.7
million, $200,000 of which was outstanding at such date. This loan was
performing according to its terms at December 31, 2004. 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 and commercial
properties, single-family subdivisions and condominiums. A feasibility study is
particularly important with respect to multi-family housing projects,
hotel/motel construction and health care facilities. 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%. 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. At
December 31, 2004, the largest commercial construction and land development
commitment was $5 million, of which $4 million was outstanding, to a local real
estate developer developing a 96-unit single family and condominium style mixed
income housing development in Berkshire County. This loan was performing
according to its terms at December 31, 2004.
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
-6-
to value ratios of 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. As a result of the foregoing, construction lending often
involves the disbursement of substantial funds with repayment dependent, in
part, on the success of the ultimate project rather than the ability of the
borrower or guarantor to repay principal and interest. If Berkshire Bank is
forced to foreclose on a project before or at completion due to default, there
can be no assurance that it will be able to recover all of the unpaid balance
of, and accrued interest on, the loan and related foreclosure and holding costs.
Multi-Family and Commercial Real Estate Loans. At December 31, 2004,
multi-family and commercial real estate loans totaled $224 million, or 27% of
total 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.
Berkshire Bank's multi-family and commercial real estate loans may generally 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. Credit enhancements in the form of additional collateral or
guarantees are normally considered for start-up businesses without a qualifying
cash flow history. 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.
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
at December 31, 2004 consisted of four loans to related recreational vehicle
camps located throughout New England and New York State totaling $10 million.
This borrower is a national operator of recreational vehicle campgrounds. All
loans to this borrower were performing according to their terms at December 31,
2004.
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, 2004, automobile loans totaled $123
million, or 15% of Berkshire Bank's total loans and 68% 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 interest rates offered
by competitors.
Berkshire Bank began offering indirect automobile loans through automobile
dealers over fifteen 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 reduce the overall size of the automobile loan
portfolio. This process was accelerated through the sale of $70 million of
sub-prime automobile loans in 2002 and the sale of an additional $10 million of
sub-prime automobile loans in 2003. At December 31, 2004, $400,000 of lower
quality or sub-prime automobile loans remained. In 2004, Berkshire Bank achieved
19% growth in its automobile loan portfolio, while adhering to its improved
standards. At December 31, 2004, the average FICO score of existing consumer
loans (at origination) was 705.
-7-
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, 2004, outstanding loans under home equity lines of
credit totaled $54 million, or 6% of Berkshire Bank's total loans and 30% of
consumer loans. Additionally, at December 31, 2004, the unadvanced amounts of
home equity lines of credit totaled $57 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
generally will not be made if the borrower's first mortgage payment, monthly
real estate payment and amortized equity line payment exceed 28% 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 monthly 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, 2004 amounted to $4 million, or 1% of
Berkshire Bank's total loans and 2% 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, 2004, Berkshire Bank had $151 million in
commercial loans which amounted to 18% of total loans. In addition, at such
date, Berkshire Bank had $44 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 $6 million credit exposure, $5
million of which was outstanding at December 31, 2004, to a long-time Berkshire
County customer secured by various types of business assets consisting primarily
of construction equipment. This loan was performing according to its terms at
December 31, 2004.
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. Policies regarding
debt-service coverage ability and guarantees are similar to those which govern
commercial real estate lending. Commercial business loans are generally secured
by a variety of collateral such as accounts receivable, inventory and equipment,
and are generally supported by personal guarantees. Depending on the collateral
used to secure the loans, commercial loans are generally made in amounts of up
to 95% of the liquidation value of the collateral securing the loan. Berkshire
Bank generally does not make unsecured commercial loans; the largest unsecured
commercial loan at December 31, 2004 had a balance of $550,000. This loan was
performing according to its terms at December 31, 2004.
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 are made primarily
on the basis of the borrower's ability to make repayment
-8-
from the cash flows 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.
Commercial loans at December 31, 2004, including commercial real estate
and construction loans and excluding loans guaranteed by the U.S. Small Business
Administration, broken down by industry, were as follows: non-residential
building operators - $58 million; lodging - $46 million; apartment buildings -
$34 million; subdividers/developers - $21 million; automobile dealers - $21
million; and recreational vehicle parks - $16 million.
Loans to One Borrower. The maximum amount that Berkshire Bank may lend to
one borrower is limited by statute. At December 31, 2004, Berkshire Bank's
statutory limit on loans to one borrower was $24 million. At that date,
Berkshire Bank's largest amount of loans to one borrower, including the
borrower's related interests, was approximately $10 million and consisted of
five loans secured by various types of business and real estate assets. These
loans were performing according to their terms at December 31, 2004.
Maturity of Loan Portfolio. The following table shows the remaining
contractual maturity of Berkshire Bank's total loans at December 31, 2004,
excluding the effect of future principal prepayments, and contractual repricing.
At December 31, 2004
-------------------------------------------------------------------------------------------------
Home
One- to Construction Commercial Equity
Four- and Land and Lines of Other
Family Development Multi-Family Credit Automobile Consumer Commercial Total
-------- ----------- ------------ -------- ---------- -------- ---------- --------
(In thousands)
Amounts due in:
One year or less $ 4,408 $23,357 $ 2,859 $ 1,724 $ 2,514 $ 862 $ 50,585 $ 86,309
More than one year
to five years 9,302 15,345 22,007 13,981 91,928 1,781 28,372 182,716
More than five years 218,788 -- 199,133 38,452 28,388 1,649 71,975 558,385
-------- ------- -------- ------- -------- ------ -------- --------
Total amount due $232,498 $38,702 $223,999 $54,157 $122,830 $4,292 $150,932 $827,410
======== ======= ======== ======= ======== ====== ======== ========
-9-
The following table sets forth at December 31, 2004, the dollar amount of
loans contractually due after December 31, 2005 and whether such loans have
fixed interest rates or adjustable interest rates.
Due After December 31, 2005
----------------------------------
Fixed Adjustable Total
-------- ---------- --------
(In thousands)
Real estate loans:
One- to four-family $ 80,104 $147,986 $228,090
Construction and land
development -- 15,345 15,345
Commercial and
multi-family 12,713 208,427 221,140
-------- -------- --------
Total real estate loans 92,817 371,758 464,575
Home equity lines of credit -- 52,433 52,433
Automobile 120,316 -- 120,316
Other consumer 2,128 1,302 3,430
Commercial loans 10,561 89,786 100,347
-------- -------- --------
Total $225,822 $515,279 $741,101
======== ======== ========
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 six 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 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 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 on the Bank's forms and are immediately assigned to
Berkshire Bank, which then services the loans. On loans originated by its
automobile dealers, Berkshire Bank compensates the originator for the interest
rate paid on the loan that 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 2004 and 2003, Berkshire Bank
originated or purchased $78 million and $60 million of automobile loans,
respectively, of which 95% and 91%, respectively, were originated indirectly
through the automobile dealers.
-10-
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's only purchase in 2004 was a $147,000 participation interest in
a commercial loan. Amounts outstanding related to loan participation interests
purchased by Berkshire Bank totaled $32 million and $51 million at December 31,
2004 and December 31, 2003, respectively, and consisted primarily of loans
secured by real estate.
At December 31, 2004, Berkshire Bank was servicing $2 million of
automobile loans, $13 million of commercial business and commercial real estate
loan participations sold to others and $48 million of residential one- to
four-family mortgage loans. The residential mortgage servicing portfolio
included the $46 million year-end balance of mortgages securitized to Fannie Mae
in 2003 and 2004; the Bank utilizes the services of a subcontract servicing
provider for these loans. Loan servicing includes collecting and remitting loan
payments, accounting for principal and interest, contacting delinquent
borrowers, supervising foreclosures and property dispositions when there are
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. Commercial loan participation service fees are negotiated on
each transaction.
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 securitized $39 million in fixed-rate
residential one- to four-family mortgages in 2004 and the Bank sold $11 million
of securitized mortgages in the fourth quarter of 2004.
-11-
The following table presents total loans originated, purchased, sold and
repaid during the years indicated. Loan originations included new committed
lines of credit, where applicable. Loans exclude net deferred loan origination
costs and unamortized premium/discount on purchased loans.
For the Years Ended December 31,
-----------------------------------
2004 2003 2002
-------- -------- ---------
(In thousands)
Loans at beginning of year $791,644 $723,181 $ 802,985
-------- -------- ---------
Originations:
Real estate loans:
One-to four-family 66,606 113,606 88,770
Construction and land development 42,560 32,246 30,678
Commercial 67,497 48,644 37,564
Multi-family 3,046 2,862 5,242
-------- -------- ---------
Total real estate loans 179,709 197,358 162,254
-------- -------- ---------
Consumer loans:
Home equity lines of credit 24,940 15,380 16,361
Automobile 77,670 60,174 54,284
Other 2,593 3,466 4,613
-------- -------- ---------
Total consumer loans 105,203 79,020 75,258
Commercial loans:
Commercial loans and lines of credit 40,975 44,727 48,343
-------- -------- ---------
Total loans originated 325,887 321,105 285,855
-------- -------- ---------
Purchases:
Real estate loans:
Residential -- 53,814 --
Commercial real estate -- 3,041 2,724
-------- -------- ---------
Total real estate loans -- 56,855 2,724
Consumer loans:
Other -- -- --
Commercial loans:
Commercial 147 500 --
-------- -------- ---------
Total loans purchased 147 57,355 2,724
-------- -------- ---------
Deduct:
Principal loan repayments, prepayments, revolving
credit activity and other, net 223,806 225,528 285,852
Loan sales 25,608 65,400 73,625
Securitization of loans 39,657 16,270 --
Net loan charge-offs 1,197 2,799 6,906
Transfers to real estate owned -- -- 2,000
-------- -------- ---------
Total deductions 290,268 309,997 368,383
-------- -------- ---------
Net increase (decrease) in loans 35,766 68,463 (79,804)
-------- -------- ---------
Loans at end of year $827,410 $791,644 $ 723,181
======== ======== =========
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, 2004,
Berkshire Bank had loan commitments and unadvanced loans and lines of credit
totaling $169 million, of which $36 million was commitments to originate new
loans.
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.
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
-12-
recognized over the contractual remaining lives of the related loans on a level
yield basis. At December 31, 2004, Berkshire Bank had approximately $574,000 of
net deferred loan fees and costs. Berkshire Bank amortized approximately $77,000
of net deferred loan fees and costs during the year ended December 31, 2004.
Loan Administration. Lending activities are governed by a Board approved
loan policy. The loan policy sets certain limits on concentrations of credit and
requires periodic reporting of concentrations to the Board. The Bank has
designated internal staff who perform post-closing loan documentation review,
quality control and ongoing loan review. The Bank's policy is to assign a risk
rating to all commercial loans and loan review staff perform an ongoing program
of loan and risk rating reviews. Management also employs an independent third
party for loan reviews, as discussed in "Allowance for Loan Losses."
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. 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.
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,
--------------------------------------------------
2004 2003 2002 2001 2000
------ ------ ------ ------ ------
(Dollars in thousands)
Nonaccruing loans:
One- to four-family real estate $ 327 $ 348 $ 230 $ 310 $ 390
Commercial real estate 147 496 -- -- --
Commercial 523 1,887 2,850 2,077 466
Consumer 155 468 661 315 2,013
------ ------ ------ ------ ------
Total nonperforming loans 1,152 3,199 3,741 2,702 2,869
Real estate owned -- -- 1,500 -- 50
------ ------ ------ ------ ------
Total nonperforming assets $1,152 $3,199 $5,241 $2,702 $2,919
====== ====== ====== ====== ======
Total nonperforming loans as a
percentage of total loans 0.14% 0.40% 0.52% 0.34% 0.36%
Total nonperforming assets as a
percentage of total assets 0.09% 0.26% 0.36% 0.26% 0.29%
Loans 90 days or more past due
and still accruing (1) $ 65 $ 306 $ 590 $1,306 $ --
- ----------
(1) Reflects the 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. Prior to 2001,
automobile loans past due 90 days or more were reported as nonaccrual.
Nonaccruing commercial loans and commercial real estate loans decreased to
$670,000 at December 31, 2004 from $2.4 million at December 31, 2003 primarily
as the result of the sale of the largest non-performing commercial loan
relationship totaling $1.3 million, payments collected on accounts remaining on
nonaccruing status and $356,000 in gross commercial loan charge-offs.
Nonaccruing consumer loans and past accruing loans delinquent over 90 days,
decreased due to the sale of the sub-prime automobile loan portfolio near the
end of 2003. Interest income that would have been recorded for the year ended
December 31, 2004, had nonaccruing loans been current according to their
original terms, amounted to $173,000. The amount of interest income on those
loans that was included in net income in 2004 was $8,000.
-13-
The following table sets forth the delinquencies in Berkshire Bank's loan
portfolio as of the dates indicated.
At December 31, 2004 At December 31, 2003
-------------------------------------- --------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
------------------ ------------------ ------------------ ------------------
Number Principal Number Principal Number Principal Number Principal
of Balance of Balance of Balance of Balance
Loans of Loans Loans of Loans Loans of Loans Loans of Loans
------ --------- ------ --------- ------ --------- ------ ---------
(Dollars in thousands)
Real estate loans:
One- to four-
family 4 $ 277 2 $ 258 3 $ 236 3 $ 220
Commercial 2 304 -- -- -- -- -- --
Multi-family -- -- -- -- -- -- -- --
Consumer loans:
Home equity lines
of credit -- -- -- -- -- -- -- --
Auto and other 30 101 35 135 80 460 85 612
Commercial loans 3 45 -- -- 1 36 6 215
------ ------ ------ ------ ------ ------ ------ ------
Total 39 $ 727 37 $ 393 84 $ 732 94 $1,047
====== ====== ====== ====== ====== ====== ====== ======
Delinquent loans to
total loans 0.19% 0.09% 0.18% 0.05% 0.42% 0.09% 0.47% 0.13%
At December 31, 2002
-------------------------------------
60-89 Days 90 Days or More
------------------ -----------------
Number Principal Number Principal
of Balance of Balance
Loans of Loans Loans of Loans
------ --------- ------ ---------
(Dollars in thousands)
Real estate loans:
One- to four-
family 3 $ 207 4 $ 92
Commercial -- -- -- --
Multi-family -- -- -- --
Consumer loans:
Home equity lines
of credit -- -- -- --
Auto and other 120 924 118 893
Commercial loans 2 49 4 110
------ ------ ------ ------
Total 125 $1,180 126 $1,095
====== ====== ====== ======
Delinquent loans to
total loans 0.57% 0.16% 0.57% 0.15%
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, 2004, Berkshire
Bank had no foreclosed real estate.
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 normally fully
charged-off. "Substandard" assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Nonaccruing loans are
normally classified as substandard. "Doubtful" assets have the weaknesses of
substandard assets with the additional characteristic that the weaknesses make
collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable, and there is a high possibility of loss.
Assets that do not currently expose the insured institution to sufficient risk
to warrant classification in one of the aforementioned categories but possess
weaknesses are designated "special mention."
-14-
At December 31, 2004, Berkshire Bank had no loss rated loans and two
doubtful rated commercial loans totaling $391,000. The following table sets
forth Berkshire Bank's substandard and special mention loans at December 31,
2004.
Substandard Special Mention
-------------------- --------------------
Number Number
of Principal of Principal
Loans Balance Loans Balance
------- --------- ------- ---------
(Dollars in thousands)
Real estate loans:
One- to four-family 6 $ 484 5 $ 276
Commercial 6 4,216 5 8,436
Multi-family 2 659 -- --
Construction and land
development -- -- 1 938
Consumer loans:
Automobile 51 215 19 81
All other 5 6 5 6
Commercial loans 41 5,594 53 8,310
------- ------- ------- -------
Total 111 $11,174 88 $18,047
======= ======= ======= =======
Berkshire Bank had no substandard loans greater than $500,000, which were
not performing according to their terms on December 31, 2004. At December 31,
2004, the largest three substandard commercial relationships totaled $5.4
million. These relationships were rated substandard during 2004. At December 31,
2004, they were performing in accordance with their terms and not deemed
impaired by management.
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 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 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 based
on management's judgment, including consideration 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 loss
factors may be adjusted for significant factors that, in management's judgment,
affect the collectibility of the portfolio as of the evaluation date.
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." Generally, nonaccruing commercial loans are deemed impaired
and evaluated for specific valuation allowances. At December 31, 2004 and
December 31, 2003, Berkshire Bank had $787,000 and $388,000, respectively,
recorded investment in impaired loans, which had no specific allowances and
$393,000 and $2.0 million in loans with specific valuation allowances of
$230,000 and $267,000, respectively. 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.
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
-15-
management's objective that the overall allowance appropriately reflects a
margin for the imprecision necessarily inherent in estimates of expected credit
losses.
Although management believes that it uses the best information available
to establish the allowance for loan losses, future adjustments to the allowance
for loan losses may be necessary and results of operations could be adversely
affected if circumstances differ substantially from the assumptions used in
making its determinations. Furthermore, while Berkshire Bank believes it has
established the 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 loan 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,
-----------------------------------------------------------
2004 2003 2002 2001 2000
------- ------- ------- ------- -------
(Dollars in thousands)
Allowance for loan losses,
beginning of year $ 8,969 $10,308 $11,034 $10,216 $ 8,534
------- ------- ------- ------- -------
Charged-off loans:
One- to four-family real estate -- -- -- 2 --
Multi-family -- -- -- 222 --
Commercial real estate 138 -- 510 -- 19
Consumer 1,846 4,175 9,074 5,989 1,422
Home equity lines of credit -- 32 -- 52 --
Commercial 218 157 444 797 469
------- ------- ------- ------- -------
Total charged-off loans 2,202 4,364 10,028 7,062 1,910
Recoveries on loans previously
charged-off 1,005 1,565 3,122 705 422
------- ------- ------- ------- -------
Net loans charged-off 1,197 2,799 6,906 6,357 1,488
Provision for loan losses 1,565 1,460 6,180 7,175 3,170
------- ------- ------- ------- -------
Allowance for loan losses,
end of year $ 9,337 $ 8,969 $10,308 $11,034 $10,216
======= ======= ======= ======= =======
Ratios:
Net loans charged-off to average
total loans 0.15% 0.35% 0.87% 0.78% 0.20%
Allowance for loan losses to
total loans 1.13 1.13 1.43 1.37 1.29
Allowance for loan losses to
nonperforming loans 810.50 280.37 275.54 408.36 356.08
Net loans charged-off to allowance
for loan losses 12.82 31.21 67.00 57.61 14.57
Recoveries to charged-off loans 45.64 35.86 31.13 9.98 22.09
-16-
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,
-----------------------------------------------------------------------------------------------------------
2004 2003 2002
---------------------------------- ---------------------------------- ---------------------------------
Percent of Percent of Percent of
Allowance Percent of Allowance Percent of Allowance Percent of
in Each Loans in Each Loans in Each Loans
Category in Each Category in Each Category in Each
to Total Category to to Total Category to to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans Amount Allowance Total Loans
------- ---------- ----------- ------- ---------- ----------- ------- --------- -----------
(Dollars in thousands)
Real estate loans $ 4,263 46% 60% $ 3,436 38% 60% $ 2,289 22% 55%
Consumer loans 1,730 18 22 2,171 24 19 4,650 45 22
Commercial loans 3,344 36 18 3,362 38 21 3,369 33 23
------- ------- ------- ------- ------- ------- ------- ------- -------
Total allowance
for loan losses $ 9,337 100% 100% $ 8,969 100% 100% $10,308 100% 100%
======= ======= ======= ======= ======= ======= ======= ======= =======
At December 31,
-----------------------------------------------------------------------
2001 2000
---------------------------------- ----------------------------------
Percent of Percent of
Allowance Percent of Allowance Percent of
in Each Loans in Each Loans
Category in Each Category in Each
to Total Category to to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans
------- ---------- ----------- ------- ---------- -----------
(Dollars in thousands)
Real estate loans $ 2,347 21% 45% $ 2,337 23% 43%
Consumer loans 4,217 38 34 4,528 44 36
Commercial loans 4,470 41 21 3,351 33 21
------- ------- ------- ------- ------- -------
Total allowance
for loan losses $11,034 100% 100% $10,216 100% 100%
======= ======= ======= ======= ======= =======
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 security 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 average maturity or repricing and the types
of securities are based upon the composition and quality of the loan portfolio,
interest rate risk 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
-17-
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; actual maturities may differ from expectations due
to interest rate fluctuations. Real estate mortgage investment conduits, a type
of 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, 100% 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. When purchasing
mortgage-backed securities in the past two years, the Bank has focused on buying
adjustable rate mortgage-backed securities that have limited extension risk,
such as five- and seven-year hybrid and 10-year fixed rate mortgage-backed
securities. These securities typically have an average duration of 3-5 years.
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. The marketable equity
securities portfolio consists primarily of bank, utility and industrial stocks.
However, Berkshire Bank has restructured its investment portfolio by placing
less emphasis on equity securities. At December 31, 2004, equities, excluding
Federal Home Loan Bank and Savings Bank Life Insurance stock, comprised 3% of
the investment portfolio compared to 4% at December 31, 2003. The gross
unrealized gains associated with the marketable equity securities portfolio were
$8 million at December 31, 2004. At such date, there were no gross unrealized
losses. As discussed below, unrealized gains and losses on these securities are
included in accumulated other comprehensive income in equity, and thus, if
equity prices decline due to unfavorable market conditions or other factors, the
Company'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.
-18-
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,
-------------------------------------------------------------------------
2004 2003 2002
--------------------- --------------------- ---------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- -------- --------- -------- --------- --------
(In thousands)
Mortgage-backed securities:
Freddie Mac $ 75,846 $ 75,388 $ 53,883 $ 53,638 $ 3,558 $ 3,605
Fannie Mae 248,052 247,139 185,018 185,551 3,066 3,051
Private label REMICs 37 37 653 648 9,761 9,750
Ginnie Mae 21 21 32 33 52 54
-------- -------- -------- -------- -------- --------
Total mortgage-backed securities 323,956 322,585 239,586 239,870 16,437 16,460
-------- -------- -------- -------- -------- --------
Other investment securities:
Obligations of U.S. Treasury and
U.S. Government Agencies 1,106 1,113 20,840 20,969 98,058 98,719
Corporate bonds and notes 8,977 8,977 17,102 17,310 31,284 31,637
Municipal notes 19,169 19,172 12,294 12,282 -- --
Asset-backed securities 441 452 2,566 2,106 6,956 6,772
Marketable equity securities 5,193 13,105 6,515 14,888 11,132 19,581
-------- -------- -------- -------- -------- --------
Total other investment securities 34,886 42,819 59,317 67,555 147,430 156,709
-------- -------- -------- -------- -------- --------
Total available-for-sale securities $358,842 $365,404 $298,903 $307,425 $163,867 $173,169
======== ======== ======== ======== ======== ========
The following table presents the amortized cost and fair value of
Berkshire Bank's held-to-maturity securities, by type of security, at the dates
indicated.
At December 31,
-------------------------------------------------------------------------
2004 2003 2002
--------------------- --------------------- ---------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- -------- --------- -------- --------- --------
(In thousands)
Mortgage-backed securities:
Freddie Mac $ 1,578 $ 1,569 $ 10,163 $ 10,146 $ 17,120 $ 17,164
Fannie Mae 2,445 2,422 3,743 3,742 11,657 11,688
Ginnie Mae 692 681 2,452 2,435 1,010 1,016
-------- -------- -------- -------- -------- --------
Total mortgage-backed securities 4,715 4,672 16,358 16,323 29,787 29,868
-------- -------- -------- -------- -------- --------
Other investment securities:
Municipal notes and other
obligations 25,227 25,227 20,545 20,545 14,480 14,480
-------- -------- -------- -------- -------- --------
Total held-to-maturity securities $ 29,942 $ 29,899 $ 36,903 $ 36,868 $ 44,267 $ 44,348
======== ======== ======== ======== ======== ========
At December 31, 2004, the largest exposure to any securities issuer had a
book value $4 million, excluding government and agency securities. This security
is a development bond issued by a local service agency.
-19-
The following table presents the activity in the mortgage-backed
securities and other investment securities portfolios for the years indicated.
For the Years Ended December 31,
---------------------------------------
2004 2003 2002
--------- --------- ---------
(In thousands)
Mortgage-backed securities:
Mortgage-backed securities, beginning of year $ 256,228 $ 46,247 $ 39,901
Purchases 117,869 266,586 63,065
Securitized mortgages 39,657 16,270 --
Repayments and prepayments (72,631) (66,918) (56,037)
Sales (11,336) (5,139) --
Net premium (867) (801) (525)
Decrease in unrealized gain (1,663) (17) (157)
--------- --------- ---------
Net increase in mortgage-backed securities 71,029 209,981 6,346
--------- --------- ---------
Mortgage-backed securities, end of year 327,257 256,228 46,247
--------- --------- ---------
Other investment securities:
Other investment securities, beginning of year 88,100 171,189 97,808
Purchases 32,816 83,227 195,005
Sales (4,833) (12,133) (13,112)
Loss on impairment of securities -- -- (673)
Maturities and calls (46,347) (147,286) (84,606)
Repayments and prepayments (1,049) (5,140) (3,191)
Net premium (336) (994) (578)
Decrease in unrealized gain (305) (763) (19,464)
--------- --------- ---------
Net (decrease)/increase in other investment securities (20,054) (83,089) 73,381
--------- --------- ---------
Other investment securities, end of year 68,046 88,100 171,189
--------- --------- ---------
Total securities, end of year $ 395,303 $ 344,328 $ 217,436
========= ========= =========
The following table presents certain information regarding the amortized
cost, weighted average yields and estimated maturities of Berkshire Bank's debt
securities at December 31, 2004.
At December 31, 2004
-----------------------------------------------------------------------
More than One More than Five Years
One Year or Less Year to Five Years to Ten Years
-------------------- -------------------- --------------------
Weighted Weighted Weighted
Amortized Average Amortized Average Amortized Average
Cost Yield Cost Yield Cost Yield
--------- -------- --------- -------- --------- --------
(Dollars in thousands)
Obligations of U.S. Treasury
and U.S. Government Agencies $ 1,000 4.56% $ 88 6.14% $ 18 6.13%
Mortgage-backed securities 11,206 2.33 294,114 4.19 23,351 4.51
Municipal and IRB 8,634 2.06 4,296 4.46 8,131 3.96
Corporate bonds and notes 3,882 4.55 -- -- 2,987 5.18
Asset-backed securities -- -- 441 6.12 -- --
-------- -------- --------
Total $ 24,722 2.67% $298,939 4.19% $ 34,487 4.44%
======== ======== ========
At December 31, 2004
---------------------------------------------
More than Ten Years Total
-------------------- --------------------
Weighted Weighted
Amortized Average Amortized Average
Cost Yield Cost Yield
--------- -------- --------- --------
(Dollars in thousands)
Obligations of U.S. Treasury
and U.S. Government Agencies $ -- --% $ 1,106 4.71%
Mortgage-backed securities -- -- 328,671 4.15
Municipal and IRB 23,335 4.44 44,396 3.89
Corporate bonds and notes 2,108 3.76 8,977 4.57
Asset-backed securities -- -- 441 6.12
-------- --------
Total $ 25,443 4.38% $383,591 4.13%
======== ========
-20-
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 Federal Home Loan
Bank and other creditors of Berkshire Bank also have priority over Berkshire
Hills for repayment of their claims.
The following table presents the deposit activity of Berkshire Bank for
the years indicated.
For the Years Ended December 31,
--------------------------------
2004 2003 2002
------- ------- -------
(In thousands)
Increase before interest credited $ 3,152 $34,022 $21,854
Interest credited 12,393 13,862 17,777
------- ------- -------
Net increase $15,545 $47,884 $39,631
======= ======= =======
At December 31, 2004, Berkshire Bank had certificate of deposit accounts
in amounts of $100,000 or more maturing as follows:
Weighted
Average
Maturity Period Amount Rate
---------------------------------------------------------
(Dollars in thousands)
Three months or less $ 26,484 1.88%
Over 3 months through 6 months 22,493 2.29
Over 6 months through 12 months 24,384 3.23
Over 12 months 66,737 4.01
--------
Total $140,098 3.19%
========
-21-
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,
---------------------------------------------------------------------------------------------------------
2004 2003 2002
--------------------------------- --------------------------------- ---------------------------------
Percent Percent Percent
of Total Weighted of Total Weighted of Total Weighted
Average Average Average Average Average Average Average Average Average
Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
--------------------------------- --------------------------------- ---------------------------------
(Dollars in thousands)
NOW accounts $ 97,886 11% 0.09% $ 90,170 11% 0.17% $ 83,399 11% 0.75%
Money market accounts 160,265 19 1.29 132,497 16 1.24 117,950 15 1.69
Savings 168,551 20 0.77 170,749 21 1.01 157,444 21 1.70
Certificates of deposit 320,982 38 2.78 330,116 41 3.13 320,418 42 3.91
Demand accounts 103,752 12 -- 91,627 11 -- 82,752 11 --
-------- -------- -------- -------- -------- --------
Total $851,436 100% 1.46% $815,159 100% 1.70% $761,963 100% 2.33%
======== ======== ======== ======== ======== ========
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, 2004
---------------------------------------------
Less Than One to Two to Over Total at December 31,
One Two Three Three --------------------------------
Year Years Years Years 2004 2003 2002
--------- -------- -------- -------------------- -------- --------
(In thousands)
0.00-4.00% $156,442 $ 68,381 $ 7,906 $ 9,412 $242,141 $247,036 $236,829
4.01-5.00% 14,877 1,249 5,178 24,055 45,359 40,113 43,019
5.01-6.00% 1,270 1,944 226 9,690 13,130 16,947 20,196
6.01-7.00% 2,879 571 6,776 2,622 12,848 15,428 28,423
7.01% and above 1,797 -- -- -- 1,797 1,826 1,722
-------- -------- -------- -------- -------- -------- --------
Total $177,265 $ 72,145 $ 20,086 $ 45,779 $315,275 $321,350 $330,189
======== ======== ======== ======== ======== ======== ========
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, 2004,
Berkshire Bank had the ability to borrow a total of approximately $361 million
from the Federal Home Loan Bank of Boston. At that date, Berkshire Bank had
outstanding advances of $328 million. The Bank had a line of credit with the
Federal Home Loan Bank totaling $13 million at December 31, 2004; there were no
outstanding borrowings under this line. In addition, Berkshire Bank had a $50
million repurchase agreement line of credit with a nationally recognized
broker-dealer. At December 31, 2004, Berkshire Bank had no outstanding
borrowings against this agreement.
-22-
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,
----------------------------------
2004 2003 2002
-------- -------- --------
(Dollars in thousands)
Maximum amount of advances
outstanding at any month end $327,926 $251,465 $143,053
Average advances outstanding 305,642 167,621 140,406
Weighted average rate paid
on advances 2.73% 2.91% 4.01%
At December 31,
----------------------------------
2004 2003 2002
-------- -------- --------
(Dollars in thousands)
Balance outstanding at end of year $327,926 $251,465 $133,002
Weighted average rate on advances
at end of year 3.11% 2.61% 3.27%
Berkshire Bank has offered retail repurchase agreements to selected higher
balance customers and certain municipalities. These agreements were 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, 2004, there were no
such retail repurchase agreements, although the Bank may offer such agreements
in the future.
The following tables represent certain information regarding Berkshire
Bank's retail repurchase agreements at or for the years ended December 31, 2003
and 2002. There were no repurchase agreements booked in 2004 or outstanding at
December 31, 2004.
For the Years
Ended December 31,
----------------------
2003 2002
------ ------
(Dollars in thousands)
Maximum amount of retail repurchase
agreements outstanding at any month end $ 500 $1,830
Average retail repurchase agreements
outstanding 88 1,349
Weighted average rate paid on retail
repurchase agreements 1.24% 1.72%
At December 31,
----------------------
2003 2002
------ ------
(Dollars in thousands)
Balance outstanding at end of year $ -- $ 700
Weighted average rate on retail repurchase
agreements at end of year --% 1.59%
Wealth Management Services
- --------------------------
Berkshire Bank wealth management provides services to individuals,
partnerships, corporations and other institutions and also acts as a fiduciary
of estates and conservatorships and as a trustee under various wills, trusts and
other plans. Berkshire Bank emphasizes the growth of its wealth management
services primarily to increase fee-based income. Berkshire Bank has implemented
several policies governing the practices and procedures of trust operations,
including policies relating to maintaining confidentiality of trust records,
investment of trust property, handling conflicts of interest, and maintaining
impartiality. At December 31, 2004, assets under management totaled $358
million. Wealth management fee income totaled $2.7 million in 2004.
-23-
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, 2004, Berkshire Bank was
working with approximately 68 municipal entities.
Technology
- ----------
Core bank systems, transaction processing, electronic banking and other
financial technologies are significant aspects of the competitive and control
environment in which the Company operates. These technologies are integral to
the Company's operations and to the achievement of its business strategies.
Following the sale of its investment interest in EastPoint Technologies, LLC,
the Company entered into an agreement with the acquirer for the conversion of
the Company's core processing systems to the acquirer's technology platform in
2005. This technology partner is a prominent industry provider of data
processing and related technologies. The sale of EastPoint eliminated its
operating costs to the Company and resulted in a technology partnership better
suited to ensure the proper infrastructure as the Bank expands.
Risk Factors
- ------------
Berkshire Bank's increased emphasis on commercial and consumer lending may
expose it to increased lending risks. At December 31, 2004, $577 million, or
70%, of Berkshire Bank's portfolio consisted of commercial and multi-family real
estate loans, commercial construction loans, commercial business loans and
consumer loans. Berkshire Bank intends to continue to emphasize these types of
lending. Consumer loans entail greater risks than one- to four-family mortgage
loans because they are secured by rapidly depreciable assets such as
automobiles, or to a lesser extent, are unsecured. Commercial loans generally
expose a lender to greater risk of non-payment and loss than one- to four-family
residential mortgage loans because repayment of the loans often depends on the
successful operation of the property and the income stream of the borrowers.
Commercial loans also typically involve larger loan balances to single borrowers
or groups of related borrowers compared to one- to four-family residential
mortgage loans. Additionally, many of Berkshire Bank's commercial borrowers have
more than one loan outstanding with Berkshire Bank. Consequently, an adverse
development with respect to one loan or one credit relationship can expose it to
a significantly greater risk of loss compared to an adverse development with
respect to a one- to four-family residential mortgage loan.
Berkshire Bank's geographic expansion and growth, if not successful, could
negatively impact earnings. The Company's operations have grown in recent years,
both organically and through acquisitions. In the past year, Berkshire Bank has
expanded its geographic presence by opening a representative office in Albany,
New York and by acquiring a branch office in Oriskany Falls, New York. The
Company has also recently obtained regulatory approval to establish a branch
office in Albany, New York and intends to establish additional branches in
eastern New York, including in the Albany metropolitan area. Additionally, the
Company will expand into the Springfield, Massachusetts metropolitan area with
the completion of its proposed acquisition of Woronoco Bancorp.
The success of this expansion will depend on the acceptance by customers
of the Company and its products and services into these new markets.
Additionally, the profitability of Berkshire Bank's expansion strategy will
depend on whether the income it generates in the new markets will offset the
increased expenses of operating a larger entity with increased personnel, more
branch locations and additional product offerings. Berkshire Bank expects that
it may take a period of time before certain of its new branches can become
profitable, especially in areas in which Berkshire Bank does not have an
established physical presence. During this period, operating these new branches
may negatively impact net income.
Additionally, in connection with the Company's expansion, the Company will
need to increase its operational and financial procedures, systems and controls.
If the Company has difficulty in doing so, it could harm the Company's business,
results of operations and financial condition.
The Company may fail to realize the anticipated benefits of its proposed
merger with Woronoco Bancorp, Inc. The success of the merger with Woronoco
Bancorp, Inc. will depend on many factors, including the Company's ability to
realize anticipated cost savings and revenue enhancements and to combine the
businesses of the Company and Woronoco Bancorp in a manner that permits growth
opportunities to occur and that does not materially disrupt the existing
customer relationships of Woronoco Bancorp and its subsidiaries or result in
decreased revenues resulting from any loss of customers. If the Company is not
able to successfully achieve these objectives, the anticipated benefits of the
merger may not be fully realized or at all or may take longer to realize than
expected.
-24-
The Company and Woronoco Bancorp have operated and, until the completion
of the merger, will continue to operate, independently. It is possible that the
integration process could result in a loss of key personnel, the disruption of
the Company or Woronoco Bancorp's ongoing businesses or inconsistencies in
standards, controls, procedures and policies that adversely affect the Company
and Woronoco's ability to maintain relationships with customers and employees or
to achieve the anticipated benefits of the merger.
Rising interest rates may hurt the Company's profits. Interest rates were
recently at historically low levels. However, since June 30, 2004, the U.S.
Federal Reserve has increased its target for the federal funds rates six times
to 2.50%. If interest rates continue to rise, and if rates on deposits and
borrowings reprice upwards faster than the rates on loans and investments,
Berkshire Bank would experience compression of interest rates spread and net
interest margin, which would have a negative effect on profitability. However,
in the past year, Berkshire Bank has undertaken several steps to position itself
better for an increase in market interest rates, including the origination of
adjustable-rate loans and the sale and securitization of fixed-rate mortgage
loans. See "Item 7A - Quantitative and Qualitative Disclosures About Market
Risk."
A downturn in the local economy or a decline in real estate values could
hurt the Company's profits. Nearly all of Berkshire Bank's loans are secured by
real estate or made to businesses in western Massachusetts. As a result of this
concentration, a downturn in the local economy could cause significant increases
in nonperforming loans, which would hurt profits. In recent years, there has
been a significant increase in real estate values in Berkshire Bank's market
area. As a result of rising home prices, Berkshire Bank's loans have been well
collateralized. A decline in real estate values could cause some of Berkshire
Bank's mortgages to become inadequately collateralized, which would expose the
Company to a greater risk of loss.
Strong competition within Berkshire Bank's market area could hurt the
Company's profit and growth. Berkshire Bank faces intense competition both in
making loans and attracting deposits. This competition has made it more
difficult for it to make new loans and at times has forced it to offer higher
deposit rates. Price competition for loans and deposits might result in
Berkshire Bank earning less on loans paying more on deposits, which would reduce
net interest income. Competition also makes it more difficult to grow loans and
deposits. Some of the institutions with which Berkshire Bank competes have
substantially greater resources and lending limits than it has and may offer
services that Berkshire Bank does not provide. Competition will likely increase
in the future as a result of legislative, regulatory and technological changes
and the continuing trend of consolidation in the financial services industry.
The Company's profitability depends upon Berkshire Bank's continued ability to
compete successfully in its market area.
Because of Berkshire Bank's heavy reliance on technology and data
processing, Berkshire Bank's business could be materially and adversely affected
if Berkshire Bank's conversion and upgrading of various computer systems are not
performed properly. Berkshire Bank relies heavily on technology, including the
use of data processing and core application software, to conduct its business.
Berkshire Bank is in the process of updating and converting many of its systems,
including changing its data processor. If Berkshire Bank encounters problems in
either converting or upgrading any of its systems or in operating the new
systems once installed it could affect Berkshire bank's ability to adequately
process and account for customer transactions, which could significantly affect
the Company's business, financial condition and results of operation.
Berkshire Bank and the Company operate in a highly regulated environment
and may be adversely affected by changes in laws and regulations. The Company is
subject to extensive regulation, supervision and examination by the Office of
Thrift Supervision, its chartering authority, and Berkshire Bank is subject to
extensive supervision and examination by the Massachusetts Division of Banks,
its chartering authority, and the Federal Deposit Insurance Corporation, as
insurer of Berkshire Bank's deposits. Such regulations and supervision governs
the activities in which an institution and its holding company may engage, and
are intended primarily for the protection of the insurance fund and depositors.
Regulatory authorities have extensive discretion in their supervisory and
enforcement activities, including the imposition of restrictions on operations,
the classification of assets and determination of the level of allowance for
loan losses. Any change in such regulation and oversight, whether in the form of
regulatory policy, regulations, legislation or supervisory claim may have a
material impact on Berkshire Bank's operations.
Personnel
- ---------
As of December 31, 2004, the Bank had 241 full-time equivalent employees.
The employees are not represented by a collective bargaining unit and the Bank
will strive to continue its strong relationship with its employees.
-25-
Subsidiary Activities
- ---------------------
The following are descriptions of Berkshire Bank's 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") 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, 2004, North Street
had assets totaling $140 million, consisting primarily of a variety of
investment securities.
Woodland Securities, Inc. ("Woodland"), is also qualified as a "securities
corporation" for Massachusetts income tax purposes. As of December 31, 2004,
Woodland had assets of $233 million consisting primarily of agency
mortgage-backed securities. The Bank has pledged all of its shares of Woodland
to the Federal Home Loan Bank of Boston to secure its borrowing facility.
Gold Leaf Securities Corporation is qualified as a "securities
corporation" for Massachusetts income tax purposes. As of December 31, 2004,
Gold Leaf Securities Corporation had assets totaling $9 million, consisting
primarily of Industrial Revenue Bonds.
Berkshire Financial Planning, Inc. (formerly known as Gold Leaf Investment
Services, Inc.) previously offered access to brokerage services, through a
partnership with UVEST Investment Services, a registered securities
broker-dealer. These services are now being offered through the Bank in
partnership with Commonwealth Financial Network, a registered securities
broker/dealer. This subsidiary changed its name from Gold Leaf Investment
Services, Inc. in 2004. Berkshire Financial Planning, Inc. was inactive at
December 31, 2004.
Gold Leaf Insurance Agency, Inc. offers a full-line of products including
automobile, home, business and life insurance.
Berkshire Hills' subsidiaries, in addition to Berkshire Bank, are
described below. These companies are incorporated in Massachusetts and are
wholly owned by Berkshire Hills.
Berkshire Hills Funding Corporation was established in 2000 to lend funds
to Berkshire Bank's Employee Stock Ownership Plan ("ESOP") to purchase shares of
Berkshire Hills common stock in the initial public offering.
Berkshire Hills Technology, Inc. is discussed below under discontinued
operations.
Discontinued Operations
- -----------------------
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. invested $4.7 million in EastPoint Technologies, LLC ("EastPoint"). The
Company's equity interest in EastPoint equaled 60.3%. EastPoint, headquartered
in Bedford, New Hampshire, is a software and data processing provider for
financial institutions. On June 18, 2004, EastPoint was sold to EP Acquisition
Corp., a subsidiary of Open Solutions Inc. (NASDAQ: OPEN), for $7.0 million in
cash. The Company received approximately $2.6 million for its 60.3% equity
interest and recorded a $75,000 loss on sale, which was included in the 2004
loss from discontinued operations. Berkshire Hills Technology, Inc. was inactive
at December 31, 2004.
Segment Reporting
- -----------------
Management monitors the revenue streams of the various products and
services in evaluating the Company's operations and financial performance. All
of the Company's operations are considered by management to be aggregated in one
reportable operating segment. Prior to their discontinuation, the operations of
Berkshire Hills Technology, Inc., were evaluated on a stand-alone basis.
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
-26-
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 and is qualified in its entirety
by reference to the actual laws and regulations.
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.
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.
-27-
Assessments. Savings banks are required to pay assessments to the
Commissioner of Banks to fund operations. The expense paid for state exam fees
and assessments for the fiscal year ended December 31, 2004 totaled $41,000.
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.
Berkshire Bank's regulatory capital at December 31, 2004 is included in
the Stockholders' Equity note of the Company's financial statements in Item 8 of
this report. At December 31, 2004, Berkshire Bank met each of its capital
requirements.
Standards for Safety and Soundness. The federal banking agencies have
adopted Interagency Guidelines prescribing 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 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
-28-
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, 2004, Berkshire Bank had marketable equity
securities, including money market preferred stocks, with a market value of
$13.1 million, which were held under such grandfathering authority.
Interstate Banking and Branching
- --------------------------------
The Interstate Banking Act permits a bank, such as Berkshire Bank, to
acquire an institution by merger in a state other than Massachusetts unless the
other state has opted out 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. During 2004, Berkshire Bank acquired a branch in Oriskany
Falls, New York. At its interstate branches, Berkshire Bank may conduct any
activity that is authorized under Massachusetts law that is permissible either
for a New York bank (subject to applicable federal restrictions) or a New York
branch of an out-of-state national bank.
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, 2004, 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 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.
-29-
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 maintains a risk-based
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 that it is assigned. Assessment rates for
insurance fund deposits currently range from 0 basis points for the healthiest
institutions to 27 basis points of assessable deposits for the riskiest. 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.
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 generally provide that reserves be maintained against aggregate
transaction accounts as follows: for that portion of transaction accounts
aggregating $47.6 million less an exemption of $7 million (which may be adjusted
by the Federal Reserve Board) the reserve requirement is 3%; and for accounts
greater than $47.6 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 $47.6 million. Berkshire Bank is in compliance with these
requirements.
-30-
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. Berkshire Bank
was in compliance with this requirement with an investment in Federal Home Loan
Bank of Boston stock at December 31, 2004 of $17.0 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 2004,
2003, 2002, 2001, and 2000, cash dividends from the Federal Home Loan Bank of
Boston to Berkshire Bank amounted to approximately $513,000, $249,000, $283,000,
$304,000 and $333,000, 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-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
-31-
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, 2004, Berkshire Bank maintained 93% 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 the following: any 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. Except for the planned merger with Woronoco Bancorp, Inc., 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
-32-
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.
Financial Privacy
- -----------------
In accordance with the Gramm-Leach-Bliley Financial Modernization Act of
1999, federal banking regulators adopted rules that limit the ability of banks
and other financial institutions to disclose non-public information about
consumers to nonaffiliated third parties. These limitations require disclosure
of privacy policies to consumers and, in some circumstances, allow consumers to
prevent disclosure of certain personal information to a nonaffiliated third
party. The privacy provisions of the GLB Act affect how consumer information is
transmitted through diversified financial companies and conveyed to outside
vendors.
Anti-Money Laundering Initiatives and the USA Patriot Act
- ---------------------------------------------------------
A major focus of governmental policy on financial institutions in recent
years has been aimed at combating money laundering and terrorist financing. The
USA PATRIOT Act of 2001 (the "USA Patriot Act") substantially broadened the
scope of United States anti-money laundering laws and regulations by imposing
significant new compliance and due diligence obligations, creating new crimes
and penalties and expanding the extra-territorial jurisdiction of the United
States. The United States Treasury Department has issued a number of
implementing regulations which apply to various requirements of the USA Patriot
Act to financial institutions such as Berkshire Bank and broker-dealer
subsidiaries. These regulations impose obligations on financial institutions to
maintain appropriate policies, procedures and controls to detect, prevent and
report money laundering and terrorist financing and to verify the identity of
their customers. Failure of a financial institution to maintain and implement
adequate programs to combat money laundering and terrorist financing, or to
comply with all of the relevant laws or regulations, could have serious legal
and reputational consequences for the institution.
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 2004 tax year,
Berkshire Bank's maximum federal income tax rate was 35%.
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.
-33-
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
bonus depreciation or 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.
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.
-34-
ITEM 2. PROPERTIES
- --------------------------------------------------------------------------------
The Company and the Bank currently conduct their business through the main
office located in Pittsfield, Massachusetts, and 12 other full-service banking
offices and two other facilities 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 or Leasehold
Or Leased Date of Lease Improvements at
Location Own or Acquired Expiration December 31, 2004
- -------- ----- ------------- ------------- -----------------
(In thousands)
Main Office
24 North Street
Pittsfield, Massachusetts Own 1898 -- $1,588
Banking Offices
244 Main Street
Great Barrington, Massachusetts Own 1950 -- 1,956
103 North Main Street
Sheffield, Massachusetts Own 1966 -- 173
Old Town Hall
43 East Street
Pittsfield, Massachusetts Lease 1969 2030 444
2 Depot Street
West Stockbridge, Massachusetts Own 1975 -- 296
165 Elm Street
Pittsfield, Massachusetts Own 1977 -- 258
255 Stockbridge Road
Great Barrington, Massachusetts Own 1985 -- 205
37 Main Street
North Adams, Massachusetts Lease 1985 2015(1) 314
1 Park Street
Lee, Massachusetts Own 1991 -- 208
32 Main Street
Stockbridge, Massachusetts Own 1991 -- 247
66 West Street
Pittsfield, Massachusetts Lease 1998 2009(2) 145
Allendale Shopping Center
39 Cheshire Road
Pittsfield, Massachusetts Lease 2001 2021(3) 1,170
212 Main Street
Oriskany Falls, New York Own 2004 -- 185
Other Offices
66 Allen Street (4)
Pittsfield, Massachusetts Own 1999 -- 2,050
54 State Street - Suite 804 (5)
Albany, New York Lease 2004 2006 --
- ----------
(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.
(5) This facility houses Berkshire Bank's Representative Office, at which
loans are processed; however, no deposits are taken at this site.
-35-
ITEM 3. LEGAL PROCEEDINGS
- --------------------------------------------------------------------------------
At December 31, 2004, neither the Company nor the Bank was involved in any
pending legal proceedings believed by management to be material to the Company's
financial condition or results of operations. Periodically, there have been
various claims and lawsuits involving 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, in the
aggregate, would have a material adverse effect on the financial condition or
operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
- --------------------------------------------------------------------------------
No matters were submitted to a vote of security holders during the fourth
quarter of 2004.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
- --------------------------------------------------------------------------------
The common stock is traded on the American Stock Exchange under the symbol
"BHL." As of March 3, 2005, the Company had approximately 927 holders of record.
The following table sets forth, for the quarters indicated, the daily high and
low sales price for the common stock and the dividends paid. The closing price
of the Company's common stock on March 3, 2005 was $34.81. 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, 2004
--------------------------------------------------------
4th Quarter 3rd Quarter 2nd Quarter 1st Quarter
----------- ----------- ----------- -----------
High $38.20 $39.20 $37.30 $39.20
Low $34.55 $34.80 $32.46 $34.40
Dividend Paid $ 0.12 $ 0.12 $ 0.12 $ 0.12
For the Year Ended December 31, 2003
--------------------------------------------------------
4th Quarter 3rd Quarter 2nd Quarter 1st Quarter
----------- ----------- ----------- -----------
High $37.60 $34.30 $28.80 $24.08
Low $33.40 $28.00 $22.75 $21.77
Dividend Paid $ 0.12 $ 0.12 $ 0.12 $ 0.12
The Company did not repurchase any shares in the fourth quarter of 2004.
On June 3, 2003, the Company authorized the purchase of up to 300,000 shares,
from time to time, subject to market conditions. The repurchase plan will
continue until it is completed or terminated by the Board of Directors. As of
December 31, 2004, 111,955 shares remain available for purchase under the plan.
No plans expired during the three months ended December 31, 2004. The Company
has no plans that it has elected to terminate prior to expiration or under which
it does not intend to make further purchases.
-36-
ITEM 6. SELECTED FINANCIAL DATA
- --------------------------------------------------------------------------------
The following summary data is based in part on the consolidated financial
statements and accompanying notes, and other schedules appearing elsewhere in
this Form 10-K. Historical data is also based in part on, and should be read in
conjunction with, prior filings with the SEC.
At or For the Years Ended December 31,
--------------------------------------------------------------------------
2004 2003 2002 2001 2000
----------- ----------- ----------- ----------- -----------
(Dollars in thousands, except per share data)
Selected Financial Data:
Total assets $ 1,310,115 $ 1,218,548 $ 1,045,947 $ 1,030,701 $ 1,011,340
Loans, net 818,842 783,258 712,714 791,920 783,405
Investment securities:
Available-for-sale 365,404 307,425 173,169 104,446 99,309
Held-to-maturity 29,942 36,903 44,267 33,263 32,238
Federal Home Loan Bank (FHLB) stock 16,974 12,923 7,440 7,027 5,651
Savings Bank Life Insurance stock 2,043 2,043 2,043 2,043 2,043
Deposits 845,789 830,244 782,360 742,729 729,594
Federal Home Loan Bank advances 327,926 251,465 133,002 133,964 101,386
Repurchase agreements -- -- 700 1,890 2,030
Total stockholders' equity 131,736 123,175 120,569 139,323 161,322
Real estate owned -- -- 1,500 -- 50
Nonperforming loans 1,152 3,199 3,741 2,702 2,869
Selected Operating Data:
Total interest and dividend income $ 61,081 $ 56,308 $ 64,128 $ 75,796 $ 71,018
Total interest expense 20,724 18,742 23,428 33,560 33,468
----------- ----------- ----------- ----------- -----------
Net interest income 40,357 37,566 40,700 42,236 37,550
Provision for loan losses 1,565 1,460 6,180 7,175 3,170
----------- ----------- ----------- ----------- -----------
Net interest income after provision
for loan losses 38,792 36,106 34,520 35,061 34,380
----------- ----------- ----------- ----------- -----------
Non-interest income:
Service charges and fees 5,418 4,961 4,659 4,289 3,763
Gain on sales and dispositions of
securities, net 1,483 3,077 14,470 268 423
Gain (loss) on sale of loans 85 (1,854) (10,702) -- --
Other 778 264 (2,000) 2,526 560
----------- ----------- ----------- ----------- -----------
Total non-interest income 7,764 6,448 6,427 7,083 4,746
----------- ----------- ----------- ----------- -----------
Total non-interest expense 28,977 28,243 37,279 28,927 32,184
----------- ----------- ----------- ----------- -----------
Income from continuing operations
before income taxes 17,579 14,311 3,668 13,217 6,942
Provision for income taxes 5,639 5,161 885 4,334 2,360
----------- ----------- ----------- ----------- -----------
Income from continuing operations 11,940 9,150 2,783 8,883 4,582
----------- ----------- ----------- ----------- -----------
(Loss) income from discontinued operations (1) (653) (282) (1,040) 43 --
Income tax (benefit) expense (222) (97) (354) 15 --
----------- ----------- ----------- ----------- -----------
Net (loss) income from discontinued operations (431) (185) (686) 28 --
----------- ----------- ----------- ----------- -----------
Net income $ 11,509 $ 8,965 $ 2,097 $ 8,911 $ 4,582
=========== =========== =========== =========== ===========
Dividends per share $ 0.48 $ 0.48 $ 0.48 $ 0.43 $ 0.10
Earnings per share
Basic $ 2.18 $ 1.70 $ 0.39 $ 1.42 N/A
Diluted $ 2.01 $ 1.57 $ 0.36 $ 1.35 N/A
(footnotes on following page)
-37-
At or For the Years Ended December 31,
-------------------------------------------------------
2004 2003 2002 2001 2000
------- ------- ------- ------- -------
(Dollars in thousands, except per share data)
Selected Operating Ratios and Other Data (2):
Performance Ratios:
Average yield on interest-earning assets 5.00% 5.35% 6.49% 7.80% 8.04%
Average rate paid on interest-bearing liabilities 1.97 2.10 2.85 4.25 4.64
Interest rate spread (3) 3.03 3.25 3.64 3.55 3.40
Net interest margin (4) 3.30 3.57 4.12 4.35 4.25
Average interest-bearing assets to interest-bearing liabilities 116.06 118.01 120.33 123.04 122.53
Net interest income after provision for loan losses
to non-interest expense 133.87 127.84 92.60 121.21 106.82
Non-interest expense as a percent of average assets 2.25 2.53 3.54 2.80 3.44
Return on average assets (5) 0.89 0.80 0.20 0.86 0.49
Return on average equity (6) 9.06 7.28 1.54 5.74 3.72
Average equity to average assets 9.86 11.04 12.96 15.00 13.15
Dividend payout ratio (7) 22.02 28.24 123.08 30.28 N/A
Efficiency ratio (8) 62.02 66.00 70.06 58.97 76.86
Regulatory Capital Ratios:
Tier 1 capital to average assets 9.18 8.97 10.04 11.02 14.54
Total capital to risk-weighted assets 14.24 14.10 15.18 15.73 20.15
Asset Quality Ratios:
Nonperforming loans as a percent of
total loans (9) 0.14 0.40 0.52 0.34 0.36
Nonperforming assets as a percent of
total assets (10) 0.09 0.26 0.36 0.26 0.29
Allowance for loan losses as a percent of
total loans 1.13 1.13 1.43 1.37 1.29
Allowance for loan losses as a percent of
nonperforming loans 810.50 280.37 275.54 408.36 356.08
Net loans charged-off as a percent of
average total loans 0.15 0.35 0.87 0.78 0.20
Share Data:
Book value per share $ 22.43 $ 20.87 $ 19.71 $ 21.68 $ 21.02
Tangible book value per share $ 21.19 $ 19.13 $ 18.00 $ 20.04 $ 20.21
Market price at year end $ 37.15 $ 36.20 $ 23.55 $ 20.25 $ 15.75
- ----------
(1) Discontinued operations relate to the Company's previous 60.3% interest in
EastPoint Technologies, LLC (a provider of bank core systems software).
The assets and operations of EastPoint were acquired in 2001 and were sold
in June 2004. Results in 2004 include a $75,000 loss recorded on the sale.
(2) Regulatory Capital Ratios are end-of-period ratios. Regulatory average
assets are for the last quarter. Performance Ratios are based on daily
averages. Asset Quality Ratios are end-of-period ratios except for the
charge-off ratio, which is for the year.
(3) Difference between weighted average yield on interest-earning assets and
weighted average cost of interest-bearing liabilities.
(4) Net interest income as a percentage of average interest-earning assets.
(5) Net income divided by average total assets.
(6) Net income divided by average total equity.
(7) Dividends per share divided by basic earnings per share. Comparable
figures for 2000 are not available.
(8) Operating expenses divided by net interest income plus non-interest
income, less gain on sale of securities, plus loss on sale of sub-prime
loans in 2003 and 2002. For purposes of the 2002 computation, severance
payments of $6.9 million were deducted from operating expenses.
Discontinued operations income and expenses are excluded from the
computation of the efficiency ratio.
(9) Nonperforming loans consist of nonaccrual loans.
(10) Nonperforming assets consist of nonperforming loans and real estate owned.
-38-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATION
- --------------------------------------------------------------------------------
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.
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 policy related to 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 mission of Berkshire Bank is to be an independent, full-service
community bank committed to being the "financial institution of choice" for
people and businesses in Berkshire County and neighboring communities. It will
achieve this by consistently meeting and exceeding the expectations of its
customers in the delivery of quality financial services and products. The Bank
values and respects its customers and employees and strives to maintain an
environment within which customers want to bank and employees will want to work.
The Bank offers a wide range of deposit, loan, investment and wealth
management 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 non-interest income and by improving
operating efficiencies while managing its capital position and limiting its
credit and interest rate risk exposure. The Bank's strategy has also included
expansion of its office locations into contiguous markets.
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 offer the highest rates on deposits in its market, 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 its
objectives, the Bank has sought to:
o Expand the services and products it offers.
o Provide superior customer service.
o Build customer relationships.
o Provide innovative products, increase the functionality of its ATM
network and expand the capability of its call center.
o Increase fee income by broadening non-depository product offerings
and services.
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.
-39-
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.
The Company established profitability goals at the end of 2002, to be
achieved in three years, consisting of a return on assets of 1.0%, a return on
equity of 10.0% and an efficiency ratio of under 60%. Earnings growth is always
a priority for a public company and balancing this with community involvement
and employee retention is paramount to the Company's management.
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 acquisitions increasingly more difficult to achieve, the
Company will prudently continue to explore opportunities that will improve its
franchise and be accretive to shareholders.
Fourth Quarter Events and Recent Developments
- ---------------------------------------------
In December 2004, the Company announced that it had entered into a
definitive agreement to acquire Woronoco Bancorp, Inc., which will create a $2.0
billion company. Also, in connection with the merger, the Bank will acquire
Woronoco Savings Bank, the wholly-owned subsidiary of Woronoco Bancorp. The
combined institution will be a formidable commercial and community banking
franchise, with significant non-interest income potential, management synergies
and solid asset quality. It will serve customers through a network of 22
full-service branches in western Massachusetts and New York.
Also in December 2004, the Company acquired Berkshire Financial Planning,
Ltd. adding clients and additional financial planning resources to the Bank's
growing wealth management group. In October 2004, the Bank acquired its Oriskany
Falls, New York branch, including about $8 million in new deposits, the Bank's
first full-service office in New York. The Bank announced plans to open
additional offices in Eastern New York in 2005. The Bank opened a representative
office in Albany in July 2004, for the specific purpose of originating
commercial loans.
Total loans increased by $10 million in the fourth quarter. The Bank
purchased a $10 million single premium bank owned life insurance ("BOLI")
contract, bringing total BOLI investments to $18 million. These contracts
provide earnings credits, which are recorded as non-interest income. The growth
in loans and BOLI contracts was offset by a $23 million decrease in securities
available for sale during the quarter.
Deposit transaction accounts (demand deposits and NOW accounts) increased
by $10 million, or 5%, during the quarter. This was offset by decreases in other
deposit categories, with total deposits decreasing by $7 million, or 1%, during
the quarter.
Service fee income increased $172,000, or 14%, as compared to the quarter
ended September 30, 2004. All major service fee categories increased in the
fourth quarter. The largest fee increase was in wealth management service fees,
which increased by 13% compared to the prior quarter.
The return on average stockholders' equity increased to 9.72% in the
fourth quarter of 2004, compared to 9.71% and 8.49% in the prior quarter and
fourth quarter of 2003, respectively. For these periods, the return on average
assets increased to 0.97% from 0.92% and 0.86%; the efficiency ratio also
improved to 60.80% from 61.60% and 62.86%. These improvements primarily resulted
from growth in net interest income and service fee income, combined with a
modest increase in non-interest expense. Results in the fourth quarter came
close to achieving the Company's near-term goals of a 10.0% return on equity, a
1.0% return on assets, and an efficiency ratio under 60%.
Comparison of Financial Condition at December 31, 2004 and 2003
- ---------------------------------------------------------------
Total Assets. Total assets at year-end 2004 were $1.31 billion, an
increase of $92 million, or 8%, from $1.22 billion at year-end 2003. The
increase was primarily due to a $68 million gross increase in loans (excluding
the effect of $39 million in mortgage loans converted to securities in the first
quarter). Loan growth resulted from record loan originations totaling $326
million in 2004. Asset growth was largely funded by a $76 million increase in
Federal Home Loan bank advances, and an increase of $16 million in deposits.
Total Loans. Total loans increased to $828 million at year-end 2004. The
Bank securitized $39 million of one- to four-family longer-term fixed rate
mortgages, as it continued to liquefy and reduce its exposure to loans and
investments with longer maturities. Excluding this transfer, the $68 million
gross increase in loans amounted to a 9% growth rate due to the Company's record
loan origination volume in 2004. All loan categories increased (excluding the
mortgage transfer), except for commercial
-40-
business loans. The biggest increase was in commercial mortgages, which grew by
$53 million, or 35%. Commercial and commercial real estate loan originations
benefited from business development outside of Berkshire County, which accounted
for 30% of these originations, including 21% in Eastern New York, where the
Company opened new offices in 2004. Consumer loans increased by $19 million, or
18%, primarily due to marketing efforts aimed at generating high quality
automobile loans with FICO scores above 700. Loan originations also benefited
from a strong local real estate market, which was supported by a generally
favorable interest rate environment.
Asset Quality. There was no foreclosed real estate at either year-end.
Total nonaccruing loans decreased to $1.15 million, or 0.09% of total assets, at
year-end 2004, compared to $3.20 million, or 0.26% of total assets at year-end
2003. This improvement included the benefit of the sale of the largest
nonperforming commercial loan relationship, which had a $1.3 million balance.
Net loan charge-offs were $1.2 million in 2004, or 0.15% of average loans,
compared to $2.8 million, or 0.35% of average loans, in 2003. Charge-offs in
2003 included losses on the remaining portfolio of sub-prime automobile loans,
which were sold in December 2003. The allowance for loan losses increased by
$368,000 to $9.3 million at year-end 2004; the allowance measured 1.13% of total
loans at both year-ends. The allowance was 811% of nonaccruing loans at year-end
2004, compared to 280% at the prior year-end. The level of the allowance is
determined in accordance with a critical accounting policy subject to
uncertainty, which is discussed further in Item 1 of this report. Loans
delinquent 60-89 days totaled $727,000 at year-end 2004, measuring 0.09% of
total loans, which was flat from the prior year-end. Substandard loans increased
to $11.2 million from $7.0 million due to the addition of several commercial
relationships, which were performing and are expected to continue to perform.
Investment Securities. Total investment securities (including Federal Home
Loan Bank stock and Savings Bank Life Insurance stock) increased to $414 million
at year-end 2004. This increase included the $39 million securitization of
residential mortgages. During October, the Company sold $11 million of these
securitized mortgages. Excluding the impact of these transactions, investment
securities grew by $27 million, or 8%, compared to $359 million at year-end
2003. In 2004, securities purchases consisted primarily of pass-through
mortgage-backed securities with average repricing intervals of 3-5 years, which
have limited risk of interest rate extension. These securities were purchased to
leverage the Bank's capital and reduce interest rate risk exposure to
longer-term investments while taking advantage of a steep yield curve. The net
unrealized gain in the portfolio was $6.6 million at year-end 2004, compared to
$8.5 million at year-end 2003, primarily due to the recognition of $1.5 million
in net gains on sale during the year.
Other Assets. Goodwill decreased by $4.4 million in 2004 due to the sale
of the assets of the Company's EastPoint Technologies, LLC subsidiary in June.
Goodwill booked in relation to acquisitions in 2004 totaled $1.0 million. Bank
owned life insurance increased by $10 million due to the purchase of a single
premium contract in October.
Deposits. Total deposits increased by $16 million, or 2%, to $846 million
in 2004. The increase for the year was primarily due to a $22 million increase
in core deposit balances (total deposits excluding certificates), which grew by
4% to $531 million at year-end. Contributing to this growth were increases of
$13 million, or 7%, in transaction accounts and $17 million, or 12%, in money
market accounts. The Bank actively pursued relationships through its branding
campaign initiated in early 2004. Deposit growth also included the benefit of
the $8 million Oriskany Falls branch purchase in October. Savings accounts
decreased by $8 million, or 5%, and certificate accounts decreased by $6
million, or 2%, in 2004. The pricing environment became more competitive in
2004, as short-term interest rates began to increase in line with actions taken
by the Federal Reserve to increase short-term interest rates, following several
years of decreases to comparatively low levels.
Borrowings. Borrowings increased by $76 million, or 30%, to $328 million
at year-end 2004. The Bank took advantage of the lower cost of borrowings
relative to the cost of time deposits to fund asset growth. This increase
represented new borrowings with terms ranging from one month to four years.
Equity. Total stockholders' equity increased by $8.6 million, or 7%, to
$131.7 million at year-end 2004, primarily due to the benefit of retained
earnings. Cash dividends remained unchanged at $0.48 per share in 2004, totaling
$2.6 million, and treasury stock purchases totaled $2.5 million. Tangible book
value per share was $21.19 at year-end 2004, compared to $19.13 at the prior
year-end. The ratio of stockholders' equity to total assets measured 10.06% at
year-end 2004, compared to 10.11% at the prior year-end.
-41-
Comparison of Operating Results for the Years Ended December 31, 2004 and 2003.
- -------------------------------------------------------------------------------
Net Income. Net income for the year 2004 was a record $11.5 million,
compared to $9.0 million for 2003. Net income from continuing operations totaled
$11.9 million for the year 2004, compared to $9.2 million for 2003, excluding
the loss from discontinued operations of EastPoint Technologies, LLC, which was
sold in June 2004. Earnings from continuing operations were a record $2.08 per
diluted share for the year 2004, an increase of 30% over prior year results. Net
income after the loss from discontinued operations was $2.01 per diluted share,
an increase of 28% over prior year results.
The Company's performance in 2004 benefited from a $2.8 million increase
in net interest income, resulting from growth in loans and investments. Total
service fee income increased by 9% in 2004, while non-interest expense growth
was limited to 3%. The return on average stockholders' equity increased to 9.06%
in 2004, compared to 7.28% in 2003. The return on average assets increased to
0.89% from 0.80% for the same periods. The efficiency ratio also improved to
62.0% from 66.0%.
Net Interest Income. Net interest income increased by $2.8 million, or 7%,
to $40.4 million in 2004, compared to $37.6 million in 2003. Average earning
assets increased by $171 million, or 16% in 2004. This growth in earning assets
more than offset the impact of a decrease in the net interest margin to 3.30% in
2004 from 3.57% in the prior year. Interest rates had declined to relative lows
in 2003 and 2004, prompting higher prepayment speeds for loans and mortgage
backed securities. These proceeds were reinvested at lower yields, reflecting
lower market rates and management's strategy to shorten the duration of these
assets. The Company used borrowings to fund earning asset growth, lowering the
cost of new funds compared to higher costing time certificates of deposit.
Average earning asset growth was concentrated in average investment
securities, which increased by $180 million in 2004, reflecting securities
purchased during 2003 and 2004, as well as the securitization of $56 million in
residential mortgages during that period. The yield on investment securities
improved to 4.07% in 2004 from 3.49% in 2003. The yield on loans decreased to
5.50% from 5.96%. The benefit of prime rate increases in 2004 was more than
offset by the impact of prepayments and the mortgage securitization. Due to the
declining loan yield and the shift in mix towards lower yielding investment
securities, the yield on earning assets decreased to 5.00% from 5.35%.
Average interest bearing liabilities increased by $162 million, or 18%, in
2004. Growth in average interest bearing deposits totaled $24 million, or 3%,
and was concentrated in money market accounts, the average balance of which
increased by $28 million, or 21%. In the generally low rate environment, and
with short-term rates increasing for the first time in several years, deposit
demand favored money market accounts compared to time certificates of deposit,
the average balance of which decreased by $9 million during the year. NOW and
savings account rates also decreased in the low rate environment. These changes
led to a decrease in the cost of interest bearing deposits to 1.66% in 2004,
compared to 1.92% in the prior year. Average borrowings increased by $138
million, or 82%, in 2004 as the Bank borrowed in a range of targeted maturities
from one month to four years to fund asset growth. The cost of borrowings
decreased to 2.73% from 2.91%. These decreases in deposit and borrowing costs
both contributed to the decline in the cost of interest bearing liabilities to
1.97% from 2.10%.
The reduction in funding costs helped to mitigate the 0.35% impact of
declining asset yields, with the result that the net interest spread only
decreased by 0.22% to 3.03% in 2004 from 3.25% in the prior year. The net
interest margin decreased by 0.27% to 3.30% from 3.57%. The further decrease in
the net interest margin reflected the higher leveraging strategy in 2004. Also
contributing to this change was a $10 million investment in a bank owned life
insurance ("BOLI") contract, shifting earnings on this amount from interest
income to non-interest income. Additionally, the bank increased its investments
in lower- yielding tax preferred municipal investments. The Bank's fully taxable
equivalent net interest margin was 3.37% in 2004, compared to 3.61% in 2003. The
Bank benefited from a $12 million, or 13%, increase in average non-interest
bearing demand deposit accounts. The Bank's relationship oriented promotional
strategies has resulted in the growth of these attractive balances.
The trend of the changes in yields and costs caused the quarterly net
interest margin to decline from a 2003 high of 3.73% in the second quarter of
2003 to a low of 3.19% in the second quarter of 2004. The margin improved to
3.29% in the third and fourth quarters of 2004. As discussed further in Item 7A,
the result of management's strategies in 2004 was to make the Bank more asset
sensitive to better position itself for increases in prevailing market interest
rates. While the Bank's interest rate sensitivity model indicates that the Bank
should benefit from additional anticipated increases in short-term interest
rates, the benefit to net interest income may be mitigated by additional
flattening of the yield curve and increased deposit price competition related to
possible deposit disintermediation in a rising rate environment.
Provision for Loan Losses. The provision for loan losses is a charge to
earnings in an amount sufficient to maintain the allowance for loan losses at a
level deemed adequate by the Company. The level of the allowance is determined
in accordance with a critical accounting policy subject to uncertainty, which is
discussed further in Item 1 of this report. The level of the allowance at
year-end 2004 was discussed in the previous section on Asset Quality in the
discussion of financial condition at December 31, 2004.
-42-
The provision for loan losses was $1.57 million in 2004, an increase of
$105,000, or 7%, from 2003. The provision measured 131% of net loan charge-offs
in 2004. This measurement was 52% in 2003 due primarily to the reversal of about
$1.0 million of previously provided loan loss provision subsequent to the sale
of the remaining sub-prime automobile loan portfolio in December 2003.
Non-Interest Income. Non-interest income increased by $1.32 million, or
20%, to $7.76 million in 2004 from $6.45 million in 2003. Non-interest income
measured 16.1% of total net interest and non-interest revenues in 2004,
increasing from 14.6% in the prior year. Wealth management service fees
increased by $422,000, or 19%, due to the Company's focus on building this
source of revenues. Total assets under management increased by 19% to $358
million at year-end 2004, compared to $302 million at the prior year-end. Net
gains and losses on sales of loans and securities totaled $1.57 million in 2004
compared to $1.22 million in 2003. Securities gains in 2004 were primarily
related to sales of equity securities, as the Company continued to reduce its
exposure to potential equity price risk. The Company also reported an $81,000
gain on the sale of $11 million in securitized mortgages in the fourth quarter.
In 2003, the Company recorded higher securities gains, along with $1.85 million
in loan sale losses related to the sale of sub-prime automobile loans. All other
non-interest income increased by $308,000, or 66%, to $778,000 in 2004 primarily
due to higher income earned on cash surrender value related to the purchase of
additional bank owned life insurance in October 2004.
Non-Interest Expense. Total non-interest expense increased by $734,000, or
3%, to $29.0 million in 2004, compared to $28.2 million in 2003. As a percentage
of total average assets, non-interest expense measured 2.25% in 2004, improving
from 2.53% in the prior year as expense growth was held well below the 16%
increase in average assets. Excluding foreclosed asset expense and all other
non-interest expense, the other categories of expense all increased, with the
increase totaling $1.85 million, or 8%, in 2004 compared to 2003. This growth
primarily related to overall growth in the business activities of the Company.
Full-time equivalent employees of the Bank totaled 241 at year-end 2004,
decreasing by 2% from 247 at year-end 2003. Salary and benefit expenses
increased by $716,000, or 4%, due to higher benefits, commissions, and stock
awards expense. The net expense of foreclosed real estate and repossessed assets
decreased by $525,000, or 50%, due to the sale of sub-prime automobile loans in
December 2003. The $587,000 reduction in all other non-interest expense included
the benefit of a $243,000 reduction in FDIC insurance expense, a $211,000 refund
of Delaware franchise tax, and a $131,000 reduction in meetings and travel
expense.
Income Tax Expense. Total income tax expense increased by $353,000, or 7%,
in 2004 compared to 2003. The effective tax rate declined to 32.0% in 2004
compared to 35.7% in 2003. The higher rate in 2003 was largely due to the
disallowance by Massachusetts of the dividends received deduction from the
Bank's REIT. The Bank benefits from securities purchased in the Bank's
subsidiary securities corporations, which are taxed at a lower state income tax
rate. Additionally, the effective income tax rate benefits from tax preferences
on income from additional purchases of municipal securities and bank owned life
insurance contracts in 2004.
Net Loss from Discontinued Operations. The Company sold its interest in
the assets of EastPoint Technologies, LLC in June 2004. All revenues and
expenses related to EastPoint have been reclassified as related to discontinued
operations. A $75,000 loss recorded on the sale was included with the loss from
operations reported in 2004. The net loss from discontinued operations, after
applicable income tax expense, was $431,000 in 2004, compared to $185,000 in
2003. Results in 2003 included project related revenues of $2.82 million, which
declined to $623,000 for the nearly six months that EastPoint was operating in
2004.
Comparison of Operating Results for the Years Ended December 31, 2003 and 2002
- ------------------------------------------------------------------------------
Net Income. Net income totaled $9.0 million for the year 2003, an increase
of $6.9 million, or 328%, from $2.1 million for 2002. Net income for 2003
included $437,000 in charges related to a non-recurring retirement benefit while
net income for 2002 included $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
2003 were $1.70 and $1.57, respectively, compared to basic and diluted earnings
of $0.39 and $0.36, respectively, for 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
8%, 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 $64 million, or
6%, to $1.05 billion in 2003 from $988 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 2003 and 2002 were 3.57% and 4.12%,
respectively.
-43-
Interest and dividend income declined $7.8 million, or 12%, to $56.3
million for 2003 from $64.1 million for 2003 as interest earned on the Bank's
loan portfolio decreased $9.2 million, or 16%, from $56.9 million for 2003 due
to the sale of $70 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 26%, 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%, to $18.7
million for 2003 from $23.4 million for 2002 due to lower rates paid,
particularly on the Bank's deposit accounts. Interest expense on deposits
totaled $13.9 million for 2003, a decrease of $3.9 million, or 22.0%, from $17.8
million for 2002. Average interest-bearing deposit balances increased $44
million to $724 million in 2003 from $679 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 in
2003, a decrease of $771,000, or 14%, from $5.7 million in 2002, 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%, to $1.5 million in 2003 from $6.2 million in 2002. The sale of
$10 million of sub-prime automobile loans in December 2003 resulted in the
reversal of approximately $1 million of previously provided loan loss provision.
In assessing the provision for year 2003, management took into consideration an
$18 million decrease in sub-prime automobile loans from December 31, 2002. The
Company also considered net loan charge-offs which decreased $4 million, to $3
million in 2003, from $7 million in 2002. Foremost in this decrease were gross
consumer loan charge-offs which declined $5 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 year-end 2002, to
0.67% at year-end 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 year-end 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. The level of the allowance is determined in accordance with a
critical accounting policy subject to uncertainty, which is discussed further in
Item 1 of this report.
Non-Interest Income. Non-interest income totaled $6.5 million for 2003, an
increase of $21,000, or 0.3%, over $6.4 million for 2002. Non-interest income
for 2003 included a $3.1 million gain on the sale of securities, which was
partially offset by $2.4 million in charges relating to the sale of sub-prime
automobile loans and the valuation adjustment in repossessed automobiles.
Non-interest income for 2002 included 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, wealth
management service fees increased $289,000, or 15%, in 2003 due to an increase
of $42 million, or 17%, in trust assets under management.
Non-Interest Expenses. Non-interest expenses totaled $28.2 million for the
year 2003 compared to $37.3 million for 2002. Salaries and benefits expense
declined $7.1 million, 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 pertaining to foreclosed real estate and
other loans decreased $2.2 million to $1.0 million in 2003 compared to $3.3
million in 2002, primarily due to a decrease in the expenses associated with the
inventory and sale of repossessed automobiles.
Income Tax Expense. Income taxes for the year 2003 were $5.1 million, an
increase of $4.5 million from $531,000 in 2002, due to increased income before
taxes, as well as an increase in the effective tax rate to 35.7% 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 deduction received from the
Bank's REIT. The lower rate paid in 2002 was primarily due to a higher level of
qualifying dividends received to pre-tax income in 2002 compared to 2003.
Discontinued Operations. The net loss from discontinued operations, net of
income tax expense, was $185,000 in 2003, decreasing by $501,000 from $686,000
in 2002. This improvement reflected a $271,000, or 4%, increase in fee income
and a decrease in the provision for uncollectible receivables, which had been
boosted by a $500,000 charge in December 2002.
-44-
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,
-------------------------------------------------------------------------------
2004 2003
------------------------------------- ------------------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
---------- -------- ------- ---------- -------- -------
(Dollars in thousands)
Interest-earning assets:
Loans (1) $ 795,533 $ 43,766 5.50% $ 800,133 $47,683 5.96%
Investment securities (2) 423,965 17,276 4.07 243,930 8,516 3.49
Short-term investments 3,036 39 1.28 7,714 109 1.41
---------- -------- ---------- ------
Total interest-earning assets 1,222,534 61,081 5.00 1,051,777 56,308 5.35
Non-interest earning assets 67,009 64,056
---------- ----------
Total assets $1,289,543 $1,115,833
========== ==========
Interest-bearing liabilities:
Deposits:
NOW accounts 97,886 88 0.09% 90,170 155 0.17%
Money market accounts 160,265 2,070 1.29 132,497 1,648 1.24
Savings accounts 168,551 1,296 0.77 170,749 1,731 1.01
Certificates of deposit 320,982 8,939 2.78 330,116 10,328 3.13
---------- -------- ---------- ------
Total interest-bearing deposits 747,684 12,393 1.66 723,532 13,862 1.92
Borrowings 305,642 8,331 2.73 167,709 4,880 2.91
---------- -------- ---------- ------
Total interest-bearing liabilities 1,053,326 20,724 1.97 891,241 18,742 2.10
-------- ------
Non-interest-bearing demand
deposits 103,752 91,627
Other non-interest-bearing
liabilities 5,369 9,817
---------- ----------
Total liabilities 1,162,447 992,685
Equity 127,096 123,148
---------- ----------
Total liabilities and equity $1,289,543 $1,115,833
========== ==========
Net interest-earning assets $ 169,208 $ 160,536
========== ==========
Net interest income $ 40,357 $37,566
======== =======
Interest rate spread 3.03% 3.25%
Net interest margin (net interest income
as a percentage of total average
interest-earning assets) 3.30% 3.57%
Total average interest-earning assets
to total average interest-bearing
liabilities 116.06% 118.01%
For the Years Ended December 31,
------------------------------------
2002
------------------------------------
Average
Average Yield/
Balance Interest Rate
---------- -------- -------
(Dollars in thousands)
Interest-earning assets:
Loans (1) $ 791,328 $56,910 7.19%
Investment securities (2) 168,664 6,762 4.01
Short-term investments 27,870 456 1.64
---------- -------
Total interest-earning assets 987,862 64,128 6.49
Non-interest earning assets 63,948
----------
Total assets $1,051,810
==========
Interest-bearing liabilities:
Deposits:
NOW accounts 83,399 623 0.75%
Money market accounts 117,950 1,988 1.69
Savings accounts 157,444 2,669 1.70
Certificates of deposit 320,415 12,497 3.90
---------- -------
Total interest-bearing deposits 679,208 17,777 2.62
Borrowings 141,755 5,651 3.99
---------- -------
Total interest-bearing liabilities 820,963 23,428 2.85
-------
Non-interest-bearing demand
deposits 82,751
Other non-interest-bearing
liabilities 11,935
----------
Total liabilities 915,649
Equity 136,161
----------
Total liabilities and equity $1,051,810
==========
Net interest-earning assets $ 166,899
==========
Net interest income $40,700
=======
Interest rate spread 3.64%
Net interest margin (net interest income
as a percentage of total average
interest-earning assets) 4.12%
Total average interest-earning assets
to total average interest-bearing
liabilities 120.33%
- ----------
(1) The average balances of loans includes nonaccrual loans, loans held for
sale, and deferred fees and costs.
(2) The average balance of investment securities is based on ammortized cost.
Securities include Federal Home Loan Bank stock and Savings Bank Life
Insurance stock.
-45-
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, 2004 Year Ended December 31, 2003
Compared to Compared to
Year Ended December 31, 2003 Year Ended December 31, 2002
---------------------------------- ----------------------------------
Increase (Decrease) Due to Increase (Decrease) Due to
Rate Volume Net Rate Volume Net
-------- -------- -------- -------- -------- --------
(In thousands)
Interest-earning assets:
Loans $ (3,644) $ (273) $ (3,917) $(12,205) $ 2,978 $ (9,227)
Investment securities 1,610 7,150 8,760 (45) 1,799 1,754
Short-term investments (9) (61) (70) (55) (292) (347)
-------- -------- -------- -------- -------- --------
Total interest-earning assets (2,043) 6,816 4,773 (12,305) 4,485 (7,820)
-------- -------- -------- -------- -------- --------
Interest-bearing liabilities:
Deposits:
NOW accounts (82) 15 (67) (523) 55 (468)
Money market accounts 65 357 422 (642) 302 (340)
Savings accounts (413) (22) (435) (1,188) 250 (938)
Certificates of deposit (1,113) (276) (1,389) (2,561) 392 (2,169)
-------- -------- -------- -------- -------- --------
Total deposits (1,543) 74 (1,469) (4,914) 999 (3,915)
Borrowings (281) 3,732 3,451 (2,570) 1,799 (771)
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities (1,824) 3,806 1,982 (7,484) 2,798 (4,686)
-------- -------- -------- -------- -------- --------
Increase (decrease) in net interest
income $ (219) $ 3,010 $ 2,791 $ (4,821) $ 1,687 $ (3,134)
======== ======== ======== ======== ======== ========
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, sales/calls of investment securities, loan sales 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, 2004 and 2003,
Berkshire Bank's loan originations totaled $326 million and $321 million,
respectively. At December 31, 2004 and 2003, the Bank's investments in
investment securities totaled $395 million and $344 million, respectively. The
Bank experienced a net increase in total deposits of $16 million and $48 million
for the years ended December 31, 2004 and 2003, 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 a repurchase agreement line of credit a nationally
recognized broker-dealer.
Outstanding commitments for all loans and unadvanced construction loans
and lines of credit totaled $169 million at December 31, 2004. 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, 2004 totaled $177 million. The Bank
relies primarily on competitive rates, customer service and long-standing
relationships with customers to
-46-
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,
2004, Berkshire Bank exceeded all of its regulatory capital requirements with
Tier 1 capital of $106 million, or 8.1% of average assets, which is above the
required level of $52 million, or 4%, and total capital of $119 million, or
12.7% of risk-weighted assets, which is above the required level of $75 million,
or 8%. 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. In the current program, 188,045 shares out of an announced 300,000 have
been purchased through December 31, 2004. The Company has sufficient funds
available to complete the repurchase program without having a material adverse
effect on liquidity.
This discussion of liquidity and capital resources does not include
considerations related to the pending merger agreement with Woronoco Bancorp,
Inc. A preliminary registration statement, subject to subsequent changes, was
filed with the SEC on February 3, 2005. This statement discusses the offering of
additional shares of the Company's common stock in conjunction with the merger
agreement.
Contractual Obligations. The following table sets forth, at December 31,
2004, the dollar amount of the Bank's contractual obligations and their
subsequent time period. This table does not include obligations related to the
Company's merger agreement with Woronoco Bancorp, Inc., which is pending
regulatory and shareholder approval.
Commitments by Period
---------------------------------------------------------------------
Less than One One to Three Three to Five After Five
Total Year Years Years Years
-------- ------------- ------------ ------------- ----------
Contractual Obligations (In thousands)
Long-term debt obligations (1) $327,926 $152,589 $101,573 $ 37,000 $ 36,764
Operating lease obligations (2) 4,185 491 991 962 1,741
Purchase obligations (3) 2,561 2,006 385 170 --
-------- -------- -------- -------- --------
Total Contractual Obligations $334,672 $155,086 $102,949 $ 38,132 $ 38,505
======== ======== ======== ======== ========
- ----------
(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.
Off-Balance Sheet Arrangements
- ------------------------------
In the normal course of operations, the Company engages in a variety of
financial transactions that, in accordance with generally accepted accounting
principles are not recorded in the Company's financial instruments. These
transactions involve, to varying degrees, elements of credit, interest rate and
liquidity risk. Such transactions are used primarily to manage customers'
requests for funding and take the form of loan commitments and lines of credit.
A further presentation of the Company's off-
-47-
balance sheet arrangements is presented in Footnote 12, "Off-Balance Sheet
Activities" in the Notes to the Consolidated Financial Statements.
For the year ended December 31, 2004, the Company did not engage in any
off-balance sheet transactions reasonably likely to have a material effect on
the Company's financial condition, results of operation or cash flows.
Impact of Inflation and Changing Prices
- ---------------------------------------
The consolidated financial statements and related financial data presented
in this Form 10-K have been prepared in conformity with accounting principles
generally accepted in the United States of America, which require the
measurement of financial position and operating results in terms of historical
dollars, without considering changes in the relative purchasing power of money
over time due to inflation. Unlike many industrial companies, substantially all
of the assets and liabilities of Berkshire Bank are monetary in nature. As a
result, interest rates have a more significant impact on Berkshire Bank's
performance than the general level of inflation. Interest rates may be affected
by inflation, but the direction and magnitude of the impact may vary. A sudden
change in inflation (or expectations about inflation), with a related change in
interest rates, would have a significant impact on our operations.
Impact of New Accounting Pronouncements
- ---------------------------------------
Please refer to the note on Recent Accounting Pronouncements in Note 1 to
the financial statements for a detailed discussion of new accounting
pronouncements.
-48-
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 Loan and Investment Committee and Board of Directors on a
quarterly basis. The Asset/Liability Committee consists of five 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,
selling newly originated fixed rate mortgages on a flow basis 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 $7.9
million at December 31, 2004 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 and Berkshire
Hills' capital would decrease. In 2003, management began a strategy to reduce
the amount of equity securities it holds by gradually selling a portion of its
holdings.
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. Prepayment
cash flows are rolled into various loan products based on a review of loan
originations over the past six months, discussions with senior loan officers on
the Bank's Asset Liability Committee and a review of the Bank's plan for
strategic growth over the next twelve months. 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 categories that reflect the current investment
strategy designed by senior management and approved by the Board of Directors.
Finally, the model assumes that the Bank's balance sheet mix will remain
relatively unchanged throughout the next calendar year.
-49-
The tables below set forth, as of December 31, 2004 and 2003, estimated
net interest income and the estimated changes in Berkshire Hills' net interest
income for the next twelve-month period, given instantaneous increases or
decreases in market interest rates of 100 and 200 basis points.
Increase/(Decrease) in At December 31, 2004
Market Interest Rates in ------------------------------------
Basis Points (Rate Shock) Amount $ Change % Change
------------------------- ------- -------- --------
(Dollars in thousands)
200 $41,376 $ 1,015 2.52%
100 40,661 300 0.74
Static 40,361 -- --
(100) 40,413 52 0.13
(200) 36,452 (3,908) (9.68)
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)
In the event of a sudden and sustained decrease in prevailing market
interest rates of 100 and 200 basis points, the December 31, 2004 table
indicates that net interest income would be expected to increase $52,000 and
decrease $3.9 million, respectively. These results compare to the December 31,
2003 chart that indicates a sudden and sustained decrease in prevailing market
interest rates of 100 and 200 basis points would cause the Company's net
interest income to increase by $577,000 and decrease by $1.8 million. The
primary reason for this change compared to the previous year is the strategic
plans that the Company has undertaken to better prepare the Bank for an increase
in market interest rates, including the origination of adjustable rate
commercial and residential mortgage loans, the origination of home equity lines
of credit and the sale and securitization of fixed rate mortgages.
In the event of a sudden and sustained increase in prevailing market
interest rates of 100 and 200 basis points, the December 31, 2004 table
indicates that net interest income would be expected to increase $300,000 and
$1.0 million, respectively, compared to the December 31, 2003 table, which
indicates that net interest income would decrease by $739,000 and $1.8 million,
respectively. Again, these changes in the Bank's interest rate risk sensitivity
can be explained by management's desire to better position the Bank for a
potential rise in market interest rates and has done so by executing the
above-mentioned strategic plans throughout 2004.
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. The most significant
assumption relates to expectations for the interest sensitivity of non-maturity
deposit accounts in a rising rate environment. The model assumes that deposit
rate sensitivity will be a percentage of the market interest rate change as
follows: Now accounts 25%, money market accounts - ranging between 50 and 75%
depending on the balance, and savings accounts 50%.
-50-
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
- --------------------------------------------------------------------------------
TABLE OF CONTENTS
PAGE
REPORT OF INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM 52
CONSOLIDATED BALANCE SHEETS AS OF
DECEMBER 31, 2004 AND 2003 53
CONSOLIDATED STATEMENTS OF INCOME FOR THE
YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002 54
CONSOLIDATED STATEMENTS OF CHANGES IN 55
STOCKHOLDERS' EQUITY FOR THE YEARS ENDED
DECEMBER 31, 2004, 2003 AND 2002
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR 56
THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 58
-51-
WOLF Certified Public Accountants
& COMPANY, P.C. and Business Consultants
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of
Berkshire Hills Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of Berkshire Hills
Bancorp, Inc. and subsidiaries as of December 31, 2004 and 2003, 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, 2004.
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 the standards of the Public Company
Accounting Oversight Board (United States). 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, 2004 and 2003 and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 2004 in conformity with accounting principles
generally accepted in the United States of America.
/s/ Wolf & Company, P.C.
Boston, Massachusetts
March 9, 2005
99 High Street o Boston, Massachusetts o 02210-2320
o Phone 617-439-9700 o Fax 617-542-0400
1500 Main Street o Suite 1908 o Springfield, Massachusetts o 01115
o Phone 413-747-9012 o Fax 413-739-5149
www.wolfandco.com
-52-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2004 and 2003
2004 2003
----------- -----------
(In thousands)
Assets
Cash and due from banks $ 15,237 $ 15,583
Short-term investments 2,665 1,859
----------- -----------
Total cash and cash equivalents 17,902 17,442
Securities available-for-sale, at fair value 365,404 307,425
Securities held-to-maturity (fair value approximates $29,899,000 and
$36,868,000 at December 31, 2004 and 2003, respectively) 29,942 36,903
Federal Home Loan Bank stock, at cost 16,974 12,923
Savings Bank Life Insurance stock, at cost 2,043 2,043
Loans held for sale 1,053 --
Total loans 828,179 792,227
Less: Allowance for loan losses (9,337) (8,969)
----------- -----------
Net loans 818,842 783,258
Premises and equipment, net 14,780 12,626
Accrued interest receivable 5,472 5,080
Goodwill and other intangibles 7,254 10,233
Net deferred tax asset 819 1,725
Bank owned life insurance 18,200 7,721
Due from broker -- 7,089
Other assets 11,430 14,080
----------- -----------
Total assets $ 1,310,115 $ 1,218,548
=========== ===========
Liabilities and Stockholders' Equity
Deposits $ 845,789 $ 830,244
Federal Home Loan Bank advances 327,926 251,465
Loans sold with recourse -- 473
Due to broker -- 5,646
Accrued expenses and other liabilities 4,664 5,293
----------- -----------
Total liabilities 1,178,379 1,093,121
----------- -----------
Minority Interests (Note 19) -- 2,252
----------- -----------
Commitments and contingencies (Notes 6, 12 and 13)
Stockholders' equity:
Preferred stock ($.01 par value; 1,000,000 shares
authorized; none issued or outstanding) -- --
Common stock ($.01 par value; 26,000,000 shares authorized;
7,673,761 shares issued at December 31, 2004 and
2003; shares outstanding: 5,873,563 at December 31, 2004
and 5,903,082 at December 31, 2003) 77 77
Additional paid-in capital 77,588 75,764
Unearned compensation (7,414) (8,507)
Retained earnings 94,996 86,276
Accumulated other comprehensive income 4,214 5,559
Treasury stock, at cost (1,800,198 shares at December 31, 2004 and
1,770,679 at December 31, 2003) (37,725) (35,994)
----------- -----------
Total stockholders' equity 131,736 123,175
----------- -----------
Total liabilities and stockholders' equity $ 1,310,115 $ 1,218,548
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
-53-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2004, 2003 and 2002
2004 2003 2002
-------- -------- --------
(In thousands, except per share data)
Interest and dividend income
Loans $ 43,766 $ 47,683 $ 56,910
Debt securities, taxable 15,207 7,298 5,234
Debt securities, tax-exempt 893 262 173
Equity securities dividends 1,176 956 1,355
Short-term investments 39 109 456
-------- -------- --------
Total interest and dividend income 61,081 56,308 64,128
-------- -------- --------
Interest expense
Deposits 12,393 13,862 17,777
Borrowings 8,331 4,880 5,651
-------- -------- --------
Total interest expense 20,724 18,742 23,428
-------- -------- --------
Net interest income 40,357 37,566 40,700
Provision for loan losses 1,565 1,460 6,180
-------- -------- --------
Net interest income, after provision for loan losses 38,792 36,106 34,520
-------- -------- --------
Non-interest income
Customer service fees 2,347 2,300 2,140
Wealth management service fees 2,697 2,275 1,986
Loan servicing fees 374 386 533
Gain on sales and dispositions of securities, net 1,402 3,077 15,143
Loss on impairment of securities -- -- (673)
Gain on sale of securitized loans 81 -- --
Gain (loss) on sale of loans 85 (1,854) (10,702)
Loss on impairment of other assets -- (206) (1,262)
Penalty on prepayment of FHLB borrowings -- -- (1,067)
Other non-interest income 778 470 329
-------- -------- --------
Total non-interest income 7,764 6,448 6,427
-------- -------- --------
Non-interest expense
Salaries and employee benefits 16,882 16,166 23,295
Occupancy and equipment 4,085 3,800 4,360
Marketing and advertising 991 678 648
Data processing 1,411 1,204 950
Professional services 1,552 1,227 1,152
Foreclosed real estate and repossessed assets, net 522 1,047 3,250
Other non-interest expense 3,534 4,121 3,624
-------- -------- --------
Total non-interest expense 28,977 28,243 37,279
-------- -------- --------
Income from continuing operations before income taxes 17,579 14,311 3,668
Provision for income taxes 5,639 5,161 885
-------- -------- --------
Income from continuing operations 11,940 9,150 2,783
Loss from discontinued operations (653) (282) (1,040)
Income tax benefit (222) (97) (354)
-------- -------- --------
Net loss from discontinued operations (431) (185) (686)
-------- -------- --------
Net income $ 11,509 $ 8,965 $ 2,097
======== ======== ========
Earnings per share
Basic $ 2.18 $ 1.70 $ 0.39
Diluted $ 2.01 $ 1.57 $ 0.36
Weighted average shares outstanding
Basic 5,284 5,266 5,435
Diluted 5,731 5,703 5,867
The accompanying notes are an integral part of these consolidated financial
statements.
-54-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 2004, 2003 and 2002
Accumulated
Additional other
Common paid-in Unearned Retained comprehensive Treasury
stock capital compensation earnings income stock Total
--------- ---------- ------------ --------- ------------- --------- ---------
(In thousands)
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 adjustments
and tax effects -- -- -- -- (13,294) -- (13,294)
---------
Total comprehensive loss (11,197)
---------
Cash dividends declared ($0.48 per share) -- -- -- (2,737) -- -- (2,737)
Treasury stock purchased -- -- -- -- -- (6,989) (6,989)
Exercise of stock options (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:
Net income -- -- -- 8,965 -- -- 8,965
Change in net unrealized gain on
securities available-for-sale, net
of reclassification adjustments
and tax effects -- -- -- -- 17 -- 17
---------
Total comprehensive income -- -- -- -- -- -- 8,982
---------
Cash dividends declared ($0.48 per share) -- -- -- (2,628) -- -- (2,628)
Treasury stock purchased -- -- -- -- -- (7,099) (7,099)
Exercise of stock options (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
---------
Comprehensive income:
Net income -- -- -- 11,509 -- -- 11,509
Change in net unrealized gain on
securities available-for-sale, net
of reclassification adjustments
and tax effects -- -- -- -- (1,345) -- (1,345)
---------
Total comprehensive income -- -- -- -- -- -- 10,164
---------
Reversals from discontinued operations -- 142 -- (142) -- -- --
Cash dividends declared ($0.48 per share) -- -- -- (2,614) -- -- (2,614)
Treasury stock purchased -- -- -- -- -- (2,545) (2,545)
Exercise of stock options (32,415 shares) -- -- -- (33) -- 576 543
Reissuance of treasury stock - other -- 358 -- -- -- 238 596
Change in unearned compensation -- 1,324 1,093 -- -- -- 2,417
--------- --------- --------- --------- --------- --------- ---------
Balance at December 31, 2004 $ 77 $ 77,588 $ (7,414) $ 94,996 $ 4,214 $ (37,725) $ 131,736
========= ========= ========= ========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
-55-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2004, 2003 and 2002
2004 2003 2002
--------- --------- ---------
(In thousands)
Cash flows from operating activities:
Continuing operations:
Net income $ 11,940 $ 9,150 $ 2,783
Adjustments to reconcile net income to net cash
provided by continuing operating activities:
Provision for loan losses 1,565 1,460 6,180
Net amortizaton of securities 1,203 1,795 1,103
Depreciation and amortization expense 1,696 1,614 2,016
Management awards plan expense 1,216 1,066 1,165
Employee stock ownership plan expense 1,378 1,094 887
Amortization of other intangibles 4 -- --
Increase in cash surrender value of bank owned life insurance (479) (221) --
Gain on sales and dispositions of securities, net (1,483) (3,077) (15,143)
Loss on impairment of securities -- -- 673
(Gain) Loss on sale of loans, net (85) 1,854 10,702
Loss on sale/writedown of foreclosed real estate, net 2 44 500
Loss on impairments of other assets -- 206 1,262
Deferred income tax provision (benefit), net 1,521 1,088 (262)
Net change in loans held for sale (1,053) -- 2,540
Net change in accrued interest receivable and other assets 3,574 (829) 5,511
Net change in accrued expenses and other liabilities (629) (384) 747
--------- --------- ---------
Net cash provided by continuing operating activities 20,370 14,860 20,664
--------- --------- ---------
Discontinued operations:
Net loss (653) (282) (1,040)
Adjustments to reconcile net loss to net cash (used)
provided by operating activities:
Depreciation and amortization expense 188 493 398
Amortization of other intangibles 94 203 203
Minority interest (381) (186) (685)
--------- --------- ---------
Net cash (used) provided by discontinued operations (752) 228 (1,124)
--------- --------- ---------
Total net cash provided by operating activities: 19,618 15,088 19,540
--------- --------- ---------
Cash flows from investing activities:
Continuing operations:
Activity in available-for-sale securities:
Sales 16,169 20,349 28,255
Maturities 30,691 130,091 68,232
Principal payments 61,566 33,182 30,096
Purchases (127,633) (302,014) (201,258)
Activity in held-to-maturity securities:
Maturities 15,656 17,195 16,374
Principal payments 12,114 38,876 29,132
Purchases (20,998) (49,242) (56,812)
Purchase of FHLB stock (4,051) (5,483) (413)
Purchase of bank owned life insurance (10,000) (7,500) --
(continued)
The accompanying notes are an integral part of these consolidated financial
statements.
-56-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONCLUDED)
Years Ended December 31, 2004, 2003 and 2002
2004 2003 2002
--------- --------- ---------
(In thousands)
Loan originations and purchases, net of
principal payments (89,458) (153,674) (8,616)
Proceeds from sales of loans 12,737 63,546 66,400
Additions to premises and equipment (4,583) (1,386) (1,042)
Proceeds from sales of foreclosed real estate 23 1,456 --
Net cash paid for acquisitions (1,415) -- --
--------- --------- ---------
Net cash used by continuing investing activities (109,182) (214,604) (29,652)
--------- --------- ---------
Discontinued operations:
Additions to premises and equipment (76) (80) (426)
Proceeds from sale of interest in discontinued operations 1,966 -- --
Proceeds from sale of equipment 621 -- --
--------- --------- ---------
Net cash provided (used) by discontinued investing activities 2,511 (80) (426)
--------- --------- ---------
Total net cash used by investing operations: (106,671) (214,684) (30,078)
--------- --------- ---------
Cash flows from financing activities:
Net increase in deposits 15,545 47,884 39,631
Net decrease in securities sold under
agreements to repurchase -- (700) (1,190)
Proceeds from Federal Home Loan Bank advances 675,500 252,000 120,172
Repayments of Federal Home Loan Bank advances (599,039) (133,537) (121,134)
Increase (decrease) in loans sold with recourse (473) (728) 1,201
Treasury stock purchased (2,545) (7,099) (6,989)
Proceeds from reissuance of treasury stock 1,139 1,191 116
Cash dividends paid (2,614) (2,628) (2,737)
--------- --------- ---------
Net cash provided by financing activities 87,513 156,383 29,070
--------- --------- ---------
Net change in cash and cash equivalents 460 (43,213) 18,532
Cash and cash equivalents at beginning of year 17,442 60,655 42,123
--------- --------- ---------
Cash and cash equivalents at end of year $ 17,902 $ 17,442 $ 60,655
========= ========= =========
Supplemental cash flow information:
Interest paid on deposits $ 12,386 $ 13,887 $ 17,835
Interest paid on borrowed funds 8,073 4,696 6,856
Income taxes paid, net 2,440 4,175 1,618
Transfers from loans to foreclosed real estate 25 -- 2,000
Securitization of and transfer of loans to securities 39,657 16,270 --
Due to broker (5,646) 5,646 --
Due from broker (7,089) 7,089 --
The accompanying notes are an integral part of these consolidated financial
statements.
-57-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2004, 2003 and 2002
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. The Bank's wholly-owned subsidiaries are
North Street Securities Corporation, Gold Leaf Insurance Agency, Inc., Berkshire
Financial Planning, Inc., Gold Leaf Securities Corporation and Woodland
Securities, Inc. North Street Securities Corporation, Gold Leaf Securities
Corporation, and Woodland Securities, Inc. hold certain investment securities.
Gold Leaf Insurance Agency, Inc. offers insurance products to customers.
Berkshire Hills Funding Corporation was established to loan funds to the Bank's
Employee Stock Ownership Plan. Berkshire Hills Technology was formed during 2001
for the purpose of acquiring a controlling interest in EastPoint Technologies,
LLC. Gold Leaf Investment Services was inactive at December 31, 2004. 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 inter-company 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. This acquisition was accounted for under the purchase method of
accounting. The Company's equity interest in EastPoint at December 31, 2003 was
60.3% and represented a total investment of $4.7 million. On June 18, 2004,
Berkshire Hills Technology, Inc. sold the business assets of EastPoint to a
subsidiary of Open Solutions Inc. The transaction resulted in a net loss of
$75,000 to the Company ($49,500 net of taxes), which was included in net loss
from discontinued operations in 2004. The current and prior periods presented
have been adjusted to reflect the sale of EastPoint and the discontinued
operations. Berkshire Hills Technologies, LLC had no assets or operations at
December 31, 2004.
Pending merger
On December 16, 2004, the Company announced that it had entered into a
definitive merger agreement with Woronoco Bancorp, Inc., pursuant to which
Woronoco will merge with and into the Company, with the Company being the
surviving entity. Immediately following that merger, Woronoco Savings Bank, the
wholly-owned subsidiary of Woronoco, will merge with and into Berkshire Bank
with Berkshire Bank being the surviving entity. Under the terms of the
agreement, the stockholders of Woronoco will have the right to elect to receive
either $36.00 in cash or one share of the Company's common stock in exchange for
each Woronoco share held by them, subject to procedures to ensure that 75% of
the outstanding Woronoco common shares are converted into the Company's common
stock and the balance is converted into cash. The completion of the merger is
subject to approval by the stockholders of both companies and customary
regulatory approvals. The merger is expected to close in the second quarter of
2005. This merger agreement had no significant effect on the Company's financial
statements for the periods presented.
Acquisitions
During the fourth quarter of 2004, the Company acquired a bank branch in
Oriskany Falls, New York. The acquisition included $8 million in deposits, real
property related to the branch, and certain other related assets. The Company
also acquired Berkshire Financial Planning, Ltd, merging it into the Bank's
wealth management group. The acquisitions were accounted for as purchase
transactions with the total cash consideration funded through internal sources.
The purchase prices were allocated to the underlying assets and liabilities
based on estimated fair values at the date of acquisition with related
adjustments to goodwill and other intangibles. The operating results of the
acquisitions are included with the Company's results of operations since their
dates of acquisition. The branch acquisition was integral to the expansion
strategy into New York State. The financial planning acquisition strengthened
wealth management services in the core market.
-58-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Business
The Company provides a variety of financial services to individuals,
municipalities and businesses through its offices in Berkshire County and
Eastern New York. 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, wealth management services are offered to individuals and small
businesses in the Berkshire County area, which include trust, financial planning
and investment services.
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 sheets and
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates. Material estimates that are
particularly susceptible to significant change in the near term relate to the
determination of the allowance for loan losses and deferred taxes.
Reclassifications
Certain amounts in the 2003 and 2002 consolidated financial statements have been
reclassified to conform to the 2004 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.
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, with the unrealized gains and losses
determined using the specific identification method.
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 is recorded at fair
value at acquisition as determined by an appraisal performed by independent
investment consultants retained by SBLI.
-59-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Loan sale activities
Residential mortgage loans originated and held for sale are classified
separately in the consolidated balance sheets and reported at the lower of
amortized cost or market value (based on secondary market prices). An adjustment
to reduce these loans to market value was not required at December 31, 2004 and
2003. Gains or losses on sale are determined using the specific identification
method. All loans held for sale were committed for sale when their rates were
locked; loan sale commitments generally are settled within 30 days of closing.
The Company generally sells its fixed rate residential mortgage loans, servicing
released, on a flow basis. The Company also sells participation interests in
commercial loans which the Company holds and services. All sales are made on a
non-recourse basis and there are no transfers that qualify as secured borrowings
at December 31, 2004.
Statement of Financial Accounting Standards ("SFAS") No. 133 as amended by SFAS
No. 149, "Accounting for Derivative Instruments and Hedging Activities,"
establishes accounting and reporting standards for derivative instruments and
hedging activities and requires that all derivatives be recognized on the
balance sheets at fair value. The Company uses forward delivery contracts (sale
commitments) to reduce market risk on (i) closed residential mortgage loans held
for sale and (ii) rate-locked loans (origination commitments) expected to be
closed and held for sale. All such loans are committed for sale without recourse
at prices exceeding cost. Forward sale commitments are entered into with respect
to individual loan origination commitments, with delivery conditional on the
closing of the related loans. The forward sale commitments generally require
delivery within 60 days of closing the related loan and conformity with
secondary market guidelines including loan documentation. Forward sale
commitments and interest rate lock (origination) commitments are recorded in the
consolidated balance sheets at fair value. The Company had no other derivative
instruments under SFAS No. 133 as amended at December 31, 2004 and 2003.
Changes in the fair value of forward sale commitments and related origination
commitments have not been material, and are equal in amount due to the Company's
practice of entering into a sale commitment at the time it issues an origination
commitment for a particular loan. Changes in the fair value of forward sale
commitments, interest rate lock (origination) commitments and hedged loans held
for sale are included in non-interest income in the consolidated income
statement.
Forward sale commitments related to closed loans are accounted for as fair value
hedges under SFAS No. 133. Changes in the fair value of such commitments and
loans are both recorded in the consolidated income statements and, accordingly,
any hedge ineffectiveness is included in reported net income. However, because
the Company's forward sale commitments relate to specific closed loans, changes
in the fair value of the forward commitments offset changes in the fair value of
the related loans and, accordingly, there is no hedge ineffectiveness recognized
as a gain or loss in earnings. All components of the changes in fair value of
the forward sale commitments are included in the assessment of hedge
effectiveness.
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.
-60-
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 to account for losses that are estimated to occur. 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.
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 is computed on the
straight-line method over the estimated useful lives of the assets or terms of
the leases, if shorter.
Goodwill and other intangibles
Goodwill and other intangibles are described in the notes to the consolidated
financial statements. Goodwill and other intangibles are evaluated for
impairment on an annual basis. The Company records as goodwill the excess of
purchase price over the fair value of the identifiable net assets acquired.
Statements of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other
Intangible Assets", prescribes a two-step process for impairment testing of
goodwill, which is performed annually, as well as when an event triggering
impairment may have occurred. The first step tests for impairment, while the
second step, if necessary, measures the impairment.
Securities sold under agreements to repurchase
Occasionally, the Company enters into repurchase agreements with 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.
-61-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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. SFAS No. 123 was revised as
SFAS No. 123R in December 2004, with an effective date for the Company of July
2005. This revision is discussed further in the "Recent Accounting
Pronouncements" section of this Note.
At December 31, 2004, the Company maintains stock-based compensation plans,
which are described more fully in Note 15. 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,
-------------------------------------
2004 2003 2002
------- ------- -------
(In thousands, except per share data)
Net income, as reported $11,509 $ 8,965 $ 2,097
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects (434) (398) (324)
------- ------- -------
Pro forma net income $11,075 $ 8,567 $ 1,773
======= ======= =======
Earnings per share:
Basic-as reported $ 2.18 $ 1.70 $ 0.39
======= ======= =======
Basic-pro forma $ 2.10 $ 1.63 $ 0.33
======= ======= =======
Diluted-as reported $ 2.01 $ 1.57 $ 0.36
======= ======= =======
Diluted-pro forma $ 1.93 $ 1.50 $ 0.30
======= ======= =======
-62-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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.
Earnings per common share
Basic earnings per share is determined by dividing net income by the average
number of net outstanding common shares for the period. The net outstanding
common shares equals the gross number of common shares issued less Treasury
Stock repurchased, unallocated shares of the Employee Stock Ownership Plan, and
unallocated shares of stock awards granted under the Company's stock based
compensation plans. This number is computed daily and averaged for the period.
Diluted earnings per share is determined by dividing net income by the average
number of net outstanding common shares computed as if all options granted under
the Company's stock based compensation plans were exercised. The average number
of net outstanding common shares used for the basic computation is increased by
the unallocated shares of stock awards under the Company's stock based
compensation plans and by the additional diluted shares calculated by the
Treasury Stock method.
Earnings per common share have been computed based upon the following:
Years Ended December 31,
------------------------------------
2004 2003 2002
-------- -------- --------
(In thousands, except per share data)
Net income applicable to common stock $ 11,509 $ 8,965 $ 2,097
======== ======== ========
Average number of common shares outstanding 5,895 5,951 6,126
Less: average number of unallocated ESOP shares (436) (473) (510)
Less: average number of unvested stock award shares (175) (212) (181)
-------- -------- --------
Average number of basic shares outstanding 5,284 5,266 5,435
Plus: average number of unvested stock award shares 175 212 251
Plus: average number of dilutive shares based on stock options 272 225 181
-------- -------- --------
Average number of diluted shares outstanding 5,731 5,703 5,867
======== ======== ========
Basic earnings per share $ 2.18 $ 1.70 $ 0.39
Diluted earnings per share $ 2.01 $ 1.57 $ 0.36
-63-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
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.
The components of other comprehensive income and related tax effects are as
follows for the years ended December 31, 2004, 2003 and 2002:
2004 2003 2002
-------- -------- --------
(In thousands)
Change in net unrealized holding gains/losses
on available-for-sale securities $ (477) $ 2,297 $ (5,151)
Reclassification adjustment for gains
realized in income (1,483) (3,077) (15,143)
Reclassification adjustment for impairment
losses recognized in income -- -- 673
-------- -------- --------
Net change in unrealized gains/losses (1,960) (780) (19,621)
Tax effects 615 797 6,327
-------- -------- --------
Net-of-tax change $ (1,345) $ 17 $(13,294)
======== ======== ========
-64-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (concluded)
Business segments
An operating segment is a component of a business for which separate financial
information is available that is evaluated regularly by the chief operating
decision-maker in deciding how to allocate resources and evaluate performance.
The Company's operations are limited to financial services provided within the
framework of a community bank, and decisions are based generally on specific
market areas and or product offerings. Accordingly, based on the financial
information which is presently evaluated by the Company's chief operating
decision-maker, the Company operates in a single business segment.
Off-balance sheet financial instruments
In the ordinary course of business, the Bank enters into off-balance sheet
financial instruments, consisting primarily of credit related financial
instruments. These financial instruments are recorded in the consolidated
financial statements when they are funded or related fees are incurred or
received.
Recent accounting pronouncements
In December 2004, the Financial Accounting Standards Board issued a revision to
Standard No. 123, "Share-Based Payment (Revised 2004)" (SFAS 123R). SFAS 123R
establishes standards for the accounting for transactions in which an entity (i)
exchanges its equity instruments for goods or services, or (ii) incurs
liabilities in exchange for goods or services that are based on the fair value
of the entity's equity instruments or that may be settled by the issuance of the
equity instruments. SFAS 123R eliminates the ability to account for stock-based
compensation using APB 25 and requires that such transactions be recognized as
compensation cost in the income statement based on the fair value on the date of
the grant. SFAS 123R is effective for the Company on July 1, 2005. Under the
modified prospective application, as it is applicable to the Company, SFAS 123R
applies to new awards and to awards modified, repurchased, or cancelled after
July 1, 2005. Additionally, compensation cost for the portion of awards for
which the requisite service has not been rendered (generally referring to
non-vested awards) that are outstanding as of July 1, 2005 must be recognized as
the remaining requisite service is rendered during the period of and/or the
periods after the adoption of SFAS 123R. This statement allows the use of
valuation methods other than the Black-Scholes model. Therefore, the proforma
costs of stock-option expense estimated in Note 1, may not be representative of
the costs recognized by the Company upon adoption. The Company is in the process
of analyzing the adoption alternatives under this statement and has not
determined its impact on the Company's consolidated financial statements.
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.
-65-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (concluded)
Recent accounting pronouncements (concluded)
In March 2004, the Emerging Issues Task Force ratified Issue No. 03-1, "The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments" (EITF 03-1). EITF 03-1 provides guidance for determining when an
investment is considered impaired, whether impairment is other-than-temporary,
and measurement of an impairment loss. An investment is considered impaired if
the fair value of the investment is less than its cost. Generally, an impairment
is considered other-than-temporary unless: (i) the investor has the ability and
intent to hold an investment for a reasonable period of time sufficient for an
anticipated recovery of fair value up to (or beyond) the cost of the investment;
and (ii) evidence indicating that the cost of the investment is recoverable
within a reasonable period of time outweighs evidence to the contrary. If
impairment is determined to be other-than-temporary, then an impairment loss
should be recognized equal to the difference between the investment's cost and
its fair value. The disclosure, recognition and measurement provisions were
initially effective for other-than-temporary impairment evaluations in reporting
periods beginning after June 15, 2004. However, in September 2004, the effective
date of these provisions was delayed until the finalization of a FASB Staff
Position to provide additional implementation guidance. The Company has not
determined the effect that EITF 03-1 will have on its consolidated financial
statements, pending review of the planned additional implementation guidance.
SEC Staff Accounting Bulletin (SAB) No. 105, "Application of Accounting
Principles to Loan Commitments." SAB 105 summarizes the views of the staff of
the SEC regarding the application of generally accepted accounting principles to
loan commitments accounted for as derivative instruments. SAB 105 provides that
the fair value of recorded loan commitments that are accounted for as
derivatives under SFAS 133, "Accounting for Derivative Instruments and Hedging
Activities," should not incorporate the expected future cash flows related to
the associated servicing of the future loan. In addition, SAB 105 requires
registrants to disclose their accounting policy for loan commitments. The
provisions of SAB 105 must be applied to loan commitments accounted for as
derivatives that are entered into after March 31, 2004. The adoption of this
accounting standard did not have a material impact on the Company's consolidated
financial statements.
SOP No. 03-3, "Accounting for Certain Loans or Debt Securities Acquired in a
Transfer." SOP 03-3 addresses accounting for differences between the contractual
cash flows of certain loans and debt securities and the cash flows expected to
be collected when loans or debt securities are acquired in a transfer and those
cash flow differences are attributable, at least in part, to credit quality. As
such, SOP 03-3 applies to loans and debt securities acquired individually, in
pools or as part of a business combination and does not apply to originated
loans. The application of SOP 03-3 limits the interest income, including
accretion of purchase price discounts, that may be recognized for certain loans
and debt securities. Additionally, SOP 03-3 does not allow the excess of
contractual cash flows over cash flows expected to be collected to be recognized
as an adjustment of yield, loss accrual or valuation allowance, such as the
allowance for possible loan losses. SOP 03-3 requires that increases in expected
cash flows subsequent to the initial investment be recognized prospectively
through adjustment of the yield on the loan or debt security over its remaining
life.
Decreases in expected cash flows should be recognized as impairment. In the case
of loans acquired in a business combination where the loans show signs of credit
deterioration, SOP 03-3 represents a significant change from current purchase
accounting practice whereby the acquiree's allowance for loan losses is
typically added to the acquirer's allowance for loan losses. SOP 03-3 is
effective for loans and debt securities acquired by the Company beginning
January 1, 2005. The adoption of this new standard is not expected to have a
material impact on the Company's consolidated financial statements.
-66-
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, 2004 and 2003,
cash and due from banks included $2,079,000 and $1,129,000, respectively, to
satisfy such reserve requirements.
3. SHORT-TERM INVESTMENTS
- --------------------------------------------------------------------------------
Short-term investments consisted of the following at December 31, 2004 and 2003:
2004 2003
------ ------
(In thousands)
Federal funds sold $2,600 $ --
FHLB overnight deposits 65 1,859
------ ------
$2,665 $1,859
====== ======
-67-
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, was as follows:
December 31, 2004
------------------------------------------------
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 $ 1,106 $ 13 $ (6) $ 1,113
Municipal bonds and obligations 19,169 99 (96) 19,172
Other bonds and obligations 8,977 45 (45) 8,977
Mortgaged-backed securities:
FHLMC/FNMA/GNMA 323,548 1,829 (3,227) 322,150
REMICs and CMOs 408 28 (1) 435
Asset-backed securities 441 11 -- 452
-------- -------- -------- --------
Total debt securities 353,649 2,025 (3,375) 352,299
Marketable equity securities 5,193 7,912 -- 13,105
-------- -------- -------- --------
Total securities
available-for-sale $358,842 $ 9,937 $ (3,375) $365,404
======== ======== ======== ========
Securities Held-to-Maturity
Debt securities:
Municipal bonds and obligations $ 11,580 $ -- $ -- $ 11,580
Mortgaged-backed securities:
FHLMC/FNMA 3,381 9 (31) 3,359
REMICs and CMOs 1,334 -- (21) 1,313
Other bonds and obligations 13,647 -- -- 13,647
-------- -------- -------- --------
Total securities
held-to-maturity $ 29,942 $ 9 $ (52) $ 29,899
======== ======== ======== ========
-68-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (continued)
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
REMICs and CMOs 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 securities 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
REMICs and CMOs 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
======== ======== ======== ========
-69-
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, 2004 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 $ 4,882 $ 4,922 $ 8,634 $ 8,634
Over 1 year to 5 years 615 611 3,769 3,769
Over 5 years to 10 years 4,828 4,814 6,307 6,307
Over 10 years 18,927 18,915 6,517 6,517
-------- -------- -------- --------
Total bonds and obligations 29,252 29,262 25,227 25,227
Mortgage-backed and asset-backed
securities 324,397 323,037 4,715 4,672
-------- -------- -------- --------
Total debt securities $353,649 $352,299 $ 29,942 $ 29,899
======== ======== ======== ========
At December 31, 2004 and 2003, the Company had pledged securities with an
amortized cost of $1,000,000, and a fair value of $1,013,000 and $1,022,000,
respectively, as collateral for its treasury tax and loan account.
For the years ended December 31, 2004, 2003 and 2002, proceeds from the sales of
securities available-for-sale amounted to $16,169,000, $20,349,000 and
$28,255,000, respectively. Gross realized gains amounted to $1,914,000,
$3,371,000 and $16,111,000, respectively. Gross gains in 2004 included $81,000
in gross gains on the sale of securitized mortgages. Gross realized losses
amounted to $431,000, $294,000 and $968,000, respectively.
-70-
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, 2004 and 2003, aggregated by investment category and length of time that
individual securities have been in a continuous loss position, follows:
December 31, 2004
-------------------------------------------------
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 $ 75 $ 9,338 $ 73 $ 5,353
Mortgaged-backed securities 1,474 138,873 1,753 87,220
-------- -------- -------- --------
Total securities
available-for-sale 1,549 148,211 1,826 92,573
-------- -------- -------- --------
Securities Held-to-Maturity
Mortgaged-backed securities 13 1,155 39 2,930
-------- -------- -------- --------
Total temporarily
Impaired securities $ 1,562 $149,366 $ 1,865 $105,503
======== ======== ======== ========
December 31, 2003
-------------------------------------------------
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
-------- -------- -------- --------
Total temporarily
Impaired securities $ 1,625 $135,507 $ 470 $ 2,038
======== ======== ======== ========
Based on management's review, there were no write-downs of impaired securities
in 2004 and 2003; write-downs of $673,000 were recorded in 2002. The Company did
not own any equity securities with unrealized losses at December 31, 2004. None
of its rated debt securities were rated below investment grade at that date, and
all securities were performing in accordance with their terms. At December 31,
2004, these impairments were deemed to be temporary and related to changes in
market interest rates, and are not related to the underlying credit quality of
the issuers. The Company expects that these securities will continue to perform
in accordance with their terms. The unrealized losses primarily relate to pass
through adjustable rate mortgage backed securities issued by Fannie Mae and
Freddie Mac. The Company has the intent and ability to hold these investments
for a time necessary to recover the amortized cost.
-71-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. LOANS
- --------------------------------------------------------------------------------
A summary of the balances of loans at December 31, 2004 and 2003 follows:
2004 2003
-------- --------
(In thousands)
One- to four-family mortgage $232,498 $266,753
Commercial mortgage 207,619 154,244
Multi-family mortgage 16,380 15,514
Construction and land development 38,702 34,719
Home equity lines of credit 54,157 45,783
Consumer 127,122 108,180
Commercial 150,932 166,451
-------- --------
Loans subtotal 827,410 791,644
Net deferred loan origination costs 574 110
Unamortized discount on purchased loans 195 473
-------- --------
Total loans $828,179 $792,227
======== ========
An analysis of the allowance for loan losses for the years ended December 31,
2004, 2003 and 2002 follows:
2004 2003 2002
-------- -------- --------
(In thousands)
Balance at beginning of year $ 8,969 $ 10,308 $ 11,034
Provision for loan losses 1,565 1,460 6,180
Loans charged-off (2,202) (4,364) (10,028)
Recoveries 1,005 1,565 3,122
-------- -------- --------
Balance at end of year $ 9,337 $ 8,969 $ 10,308
======== ======== ========
-72-
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, 2004 and 2003:
2004 2003
------ ------
(In thousands)
Impaired loans with no valuation allowance $ 787 $ 388
Impaired loans with a valuation allowance 393 1,994
------ ------
Total impaired loans $1,180 $2,382
====== ======
Specific valuation allowance allocated to impaired loans $ 230 $ 267
====== ======
Non-accrual loans $1,152 $3,199
====== ======
Total loans past due ninety days or more and
still accruing $ 65 $ 306
====== ======
For the years ended December 31, 2004, 2003 and 2002, the average recorded
investment in impaired loans amounted to $2,412,000, $2,693,000 and $2,308,000,
respectively. The Company recognized $18,000, $14,000 and $85,000, respectively,
of interest income on impaired loans, during the period that they were impaired,
on the cash basis. No additional funds are committed to be advanced in
connection with impaired loans.
Interest income that would have been recorded had nonaccruing loans been current
totaled $173,000, $165,000 and $188,000 for the years ended December 31, 2004,
2003 and 2002, respectively.
At December 31, 2004 and 2003, troubled debt restructurings totaled $510,000 and
$214,000, respectively. These loans were classified as impaired and did not
require a specific valuation allowance. They were restructured to extend the
payment schedule. Interest income recorded on these loans while they were
impaired totaled $14,000 and $13,000 in 2004 and 2003, respectively. There were
no commitments to lend additional funds to these debtors.
There was no foreclosed real estate at December 31, 2004 or 2003.
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 $47,600,000 and $24,878,000 at December 31,
2004 and 2003, respectively, which includes $45,516,000 and $16,270,000 in
securitized mortgages in 2004 and 2003. Additionally, consumer loans sold and
serviced for others amounted to $1,742,000 and $7,159,000 at December 31, 2004
and 2003, respectively.
The balance of sold commercial loan participations totaled $12,943,000 and
$7,969,000 at December 31, 2004 and 2003. Of this amount, certain participation
agreements provide the Bank with the optional right to repurchase the
participations at par. Those agreements more recent than March 31, 2001, totaled
$2,425,000 and $160,000 at December 31, 2004 and 2003. These amounts were
considered by the Bank to be immaterial for the purpose of applying the
provisions of SFAS No. 140.
The estimated fair value of commitments to extend credit is considered
insignificant at December 31, 2004 and 2003. In its credit commitments, the
Company does not normally provide interest rate locks exceeding sixty days, and
most credit commitments are for adjustable rate loans.
Forward commitments are used to sell residential mortgage loans, which are
entered into for the purpose of reducing the market risk associated with
originating loans held for sale. The types of risk that may arise are from the
possible inability of the Company or the other party to fulfill the contracts.
At December 31, 2004, total loans held for sale were $1,053,000 consisting
entirely of fixed rate residential mortgage loans. The Company had best efforts
forward delivery sales contracts for all of these loans, with a fair value of
$14,000. Additionally, the Company had rate locked applications in process
totaling $2,246,000, which were also backed by best efforts forward delivery
sales contracts with a fair value of $31,000.
-73-
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, 2004 and
2003:
Estimated
2004 2003 Useful Lives
-------- -------- ------------
(In thousands)
Banking premises:
Land $ 1,587 $ 1,558
Buildings and improvements 20,232 18,448 5 -50 years
Equipment 12,751 11,467 2 -38 years
Construction in process 1,491 550
-------- --------
36,061 32,023
Accumulated depreciation and
amortization (21,281) (19,397)
-------- --------
$ 14,780 $ 12,626
======== ========
The majority of construction in process in 2004 was software, hardware and
related costs in conjunction with the Bank's core systems conversion project,
which was targeted for completion in the first half of 2005. The total cost of
this project was estimated at $2,887,000, of which $1,371,000 had been disbursed
at December 31, 2004, and an additional $1,406,000 had been committed at that
date.
Construction in process in 2003 related to computer conversion costs and
renovations to the Great Barrington branch. The projects were completed during
2004 and costs were transferred to the applicable categories.
Depreciation and amortization expense for the years ended December 31, 2004,
2003 and 2002 amounted to $1,884,000, $2,107,000 and $2,414,000, respectively.
7. OTHER ASSETS
- --------------------------------------------------------------------------------
Other assets consisted of the following at December 31, 2004 and 2003:
2004 2003
------- -------
(In thousands)
Prepaid dealer reserves $ 3,460 $ 3,196
Repossessed vehicles 274 352
Cash surrender values, life insurance 5,862 5,425
Other 1,834 5,107
------- -------
Total other assets $11,430 $14,080
======= =======
-74-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. GOODWILL AND OTHER INTANGIBLES
- --------------------------------------------------------------------------------
Goodwill totaled $6,782,000 and $10,132,000 at December 31, 2004 and 2003,
respectively. At both dates, goodwill included a net balance of $5,763,000
related to branch acquisitions in prior years, net of $1,700,000 in accumulated
amortization. Additionally, goodwill at December 31, 2004 included $1,019,000
related to the Oriskany Falls branch acquisition in October 2004 and the
Berkshire Financial Planning, Ltd. acquisition in December 2004. In 2003,
goodwill included a total of $4,369,000 related to the Company's investment in
EastPoint Technologies, LLC, which was sold for cash in June 2004, with a
$75,000 loss recorded on sale. 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.
Other intangibles totaled $472,000 and $101,000 at December 31, 2004 and 2003,
respectively, and were net of accumulated amortization totaling $4,000 and
$507,000 at those dates, respectively. In 2004, other intangibles represented
core deposit intangibles for the Oriskany Falls branch acquisition and the value
of customer relationships related to the Berkshire Financial Planning, Ltd.
acquisition. In 2003, other intangibles represented the unamortized balance of
EastPoint customer relationships, which were sold in June 2004. Amortization of
other intangible assets totaled $98,000, $203,000 and $203,000 for the years
ended December 31, 2004, 2003 and 2002. Other intangibles related to the
Oriskany Falls branch acquisition are being amortized over ten years on a
straight-line basis; other intangibles related to the Berkshire Financial
Planning, Ltd. purchase are being amortized over five years on a straight-line
basis. The estimated future annual amortization expense for other intangibles is
$73,000 for the years 2005, 2006, 2007 and 2008; $69,000 for 2009; and $111,000
for later years.
Included in other assets are capitalized mortgage servicing rights with a net
balance of $279,000 and $100,000 at December 31, 2004 and 2003, respectively.
These rights are associated with the residential mortgage securitizations to the
Federal National Mortgage Association (Fannie Mae) in 2004 and 2003. Mortgage
servicing rights represent the capitalized net present value of fee income
streams generated from servicing residential mortgage loans for this investor.
The Company utilized a discounted cash flow analysis prepared by a third party
appraiser to estimate the fair value at origination and to evaluate the asset on
a quarterly basis. The fair value approximated the net carrying value for
mortgage servicing rights at December 31, 2004 and 2003. The amortization
expense for mortgage servicing rights totaled $54,000 in 2004; there was no
amortization expense in 2003 or 2002. The estimated future annual amortization
expense for mortgage servicing rights is summarized as follows: 2005 - $49,000;
2006 - $41,000; 2007 - $34,000; 2008 - $28,000; 2009 - $23,000; and later years
- - $104,000.
-75-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. DEPOSITS
- --------------------------------------------------------------------------------
A summary of deposit balances, by type, is as follows at December 31, 2004 and
2003:
2004 2003
-------- --------
(In thousands)
Demand $110,129 $102,788
Savings (including escrow) 163,264 171,603
NOW 100,709 94,606
Money market 156,412 139,897
-------- --------
Total non-certificate accounts 530,514 508,894
-------- --------
Term certificates less than $100,000 175,177 180,257
Term certificates of $100,000 or more 140,098 141,093
-------- --------
Total certificate accounts 315,275 321,350
-------- --------
Total deposits $845,789 $830,244
======== ========
Interest expense on deposits is summarized as follows:
2004 2003 2002
------- ------- -------
(In thousands)
NOW $ 88 $ 155 $ 623
Money market 2,070 1,648 1,988
Savings 1,296 1,731 2,669
Certificate accounts 8,939 10,328 12,497
------- ------- -------
Total $12,393 $13,862 $17,777
======= ======= =======
A summary of certificate accounts by maturity is as follows at December 31, 2004
and 2003:
2004 2003
-------------------- --------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
-------- -------- -------- --------
(Dollars in thousands)
Within 1 year $177,265 2.22% $219,622 2.20%
Over 1 year to 3 years 92,231 3.27 55,084 3.61
Over 3 years 45,779 4.60 46,644 5.04
-------- --------
$315,275 2.87% $321,350 2.85%
======== ========
-76-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. BORROWINGS
- --------------------------------------------------------------------------------
Federal Home Loan Bank Advances
A summary of outstanding advances from the Federal Home Loan Bank of Boston, by
contractual maturity, is as follows at December 31, 2004 and 2003:
2004 2003
--------------------- ---------------------
Weighted Weighted
Average Average
Amount Rate Amount Rate
-------- -------- -------- --------
(Dollars in thousands)
Fixed rate advances maturing:
2004 $ -- % $125,000 1.43%
2005 152,589* 2.32 17,670* 2.68
2006 39,627 2.82 25,627 2.81
2007 61,946* 3.29 34,397 3.43
2008 10,000 3.53 5,000 1.25
2009 27,000 4.42 7,000 5.40
2010 20,000 5.84 20,000 5.84
2011 10,610 4.46 10,610 4.47
2013 6,000 5.19 6,000 5.18
2022 154* 2.00 161* 2.00
-------- --------
Total FHLB advances $327,926 3.11% $251,465 2.61%
======== ========
----------
* Amortizing advances requiring monthly principal and interest
payments.
Certain FHLB advances are callable in the amount of $47,000,000 during 2005.
These advances are reported based on their scheduled maturity in the summary
table above.
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 $13,055,000 and the line of credit may be increased to 2% of the
Bank's total assets in accordance with the credit policy of the Federal Home
Loan Bank of Boston. Additionally, the Bank utilizes overnight cash management
borrowings from the Federal Home Loan Bank of Boston. 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.
Securities sold under agreement 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. There were no securities sold under agreements to
repurchase in 2004. There were no outstanding securities sold under agreements
to repurchase at December 31, 2003. During 2003, the average amount outstanding
during the year was $88,000; the highest month-end balance was $500,000; and the
weighted average interest rate during the year was 1.24%.
The Bank has a $50,000,000 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, 2004 and 2003, there were no outstanding borrowings against this
agreement.
-77-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. INCOME TAXES
- --------------------------------------------------------------------------------
Allocation of federal and state income tax expense between current and deferred
portions is as follows for the years ended December 31, 2004, 2003 and 2002:
2004 2003 2002
------- ------- -------
(In thousands)
Current
Federal $ 3,632 $ 3,210 $ 644
State 264 766 149
------- ------- -------
3,896 3,976 793
------- ------- -------
Deferred
Federal 875 848 (171)
State 188 240 (91)
------- ------- -------
1,063 1,088 (262)
------- ------- -------
Change in valuation reserve 458 -- --
------- ------- -------
$ 5,417 $ 5,064 $ 531
======= ======= =======
The reasons for the differences between the statutory federal income tax rate
and the effective tax rates are summarized as follows for the years ended
December 31, 2004, 2003 and 2002:
2004 2003 2002
----- ----- -----
Statutory tax rate 35.0% 34.0% 34.0%
Increase (decrease) resulting from:
State taxes, net of federal tax benefit 1.7 4.7 1.5
Dividends received deduction (0.9) (1.1) (8.1)
Tax exempt income - investments (2.4) (0.9) (6.1)
Bank owned life insurance (1.3) (0.8) (1.0)
Valuation reserve 2.7 -- --
Other, net (2.8) (0.2) (0.1)
----- ----- -----
Effective tax rate 32.0% 35.7% 20.2%
===== ===== =====
The components of the net deferred tax asset were as follows at December 31,
2004 and 2003:
2004 2003
------- -------
(In thousands)
Deferred tax asset:
Federal $ 4,400 $ 4,789
State 1,199 1,234
Valuation reserve on asset (458) --
------- -------
5,141 6,023
------- -------
Deferred tax liability:
Federal (3,621) (3,879)
State (701) (419)
------- -------
(4,322) (4,298)
------- -------
Net deferred tax asset $ 819 $ 1,725
======= =======
-78-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
INCOME TAXES (concluded)
The tax effects of each item that gives rise to deferred taxes are as follows at
December 31, 2004 and 2003:
2004 2003
------- -------
(In thousands)
Allowance for loan losses $ 3,906 $ 3,671
Employee benefit plans 747 1,000
Charitable contribution carryover 519 824
Net unrealized gain on securities held for sale (2,348) (2,963)
Goodwill amortization (624) (416)
Investments (693) (350)
Other (230) (41)
Valuation reserve (458) --
------- -------
Deferred tax asset, net $ 819 $ 1,725
======= =======
A summary of the change in the net deferred tax asset (liabilities) was as
follows for the years ended December 31, 2004, 2003 and 2002:
2004 2003 2002
------- ------- -------
(In thousands)
Balance at beginning of year $ 1,725 $ 2,016 $(4,573)
Deferred tax (expense) benefit (1,063) (1,088) 262
Change in deferred tax effects of net unrealized
gains/losses on securities available for sale 615 797 6,327
Change in valuation reserve (458) -- --
------- ------- -------
Balance at end of year $ 819 $ 1,725 $ 2,016
======= ======= =======
There is a contribution carryover that was generated during the year ended 2000,
which expires in 2005. Management believes that the deferred tax asset related
to this contribution carryover will be realized. However, at December 31, 2004,
management believed that it was more likely than not that the state deferred tax
asset attributable to the Bank will not be realized. Thus, a valuation reserve
has been established in the amount of $458,000. No valuation reserve was
established at December 31, 2003 or December 31, 2002.
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 it was 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 it is 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.
-79-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
12. 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 is as
follows at December 31, 2004 and 2003:
2004 2003
------- -------
(In thousands)
Commitments to grant loans $35,587 $26,854
Unused funds on commercial lines-of-credit 44,188 49,380
Unadvanced funds on home equity, reddi-cash and
other consumer lines of credit 58,128 46,904
Unadvanced funds on construction loans 27,620 18,069
Standby letters of credit 3,575 1,811
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. The commitments for lines of credit may expire without
being drawn upon. Therefore, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness on a case-by-case basis. Funds to be disbursed for loans and
home equity lines of credit are collateralized by real estate. Commercial lines
of credit are generally secured by business assets and securities. Reddi-cash
lines of credit are unsecured.
Standby letters of credit are conditional commitments issued by the 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.
-80-
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, 2004, pertaining to premises and equipment, future minimum rent commitments
are as follows:
Years Ending
December 31, (In thousands)
------------
2005 $ 491
2006 498
2007 493
2008 481
2009 481
Thereafter 1,741
------
$4,185
======
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, 2004, 2003 and 2002 amounted to $401,000, $371,000 and
$391,000, 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. This commitment
was fulfilled in 2004 and no further commitment was made in 2004.
-81-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
13. STOCKHOLDERS' EQUITY
- --------------------------------------------------------------------------------
Minimum regulatory capital requirements
The Bank is subject to various regulatory capital requirements administered by
the federal and state banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company's consolidated financial statements. Under
capital adequacy guidelines and the regulatory framework for prompt corrective
action, the Bank must meet specific capital guidelines that involve quantitative
measures of its assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. The capital amounts and
classification are also subject to qualitative judgments by the regulators about
components, risk weighting and other factors. 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 believed, as of December 31, 2004 and 2003, that the Bank
met the capital adequacy requirements.
As of December 31, 2004, Berkshire Bank met the conditions to be classified as
"well capitalized" under the regulatory framework for prompt corrective action.
To be categorized as well capitalized, an institution must maintain minimum
total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in
the following tables.
The Company and Bank's actual capital amounts and ratios as of December 31, 2004
and 2003 are presented in the following table.
December 31, 2004
---------------------------------------------------------------------------
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. $133,166 14.24% N/A N/A N/A N/A
Berkshire Bank 118,554 12.69 $ 74,766 8.00% $ 93,457 10.00%
Tier 1 capital to risk weighted assets:
Berkshire Hills Bancorp, Inc. 120,269 12.86 N/A N/A N/A N/A
Berkshire Bank 105,656 11.31 37,383 4.00 56,074 6.00
Tier 1 capital to average assets:
Berkshire Hills Bancorp, Inc. 120,269 9.18 N/A N/A N/A N/A
Berkshire Bank 105,656 8.08 52,324 4.00 65,405 5.00
-82-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCKHOLDERS' EQUITY (concluded)
Minimum regulatory capital requirements (concluded)
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 106,542 12.55 $ 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 93,806 11.05 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 93,806 7.87 47,664 4.00 59,580 5.00
Common stock
A dividend reinvestment/stock purchase plan is available to all shareholders of
record of the Company's common stock, and permits cash contribution, the
reinvestment of all cash dividends, the deposit of shares for safekeeping and
the sale and gifting of shares held under the plan. A total of 171,197 common
shares were participating in this plan at December 31, 2004. All shares
purchased pursuant to the operations of the plan are purchased in open market
transactions.
In April 2002, the Company announced a fifth repurchase program for 312,516
shares, or 5%, of its outstanding common stock. In June 2003, the Company
announced the completion of the fifth program at an average price of $23.08 per
share. It also announced a sixth stock repurchase program of up to 300,000
shares, or approximately 5%, of its outstanding common stock, continuing until
its completion. At December 31, 2004, the Company had 111,955 shares remaining
to be purchased under this program.
The Company and the Bank are subject to dividend restrictions imposed by various
regulators, including a limitation on the total of all dividends that the Bank
may pay to the Company in any calendar year, to an amount that shall not exceed
the Bank's net income for the current year, plus the Bank's net income retained
for the two previous years, without regulatory approval. In addition, the Bank
may not declare or pay dividends on, and the Company may not repurchase, any of
its shares of common stock if the effect thereof would cause stockholders'
equity to be reduced below applicable regulatory capital maintenance
requirements or if such declaration, payment or repurchase would otherwise
violate regulatory 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.
-83-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
14. EMPLOYEE BENEFIT PLANS
- --------------------------------------------------------------------------------
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 contributes a non-elective 3% of
gross annual wages for each participant, regardless of the participant's
deferral, in addition to a 100% match up to 4% of gross annual wages. The
Company made total contributions which amounted to $624,000, $603,000 and
$640,000, respectively, for the years ended December 31, 2004, 2003 and 2002.
Supplemental executive retirement plan
The Company has maintained nonqualified supplemental executive retirement plans
for the benefit of two senior executives. Benefits generally commence no earlier
than age sixty-two and are payable at the executive's option, either as an
annuity or in a lump sum. As of December 31, 2004 and 2003, the Company had an
accrued expense payable in the amount of $120,000 and $1,007,000, respectively,
representing the present value of future payments under these plans.
Supplemental retirement expense was $111,000 and $247,000 for the years ended
December 31, 2004 and 2003, respectively. There was no expense recorded for the
year ended December 31, 2002. In the year ended December 31, 2004, the Company
paid out the accrued liability of $997,000 representing the accrued plan benefit
for one of these executives and this plan was terminated. In some instances, the
Company previously entered into split-dollar life insurance agreements with
former 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 in the fiscal year.
The structure of the Plan is reviewed annually by the Compensation Committee.
Incentive compensation expense for the years ended December 31, 2004, 2003 and
2002 amounted to $900,000, $925,000 and $620,000, 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, 2004 and 2003, the Company had an accrued liability in the amount
of $411,000 and $428,000, respectively, for payment of future premiums under
this plan. The Company recorded expense of $50,000 in 2004 in relation to this
plan; no plan expense was recorded in 2003 or 2002.
-84-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
15. STOCK-BASED COMPENSATION PLANS AND EMPLOYEE STOCK OWNERSHIP PLAN
- --------------------------------------------------------------------------------
Stock options
Under the Company's 2001 Stock-Based Incentive Plan, the Company may grant
options to its directors, officers and employees for up to 767,366 shares of
common stock. Under the Company's 2003 Equity Compensation Plan, the Company may
grant up to 300,000 options or stock awards to its directors, officers and
employees. For both stock option plans, shares may be issued or transferred
pursuant to the exercise of options to purchase shares of common stock. 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 granted
under the 2001 Plan vest at 20% per year. Option and stock awards under the 2003
Plan vest based on a schedule established at the time of the award. Both
incentive stock options and non-statutory stock options may be granted under
these plans.
A summary of the status of the Company's stock options for the years ended
December 31, 2004, 2003 and 2002 are presented below:
2004 2003 2002
------------------------ ------------------------ ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
--------- --------- --------- --------- --------- ---------
Fixed Options:
Outstanding at beginning of year 649,927 $ 17.80 600,848 $ 16.75 767,366 $ 16.75
Granted 36,450 37.80 120,143 22.44 -- --
Exercised (32,415) 16.75 (71,064) 16.75 (6,907) 16.75
Forfeited (10,208) 18.81 -- -- (159,611) 16.75
--------- --------- ---------
Outstanding at end of year 643,754 18.97 649,927 17.80 600,848 16.75
========= ========= =========
Options exercisable at year-end 316,926 $ 17.18 189,081 $ 16.75 146,573 $ 16.75
Weighted-average fair value of
options granted during the year $ 7.98 $ 6.15 $ --
-85-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCK-BASED COMPENSATION PLANS 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
Black-Scholes option-pricing model with the following weighted-average
assumptions:
Years Ended December 31,
------------------------
2004 2003
------- -------
Dividend yield 1.85% 1.85%
Expected life 6 years 10 years
Expected volatility 21.04% 20.34%
Risk-free interest rate 3.17% 3.85%
No options were granted during the year ended December 31, 2002.
Information pertaining to options outstanding at December 31, 2004 are as
follows:
Options Outstanding Options Exercisable
-------------------------- -----------------------
Weighted
Average Weighted
Remaining Average
Number Contractual Number Exercise
Grant Period Outstanding Life Exercisable Price
------------ ----------- ----------- ----------- --------
2001 488,161 6.08 years 292,897 $ 16.75
2003 120,143 8.10 years 24,029 22.44
2004 35,450 9.08 years -- --
Stock awards
Under the Company's 2001 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 stock awards vest at 20% per year. Under the Company's 2003
Equity Compensation Plan, the Company may grant up to 300,000 stock options or
stock awards to its directors, officers and employees. The Company applies APB
Opinion No. 25 and related Interpretations in accounting for stock awards. 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 applicable periods. The Company recorded compensation cost related to
the stock awards of approximately $1,216,000, $1,066,000 and $1,165,000 in 2004,
2003 and 2002, respectively.
A summary of the status of the Company's stock awards is presented below:
Years Ended December 31,
-------------------------------------
2004 2003 2002
--------- --------- ---------
Balance at beginning of year 290,435 206,269 306,945
Granted 15,870 84,166 --
Cancelled -- -- (100,676)
--------- --------- ---------
Balance at end of year 306,305 290,435 206,269
========= ========= =========
Fair value of stock awards granted during the year $ 37.80 $ 22.38 $ --
========= ========= =========
-86-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCK-BASED COMPENSATION PLANS AND EMPLOYEE STOCK OWNERSHIP PLAN
(continued)
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, 2004, the remaining principal balance is payable as follows:
Years Ending
December 31, (In thousands)
------------
2005 $ 325
2006 356
2007 392
2008 429
2009 472
Thereafter 3,985
------
$5,959
======
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
$1,377,500, $1,094,000 and $887,000 for the years ended December 31, 2004, 2003
and 2002, respectively.
Shares held by the ESOP include the following at December 31, 2004 and 2003:
2004 2003
------- -------
Allocated 149,545 114,188
Committed to be allocated 37,853 37,853
Unallocated 416,387 454,240
------- -------
603,785 606,281
======= =======
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 unallocated shares was
approximately $15,469,000, $16,443,000 and $11,589,000 at December 31, 2004,
2003 and 2002, respectively.
-87-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
16. RELATED PARTY TRANSACTIONS
- --------------------------------------------------------------------------------
In the ordinary course of business, the Company has granted extensions of credit
to directors and officers and their related interests. 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 related interests were performing in accordance with
the contractual terms of the loans as of December 31, 2004.
The following is an analysis of activity of such extensions of credit that
aggregate more than $60,000 on an individual basis to directors and executive
officers of the Company and their related interests. In any instances where, at
December 31, 2004 or 2003, the individual aggregate extension of credit declined
below $60,000, or the individual was no longer a director or officer, the
balance was reported as zero and the reduction was included with repayments.
Years Ended December 31,
------------------------
2004 2003
------- -------
(In thousands)
Balance at beginning of year $ 2,205 $ 5,740
Additions 4,642 1,127
Repayments (1,337) (4,662)
------- -------
Balance at end of year $ 5,510 $ 2,205
======= =======
-88-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
17. 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. 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, where practicable. 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 held for sale: Fair values are based on forward sales contracts for each
loan held for sale.
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. Fair values of loans held for sale are based on
contracted sale prices.
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.
Accrued interest: The carrying amounts of accrued interest approximate fair
value, and are immaterial.
-89-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FAIR VALUE OF FINANCIAL INSTRUMENTS (concluded)
Off-balance-sheet financial 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, 2004 and 2003:
2004 2003
-------------------- --------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- -------- -------- --------
(In thousands)
Financial assets:
Cash and cash equivalents $ 17,902 $ 17,902 $ 17,442 $ 17,442
Securities available-for-sale 365,404 365,404 307,425 307,425
Securities held-to-maturity 29,942 29,899 36,903 36,868
Federal Home Loan Bank stock 16,974 16,974 12,923 12,923
Savings Bank Life Insurance stock 2,043 2,043 2,043 2,043
Loans held for sale 1,053 1,067 -- --
Loans, net 818,842 814,458 783,258 787,490
Accrued interest receivable 5,472 5,472 5,080 5,080
Financial liabilities:
Deposits with no stated maturity 530,514 530,514 508,894 508,894
Certificate accounts 315,275 318,056 321,350 329,669
Federal Home Loan Bank advances 327,926 334,457 251,465 263,218
-90-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
18. 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,
------------------
2004 2003
-------- --------
(In thousands)
Assets
Cash due from Berkshire Bank $ 6,202 $ 6,305
Securities available-for-sale, at fair value 31 31
Investment in common stock of Berkshire Bank 117,123 105,128
Investment in common stock of Berkshire Hills
Funding Corporation 6,680 6,680
Investment in common stock of Berkshire
Hills Technology, Inc. -- 3,421
Other assets 1,709 1,640
-------- --------
Total assets $131,745 $123,205
======== ========
Liabilities and Stockholders' Equity
Accounts payable $ 9 $ 30
Stockholders' equity 131,736 123,175
-------- --------
Total liabilities and stockholders' equity $131,745 $123,205
======== ========
-91-
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,
----------------------------------
2004 2003 2002
-------- -------- --------
(In thousands)
Income:
Dividends from Berkshire Bank $ -- $ 8,000 $ 2,375
Dividends from Berkshire Hills Funding Corporation 524 559 577
Interest on securities -- 17 273
Other 11 54 44
-------- -------- --------
Total income 535 8,630 3,269
-------- -------- --------
Operating expenses 156 361 405
-------- -------- --------
Income before income taxes and equity in
undistributed income of subsidiaries 379 8,269 2,864
Income tax (benefit) provision (860) (99) 80
-------- -------- --------
Income before equity in undistributed
income of subsidiaries 1,239 8,368 2,784
Equity in undistributed income of Berkshire Bank 10,923 889 612
Equity in undistributed loss of Berkshire Hills
Funding Corporation -- (10) (259)
Equity in undistributed loss of Berkshire Hills
Technology, Inc. (653) (282) (1,040)
-------- -------- --------
Net income $ 11,509 $ 8,965 $ 2,097
======== ======== ========
-92-
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,
----------------------------------
2004 2003 2002
-------- -------- --------
(In thousands)
Cash flows from operating activities:
Net income $ 11,509 $ 8,965 $ 2,097
Adjustments to reconcile net income
to net cash provided by operating activities:
Equity in undistributed income of Berkshire Bank (10,923) (889) (612)
Equity in undistributed loss of Berkshire Hills
Funding Corporation -- 10 259
Equity in undistributed loss of
Berkshire Hills Technology, Inc. 653 282 1,040
Net accretion of securities -- -- (4)
Other, net 91 (65) 499
-------- -------- --------
Net cash provided by operating activities 1,330 8,303 3,279
-------- -------- --------
Cash flows from investing activities:
Activity in available-for-sale securities:
Principal payments -- -- 560
Activity in held-to-maturity securities:
Maturities -- 3,463 1,932
Principal payments -- -- 169
Purchases -- -- (32)
Sale of investment in Berkshire Hills Technology, Inc. 2,587 -- --
-------- -------- --------
Net cash provided by investing activities 2,587 3,463 2,629
-------- -------- --------
Cash flows from financing activities:
Proceeds from issuance of treasury stock 1,139 1,191 116
Payments to acquire treasury stock (2,545) (7,099) (6,989)
Dividends paid (2,614) (2,628) (2,737)
-------- -------- --------
Net cash used in financing activities (4,020) (8,536) (9,610)
-------- -------- --------
Net change in cash and cash equivalents (103) 3,230 (3,702)
Cash and cash equivalents at beginning of year 6,305 3,075 6,777
-------- -------- --------
Cash and cash equivalents at end of year $ 6,202 $ 6,305 $ 3,075
======== ======== ========
-93-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
19. DISCONTINUED OPERATIONS
- --------------------------------------------------------------------------------
On June 18, 2004, the business assets of EastPoint Technologies, LLC were sold
to a subsidiary of Open Solutions, Inc. for $7,000,000. The Company owned a
60.3% interest in EastPoint, with the remaining 39.7% interest recorded as
minority interest. Net of escrows and minority interest, the Company received
$2,587,000 in net cash proceeds. The Company has the potential to receive up to
an additional $750,000 in two years, representing its 60.3% share of the
combined escrowed and conditional payments. No additional proceeds were received
in 2004. Net income and cash flows related to EastPoint have been reclassified
as related to discontinued operations in the financial statements. The
transaction resulted in a net loss of $75,000 ($49,500 after taxes), which was
included in the net loss from discontinued operations in 2004.
Information about discontinued operations as of, and for the years ended
December 31, follows:
2004 2003 2002
------- ------- -------
(In thousands)
Depreciation and amortization $ 282 $ 696 $ 601
Licensing and other fee revenues 2,695 7,262 6,991
Minority interest (381) (186) (685)
Net loss before taxes (653) (282) (1,040)
Goodwill and other intangibles -- 4,470 4,673
Other assets -- 3,188 3,898
Capital expenditures 76 80 424
-94-
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONCLUDED)
20. QUARTERLY DATA (UNAUDITED)
- --------------------------------------------------------------------------------
Quarterly results of operations for the years ended December 31, 2004 and 2003
were as follows:
2004 2003
------------------------------------------ --------------------------------------------
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 $ 15,807 $ 15,546 $ 14,737 $ 14,990 $ 14,410 $ 13,858 $ 14,139 $ 13,901
Interest expense 5,608 5,304 4,985 4,828 4,666 4,549 4,706 4,821
-------- -------- -------- -------- -------- -------- -------- --------
Net interest income 10,199 10,242 9,752 10,162 9,744 9,309 9,433 9,080
Provision (credit) for loan losses 425 365 425 350 (225) 575 785 325
Non-interest income 2,198 1,726 1,965 1,875 700 1,912 1,896 1,940
Non-interest expense 7,300 7,181 6,933 7,563 6,906 6,871 7,582 6,884
Income taxes-continuing operations 1,495 1,415 1,402 1,325 1,124 1,360 786 1,891
-------- -------- -------- -------- -------- -------- -------- --------
Income from continuing operations 3,177 3,007 2,957 2,799 2,639 2,415 2,176 1,920
Net loss from discontinued operations -- -- (255) (176) (48) (1) (38) (98)
-------- -------- -------- -------- -------- -------- -------- --------
Net income $ 3,177 $ 3,007 $ 2,702 $ 2,623 $ 2,591 $ 2,414 $ 2,138 $ 1,822
======== ======== ======== ======== ======== ======== ======== ========
Earnings per share:
Basic $ 0.60 $ 0.57 $ 0.51 $ 0.50 $ 0.50 $ 0.46 $ 0.40 $ 0.34
Diluted 0.55 0.53 0.47 0.46 0.45 0.43 0.38 0.32
Results for the second quarter of 2003 included an $800,000 retirement benefit
charge. Fourth quarter 2003 results were affected by the final sale of sub-prime
automobile loans, contributing to a credit for loan losses and to a $2,094,000
loss on sale included in other non-interest income, which was partially offset
by net securities gains totaling $1,564,000. During the second quarter of 2004,
heavy loan prepayment activity caused a decrease in net interest income. Also in
that quarter, the Company sold EastPoint Technologies, LLC. Current and prior
period income and expenses related to EastPoint were reclassified as a net loss
from discontinued operations, including a $75,000 pre-tax loss recorded on sale.
Quarterly data may not sum to annual data due to rounding.
-95-
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, 2004
that has materially affected, or is reasonably likely to materially affect, the
Company's internal control over financial reporting.
The Company is in the process of documenting and testing its internal
control procedures to satisfy the requirements of Section 404 of the
Sarbanes-Oxley Act of 2002, which requires management to assess the
effectiveness of its system of internal controls over financial reporting as of
December 31, 2004, the end of its latest fiscal year. The Company's independent
Registered Public Accounting Firm must then attest to and report on that
assessment by management. The Company has expended significant resources in this
effort and believes that it has made significant progress. To date, management
has not identified any material weaknesses in the Company's internal controls
over financial reporting. However, the Company has not completed its assessment
of internal controls over financial reporting and, therefore, the independent
auditors have not completed the procedures it requires to issue its attestation
over financial reporting. Accordingly, the Company is omitting management's
annual report on internal control over financial reporting, as required by Item
308(a) of Regulation S-K and the related attestation report of the registered
public accounting firm, required by Item 308(b) of Regulation S-K from this
filing as permitted by Order of the Securities and Exchange Commission, dated
November 30, 2004. Copies of these items will be provided in an amendment to the
Form 10-K no later than May 2, 2005.
ITEM 9B. OTHER INFORMATION
- --------------------------------------------------------------------------------
None.
-96-
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 2005 Annual Meeting of Stockholders is
incorporated by reference.
The following table sets forth certain information regarding the executive
officers of Berkshire Hills and Berkshire Bank.
Name Age(1) Position
---- ------ --------
Michael P. Daly 43 President and Chief Executive Officer
Wayne F. Patenaude 44 Senior Vice President, Chief Financial Officer and Treasurer
Gayle P. Fawcett 52 Senior Vice President of Retail Banking and Operations
----------
(1) As of December 31, 2004
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 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.
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.
-97-
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) Changes in Control
Management of Berkshire Hills knows of no arrangements, including
any pledge by any person of securities of Berkshire Hills, the
operation of which may at a subsequent date result in a change in
control of the registrant.
(d) Equity Compensation Plan Information
The following table sets forth information, as of December 31, 2004, 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 643,754 $ 18.97 287,148
Equity compensation plans
not approved by security holders -- -- --
Total 643,754 $ 18.97 287,148
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 Registered
Public Accounting Firm" in the Proxy Statement.
-98-
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
- --------------------------------------------------------------------------------
(a) [1] Financial Statements
o Report of Independent Registered Public Accounting Firm
o Consolidated Balance Sheets as of December 31, 2004 and
2003
o Consolidated Statements of Income for the Years Ended
December 31, 2004, 2003 and 2002
o Consolidated Statements of Changes in Stockholders'
Equity for the Years Ended December 31, 2004, 2003 and
2002
o Consolidated Statements of Cash Flows for the Years
Ended December 31, 2004, 2003 and 2002
o Notes to Consolidated Financial Statements
[2] Financial Statement Schedules
All financial statement schedules are omitted because the
required information is either included or is not applicable.
-99-
[3] Exhibits
2.1 Agreement and Plan of Merger, dated as of December 16,
2004, by and between Berkshire Hills Bancorp, Inc. and
Woronoco Bancorp, Inc. (1)
3.1 Certificate of Incorporation of Berkshire Hills Bancorp,
Inc.(2)
3.2 Bylaws of Berkshire Hills Bancorp, Inc. (3)
4.0 Draft Stock Certificate of Berkshire Hills Bancorp,
Inc.(2)
10.1 Employment Agreement between Berkshire Bank and Michael
P. Daly(4)
10.2 Employment Agreement between Berkshire Hills Bancorp,
Inc. and Michael P. Daly(4)
10.3 Change in Control Agreement between Berkshire Bank and
Gayle P. Fawcett(3)
10.4 Change in Control Agreement between Berkshire Hills
Bancorp, Inc. and Gayle P. Fawcett(3)
10.5 Change in Control Agreement between Berkshire Bank and
Wayne F. Patenaude(3)
10.6 Change in Control Agreement between Berkshire Hills
Bancorp, Inc. and Wayne F. Patenaude(3)
10.7 Supplemental Executive Retirement Agreement between
Berkshire Bank and Michael P. Daly(3)
10.8 Berkshire Hills Bancorp, Inc. 2003 Equity Compensation
Plan(5)
10.9 Letter Agreement, dated June 26, 2003, by and among
Berkshire Hills Bancorp, Inc., Berkshire Bank and Robert
A. Wells(4)
10.10 Form of Berkshire Bank Employee Severance Compensation
Plan(2)
10.11 Form of Berkshire Bank Supplemental Executive Retirement
Plan(2)
10.12 Berkshire Hills Bancorp, Inc. 2001 Stock-Based Incentive
Plan(6)
10.13 Retirement Agreement, dated December 4, 2003, by and
among Berkshire Hills Bancorp, Inc., Berkshire Bank and
Robert A. Wells(3)
11.0 Statement re: Computation of Per Share Earnings is
incorporated herein by reference to Part II, Item 8,
"Financial Statements and Supplementary Data"
21.0 Subsidiary Information is incorporated herein by
reference to Part I, Item 1, "Business - Subsidiary
Activities"
23.0 Consent of Wolf & Company, P.C.
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32.1 Section 1350 Certification of Chief Executive Officer
32.2 Section 1350 Certification of Chief Financial Officer
- ----------
(1) Incorporated herein by reference from the Exhibits to the Form
8-K, as filed on December 17, 2004.
(2) Incorporated herein by reference from the Exhibits to Form
S-1, Registration Statement and amendments thereto, initially
filed on March 10, 2000, Registration No. 333-32146.
(3) Incorporated herein by reference from the Exhibits to the Form
10-K as filed on March 11, 2004.
(4) Incorporated herein by reference from the Exhibits to the Form
10-Q as filed on August 13, 2003.
(5) Incorporated herein by reference from the Appendix to the
Proxy Statement as filed on March 27, 2003.
(6) Incorporated herein by reference from the Appendix to the
Proxy Statement as filed on December 7, 2000.
-100-
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: March 14, 2005 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 March 14, 2005
- ------------------------------- and Director
Michael P. Daly (principal executive officer)
/s/ Wayne F. Patenaude Senior Vice President, Treasurer March 14, 2005
- ------------------------------- and Chief Financial Officer
Wayne F. Patenaude (principal accounting and financial officer)
/s/ Lawrence A. Bossidy Non-Executive Chairman March 14, 2005
- -------------------------------
Lawrence A. Bossidy
/s/ Thomas O. Andrews Director March 14, 2005
- -------------------------------
Thomas O. Andrews
/s/ Thomas R. Dawson Director March 14, 2005
- -------------------------------
Thomas R. Dawson
/s/ A. Allen Gray Director March 14, 2005
- -------------------------------
A. Allen Gray
/s/ Peter J. Lafayette Director March 14, 2005
- -------------------------------
Peter J. Lafayette
/s/ Edward G. McCormick, Esq. Director March 14, 2005
- -------------------------------
Edward G. McCormick, Esq.
/s/ Catherine B. Miller Director March 14, 2005
- -------------------------------
Catherine B. Miller
/s/ Corydon L. Thurston Director March 14, 2005
- -------------------------------
Corydon L. Thurston
/s/ Ann H. Trabulsi Director March 14, 2005
- -------------------------------
Ann H. Trabulsi
/s/ Robert A. Wells Director March 14, 2005
- -------------------------------
Robert A. Wells
-101-