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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2005
--------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
---------------- -----------------
Commission file number: 0-13649
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BERKSHIRE BANCORP INC.
----------------------
(Exact name of registrant as specified in its charter)
Delaware 94-2563513
- ---------------------------------------- ---------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
160 Broadway, New York, New York 10038
- ---------------------------------------- ---------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 791-5362
---------------
N/A
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes No X
--- ---
As of May 6, 2005, there were 6,759,675 outstanding shares of the issuers Common
Stock, $.10 par value.
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
FORWARD-LOOKING STATEMENTS
Forward-Looking Statements. Statements in this Quarterly Report on Form 10-Q
that are not based on historical fact may be "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Words such
as "believe", "may", "will", "expect", "estimate", "anticipate", "continue" or
similar terms identify forward-looking statements. A wide variety of factors
could cause the Company's actual results and experiences to differ materially
from the results expressed or implied by the Company's forward-looking
statements. Some of the risks and uncertainties that may affect operations,
performance, results of the Company's business, the interest rate sensitivity of
its assets and liabilities, and the adequacy of its loan loss allowance,
include, but are not limited to: (i) deterioration in local, regional, national
or global economic conditions which could result, among other things, in an
increase in loan delinquencies, a decrease in property values, or a change in
the housing turnover rate; (ii) changes in market interest rates or changes in
the speed at which market interest rates change; (iii) changes in laws and
regulations affecting the financial services industry; (iv) changes in
competition; (v) changes in consumer preferences, (vi) changes in banking
technology; (vii) ability to maintain key members of management, (viii) possible
disruptions in the Company's operations at its banking facilities, (ix) cost of
compliance with new corporate governance requirements, and other factors
referred to in the sections of this Annual Report entitled "Business" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Certain information customarily disclosed by financial institutions,
such as estimates of interest rate sensitivity and the adequacy of the loan loss
allowance, are inherently forward-looking statements because, by their nature,
they represent attempts to estimate what will occur in the future.
The Company cautions readers not to place undue reliance upon any
forward-looking statement contained in this Quarterly Report. Forward-looking
statements speak only as of the date they were made and the Company assumes no
obligation to update or revise any such statements upon any change in applicable
circumstances.
2
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of
March 31, 2005 (unaudited) and
December 31, 2004 4
Consolidated Statements of Income
For The Three Months Ended
March 31, 2005 and 2004 (unaudited) 5
Consolidated Statement of Stockholders'
Equity For The Three Months Ended
March 31, 2005 (unaudited) 6
Consolidated Statements of Cash Flows
For The Three Months Ended March 31,
2005 and 2004 (unaudited) 7
Notes to Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis
of Financial Condition and Results
of Operations 16
Item 3. Quantitative and Qualitative Disclosure
About Market Risk 23
Item 4. Controls and Procedures 29
PART II OTHER INFORMATION
Item 6. Exhibits 30
Signature 31
Index of Exhibits 32
3
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
(unaudited)
March 31, December 31,
2005 2004
------------------------------
ASSETS
Cash and due from banks $ 6,455 $ 9,511
Interest bearing deposits 1,267 372
Federal funds sold 9,000 7,500
---------- ---------
Total cash and cash equivalents 16,722 17,383
Investment Securities:
Available-for-sale 675,221 630,968
Held-to-maturity, fair value of $620
in 2005 and $633 in 2004 607 624
---------- ---------
Total investment securities 675,828 631,592
Loans, net of unearned income 284,772 286,979
Less: allowance for loan losses (3,022) (2,927)
---------- ---------
Net loans 281,750 284,052
Accrued interest receivable 6,087 6,014
Premises and equipment, net 8,661 8,677
Goodwill, net 18,549 18,549
Other assets 8,732 6,382
---------- ---------
Total assets $1,016,329 $ 972,649
========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 43,073 $ 42,191
Interest bearing 606,392 577,697
---------- ---------
Total deposits 649,465 619,888
Securities sold under agreements to repurchase 136,248 127,747
Long term borrowings 103,897 95,605
Subordinated debt 15,464 15,464
Accrued interest payable 2,896 2,516
Other liabilities 3,385 3,810
---------- ---------
Total liabilities 911,355 865,030
---------- ---------
Stockholders' equity
Preferred stock -- $.10 Par value: -- --
2,000,000 shares authorized - none issued
Common stock -- $.10 par value
Authorized -- 10,000,000 shares
Issued -- 7,698,285 shares
Outstanding --
March 31, 2005, 6,759,675 shares
December 31, 2004, 6,748,675 shares 770 770
Additional paid-in capital 89,969 89,543
Retained earnings 30,681 28,983
Accumulated other comprehensive loss, net (7,448) (2,602)
Treasury Stock
March 31, 2005, 938,610 shares
December 31, 2004, 946,610 shares (8,998) (9,075)
---------- ---------
Total stockholders' equity 104,974 107,619
---------- ---------
$1,016,329 $ 972,649
========== =========
The accompanying notes are an integral part of these statements
4
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Data)
(unaudited)
For The
Three Months Ended
March 31,
-------------------------
2005 2004
-------- --------
INTEREST INCOME
Loans $ 4,694 $ 4,849
Investment securities 6,179 4,786
Federal funds sold and
interest bearing deposits 94 3
-------- --------
Total interest income 10,967 9,638
-------- --------
INTEREST EXPENSE
Deposits 2,891 2,455
Short-term borrowings 765 497
Long-term borrowings 1,158 768
-------- --------
Total interest expense 4,814 3,720
-------- --------
Net interest income 6,153 5,918
PROVISION FOR LOAN LOSSES 45 45
-------- --------
Net interest income after
provision for loan losses 6,108 5,873
-------- --------
NON-INTEREST INCOME
Service charges on deposit accounts 133 127
Investment securities gains 6 93
Other income 130 198
-------- --------
Total non-interest income 269 418
-------- --------
NON-INTEREST EXPENSE
Salaries and employee benefits 1,955 1,667
Net occupancy expense 381 274
Equipment expense 99 86
FDIC assessment 69 22
Data processing expense 44 32
Other 645 881
-------- --------
Total non-interest expense 3,193 2,962
-------- --------
Income before provision for taxes 3,184 3,329
Provision for income taxes 1,486 1,378
-------- --------
Net income $ 1,698 $ 1,951
======== ========
Net income per share:
Basic $ .25 $ .29
======== ========
Diluted $ .25 $ .28
======== ========
The accompanying notes are an integral part of these statements.
5
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For The Three Months Ended March 31, 2005
(In Thousands)
Accumulated
other
Stock Additional comprehensive Total
Common Par paid-in (loss) Retained Treasury Comprehensive stockholders'
Shares value capital net earnings stock income equity
------ ----- --------- ----- -------- ------- -------- --------
Balance at December 31, 2004 7,698 $770 $89,543 $(2,602) $28,983 $(9,075) $107,619
Net income 1,698 1,698 1,698
Exercise of stock options 426 77 503
Other comprehensive (loss) net
of reclassification adjustment
and taxes (4,846) (4,846) (4,846)
-------
Comprehensive income $(3,148)
=======
----- ---- ------- ------- ------- ------- --------
Balance at March 31, 2005 7,698 $770 $89,969 $(7,448) $30,681 $(8,998) $104,974
===== ==== ======= ======= ======= ======= ========
(Unaudited)
The accompanying notes are an integral part of this statement.
6
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For The Three Months Ended
March 31,
--------------------------
2005 2004
------ ------
Cash flows from operating activities:
Net income $ 1,698 $ 1,951
Adjustments to reconcile net income to net
cash provided by operating activities:
Realized gains on investment securities (6) (93)
Net amortization of premiums of investment securities 40 813
Depreciation and amortization 156 145
Provision for loan losses 45 45
(Increase) in accrued interest receivable (73) (482)
(Increase) decrease in other assets (2,350) 845
Increase (decrease) in accrued interest payable
and other liabilities 365 (599)
--------- ---------
Net cash (used in) provided by operating activities (125) 2,625
--------- ---------
Cash flows from investing activities:
Investment securities available for sale
Purchases (191,294) (407,636)
Sales, maturities and calls 142,161 366,836
Investment securities held to maturity
Maturities 17 21
Net decrease (increase) in loans 2,257 (557)
Acquisition of premises and equipment (140) (33)
--------- ---------
Net cash (used in) investing activities (46,999) (41,369)
--------- ---------
7
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For The Three Months Ended
March 31,
--------------------------
2005 2004
------ ------
Cash flows from financing activities:
Net increase (decrease) in non interest bearing deposits 882 (51)
Net increase in interest bearing deposits 28,695 18,315
Increase in securities sold under agreements to repurchase 8,501 15,085
Proceeds from long term debt 15,000 1,947
Repayment of long term debt (6,708) --
Proceeds from exercise of common stock options 93 65
Acquisition of treasury stock -- (69)
------- --------
Net cash provided by financing activities 46,463 35,292
------- --------
Net (decrease) in cash (661) (3,452)
Cash -- beginning of period 17,383 9,310
-------- --------
Cash -- end of period $ 16,722 $ 5,858
======== ========
Supplemental disclosures of cash flow information:
Cash used to pay interest $ 4,434 $ 3,774
Cash used to pay taxes, net of refunds $ 1,507 $ 945
The accompanying notes are an integral part of these statements.
8
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
March 31, 2005 and 2004
NOTE 1. General
Berkshire Bancorp Inc., a Delaware corporation, is a bank holding
company registered under the Bank Holding Company Act of 1956. References herein
to "Berkshire", the "Company" or "we" and similar pronouns, shall be deemed to
refer to the Company and its consolidated subsidiaries unless the context
otherwise requires. Berkshire's principal activity is the ownership and
management of its wholly owned subsidiary, The Berkshire Bank (the "Bank"), a
New York State chartered commercial bank.
The accompanying financial statements of Berkshire Bancorp Inc. and
subsidiaries includes the accounts of the parent company, Berkshire Bancorp
Inc., and its wholly-owned subsidiaries: The Berkshire Bank, Greater American
Finance Group, Inc. and East 39, LLC.
During interim periods, the Company follows the accounting policies set
forth in its Annual Report on Form 10-K filed with the Securities and Exchange
Commission (the "SEC"). Readers are encouraged to refer to the Company's Form
10-K for the fiscal year ended December 31, 2004 when reviewing this Form 10-Q.
Quarterly results reported herein are not necessarily indicative of results to
be expected for other quarters or a full fiscal year.
In the opinion of management, the accompanying unaudited consolidated
financial statements contain all adjustments (consisting of normal recurring
adjustments) considered necessary to present fairly the Company's consolidated
financial position as of March 31, 2005 and December 31, 2004 and the
consolidated results of its operations for the three month periods ended March
31, 2005 and 2004, and its consolidated stockholders' equity for the three month
period ended March 31, 2005, and its consolidated cash flows for the three month
periods ended March 31, 2005 and 2004. As discussed in Note 2 below, all
weighted share and per share information in 2004 has been retroactively restated
to reflect the stock split and stock dividend.
NOTE 2. Stock Split and Stock Dividend.
At the Annual Meeting of Stockholders held on May 18, 2004, the
Company's stockholders approved an amendment to the Company's Certificate of
Incorporation effecting a one-for-ten reverse stock split of the Company's
issued and outstanding Common Stock (the "Reverse Split"). Following the
effectiveness of the Reverse Split, the Company's Board of Directors declared a
thirty-for-one forward stock split in the form of a stock dividend in Common
Stock (the "Stock Dividend) which became effective immediately. The Company paid
approximately $463,000 to purchase fractional shares from stockholders as part
of the Reverse Split. The Company's Common Stock began trading on May 19, 2004
giving effect to these transactions.
NOTE 3. Trust Preferred Securities.
As of May 18 2004, the Company established Berkshire Capital Trust I, a
Delaware statutory trust, ("BCTI"). The Company owns all the common capital
securities of BCTI. BCTI issued $15.0 million of preferred capital securities to
investors in a private transaction and invested the proceeds, combined with the
proceeds from the sale of BCTI's common capital securities, in the Company
through the purchase of $15.464 million aggregate principal amount of Floating
Rate Junior Subordinated Debentures (the "2004 Debentures") issued by the
Company. The 2004 Debentures, the sole assets of BCTI, mature on July 23, 2034
and bear interest at a floating rate, three month LIBOR plus 2.70%.
9
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE 3. - (continued)
On April 1, 2005, the Company established Berkshire Capital Trust II, a
Delaware statutory trust, ("BCTII"). The Company owns all the common capital
securities of BCTII. BCTII issued $7.0 million of preferred capital securities
to investors in a private transaction and invested the proceeds, combined with
the proceeds from the sale of BCTII's common capital securities, in the Company
through the purchase of $7.217 million aggregate principal amount of Floating
Rate Junior Subordinated Debentures (the "2005 Debentures") issued by the
Company. The 2005 Debentures, the sole assets of BCTII, mature on May 23, 2035
and bear interest at a floating rate, three month LIBOR plus 1.95%.
Based on current interpretations of the banking regulators, the 2004
Debentures and 2005 Debentures (collectively, the "Debentures") qualify under
the risk-based capital guidelines of the Federal Reserve as Tier 1 capital,
subject to certain limitations. The Debentures are callable by the Company,
subject to any required regulatory approvals, at par, in whole or in part, at
any time after five years from the date of issuance. The Company's obligations
under the Debentures and related documents, taken together, constitute a full,
irrevocable and unconditional guarantee on a subordinated basis by the Company
of the obligations of BCTI and BCTII under the preferred capital securities sold
by BCTI and BCTII to investors. FIN46(R) precludes consideration of the call
option embedded in the preferred capital securities when determining if the
Company has the right to a majority of BCTI and BCTII expected residual returns.
Accordingly, BCTI is not and BCTII will not be included in the consolidated
balance sheet of the Company.
The Federal Reserve has issued guidance on the regulatory capital
treatment for the trust-preferred securities issued by BCTI and BCTII. This rule
would retain the current maximum percentage of total capital permitted for Trust
Preferred Securities at 25%, but would enact other changes to the rules
governing Trust Preferred Securities that affect their use as part of the
collection of entities known as "restricted core capital elements." The rule
would take effect March 31, 2009; however, a five year transition period
starting March 31, 2004 and leading up to that date would allow bank holding
companies to continue to count Trust Preferred Securities as Tier 1 Capital
after applying FIN-46(R). Management has evaluated the effects of this rule and
does not anticipate a material impact on its capital ratios when the proposed
rule is finalized.
NOTE 4. Earnings Per Share
Basic earnings per share is calculated by dividing income available to
common stockholders by the weighted average common shares outstanding, excluding
stock options from the calculation. In calculating diluted earnings per share,
the dilutive effect of stock options is calculated using the average market
price for the Company's common stock during the period. The following table
presents the calculation of earnings per share for the periods indicated:
For The Three Months Ended
----------------------------------------------------------------------------------
March 31, 2005 March 31, 2004
-------------------------------------- ---------------------------------------
Per Per
Income Shares share Income Shares share
(numerator) (denominator) amount (numerator) (denominator) amount
----------- ------------- ------ ----------- ------------- ------
(In thousands, except per share data)
Basic earnings per share
Net income available to
common stockholders $1,698 6,754 $.25 $1,951 6,624 $ .29
Effect of dilutive securities
Options -- 175 -- -- 219 (.01)
------ ----- ---- ------ ----- -----
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $1,698 6,929 $.25 $1,951 6,843 $ .28
====== ===== ==== ====== ===== =====
10
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE 5. Investment Securities
The following tables summarize held to maturity and available-for-sale
investment securities as of March 31, 2005 and December 31, 2004:
March 31, 2005
-------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
---- ----- ------ -----
(In thousands)
Held To Maturity
Investment Securities
U.S. Government Agencies $607 $14 $(1) $620
---- --- --- ----
Totals $607 $14 $(1) $620
==== === === ====
December 31, 2004
-------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
---- ----- ------ -----
(In thousands)
Held To Maturity
Investment Securities
U.S. Government Agencies $ 624 $10 $(1) $633
----- --- --- ----
Totals $ 624 $10 $(1) $633
===== === === ====
March 31, 2005
--------------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
----------------- ----------------- ----------------- -----------------
(In thousands)
Available-For-Sale
Investment Securities
U.S. Treasury and Notes $ 24,921 $ -- $ (257) $ 24,664
U.S. Government Agencies 510,807 -- (8,991) 501,816
Mortgage-backed securities 106,021 311 (1,410) 104,922
Corporate notes 35,975 13 (1,072) 34,916
Municipal Securities 1,973 138 (63) 2,048
Marketable equity
securities and other 6,684 235 (64) 6,855
-------- ---- -------- --------
Totals $686,381 $697 $(11,857) $675,221
======== ==== ========= ========
11
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note 5. - (continued)
December 31, 2004
--------------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
----------------- ----------------- ----------------- -----------------
(In thousands)
Available-For-Sale
Investment securities
U.S. Treasury and Notes $ 24,896 $ -- $ (174) $ 24,722
U.S. Government Agencies 471,018 97 (3,844) 467,271
Mortgage-backed securities 109,822 504 (996) 109,330
Corporate Notes 21,089 692 (154) 21,627
Municipal securities 1,307 134 -- 1,441
Marketable equity
securities and other 6,363 279 (65) 6,577
-------- ------ ------- --------
Totals $634,495 $1,706 $(5,233) $630,968
======== ====== ======= ========
NOTE 6. Loan Portfolio
The following table sets forth information concerning the Company's
loan portfolio by type of loan at the dates indicated:
March 31, 2005 December 31, 2004
------------------------ ---------------------
% of % of
Amount Total Amount Total
------ ----- ------ -----
(Dollars in thousands)
Commercial and professional loans $ 18,201 6.4% $ 16,498 5.7%
Secured by real estate
1-4 family 152,687 53.5 155,079 53.9
Multi family 3,807 1.3 4,600 1.6
Non-residential (commercial) 108,974 38.2 109,597 38.1
Consumer 1,859 0.6 1,989 0.7
-------- ----- -------- -----
Total loans 285,528 100.0% 287,763 100.0%
===== =====
Deferred loan fees (756) (784)
Allowance for loan losses (3,022) (2,927)
-------- --------
Loans, net $281,750 $284,052
======== ========
12
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE 7. Deposits
The following table summarizes the composition of the average balances
of major deposit categories:
March 31, 2005 December 31, 2004
----------------------- -----------------------
Average Average Average Average
Amount Yield Amount Yield
------ ----- ------ -----
(Dollars in thousands)
Demand deposits $ 43,708 -- $ 38,896 --
NOW and money market 44,355 0.50% 47,677 0.65%
Savings deposits 277,340 1.73 224,542 1.55
Time deposits 296,497 2.21 309,968 1.96
-------- ---- -------- ----
Total deposits $661,900 1.76% $621,083 1.58%
======== ==== ======== ====
NOTE 8. Comprehensive Income (Loss)
The following table presents the components of comprehensive income,
based on the provisions of SFAS No. 130.:
For The Three Months Ended
----------------------------------------------------------------------------------
March 31, 2005 March 31, 2004
---------------------------------------- -------------------------------------
Tax Tax
Before tax (expense) Net of tax Before tax (expense) Net of tax
amount benefit Amount amount benefit amount
------ ------- ------ ------ ------- ------
(In thousands)
Unrealized (losses)
gains on investment
securities:
Unrealized holding $ (7,627) $2,785 $(4,842) $4,440 $(1,739) $2,589
gains (losses) arising
during period
Less reclassification
adjustment for gains
realized in net income 6 (2) 4 93 (37) 56
-------- ------ ------- ------ ------- ------
Other comprehensive $ (7,633) $2,787 $(4,846) $4,347 $(1,702) $2,645
======== ====== ======= ====== ======= ======
(loss) income, net
NOTE 9. Accounting For Stock Based Compensation
In December 2004, the Financial Accounting Standards Board (the "FASB")
issued Statement No. 123 (Revised), Share-based Payment, ("FAS 123(R)"). FAS
123(R) requires that the compensation cost relating to share-based payment
transactions be recognized in financial statements. That cost will be measured
based on the fair value of the equity or liability instruments issued. We will
be required to apply FAS 123(R) in the first quarter of 2006. The scope of FAS
123(R) includes a wide range of share-based compensation arrangements including
share options, restricted share plans, performance-based awards, share
appreciation rights and employee share purchase plans. FAS 123(R) revises FASB
Statement 123, Accounting for Stock-Based Compensation ("FAS 123"), and
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees.
13
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note 9. - (continued)
At March 31, 2005, the Company has one stock-based employee
compensation plan. The Company accounts for that plan under the recognition and
measurement principles of APB No. 25, "Accounting for Stock Issued to
Employees," and related interpretations. Stock-based employee compensation costs
are not reflected in net income, as all options granted under the plan had an
exercise price equal to the market value of the underlying common stock on the
date of the grant. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of SFAS No. 123, "Accounting for Stock-Based Compensation," to
stock-based employee compensation.
The fair value of each option is estimated on the date of grant using
the Black-Scholes options-pricing model using weighted-average assumptions for
expected volatility, risk-free interest and expected life of the option. All
stock options outstanding are vested. The Company did not grant stock options
during the three months ended March 31, 2005 and 2004.
Note 10. Employee Benefit Plans
The Company has a Retirement Income Plan (the "Plan"), a
noncontributory plan covering substantially all full-time, non-union United
States employees of the Company. The following interim-period information is
being provided in accordance with FASB Statement 132(R).
For The
Three Months Ended
March 31,
--------------------------
2005 2004
---- ----
Service cost $ 66,000 $ 56,000
Interest cost 28,000 28,750
Expected return on plan assets (34,000) (37,500)
Amortization and Deferral:
Transition amount -- --
Prior service cost 4,593 4,500
(Gain)/loss 6,407 3,000
Net periodic pension cost 71,000 54,750
During the fiscal year ending December 31, 2005, we expect to
contribute approximately $112,000 to the Plan. We did not make any
contributions, required or otherwise, to the Plan in the three months ended
March 31, 2005 and 2004.
NOTE 11. New Accounting Pronouncements
Stock-Based Compensation
In December 2004, the Financial Accounting Standards Board (the "FASB")
issued Statement No. 123 (Revised), Share-based Payment, ("FAS 123(R)"). FAS
123(R) requires that the compensation cost relating to share-based payment
transactions be recognized in financial statements. That cost will be measured
based on the fair value of the equity or liability instruments issued. In
accordance with recent guidance from the Securities and Exchange Commission, the
Company will be required to apply FAS 123(R) on January 1, 2006.
14
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note 11. - (continued)
The scope of FAS 123(R) includes a wide range of share-based
compensation arrangements including share options, restricted share plans,
performance-based awards, share appreciation rights and employee share purchase
plans. FAS 123(R) revises FASB Statement 123, Accounting for Stock-Based
Compensation ("FAS 123"), and supersedes the Accounting Principles Board (the
"APB") Opinion No. 25, Accounting for Stock Issued to Employees ("APB Opinion
No. 25").
FAS 123(R) provides two methods for companies to transition to the new
standard requiring the expensing of options. Companies may elect to (i) restate
results for prior quarters in the fiscal year of adoption of FAS 123(R) to
reflect the FAS 123 proforma compensation costs, or (ii) restate results for
prior periods, whether annual or quarterly, to reflect the FAS 123 proforma
compensation costs. We are in the process of determining which transition
approach to use and the effect, if any, such transition approach will have on
our financial statements.
Internal Control Over Financial Reporting
The current objective of the Bank's Internal Control Program is to
allow management to comply with FDICIA requirements and with Section 302 of the
Sarbanes-Oxley Act of 2002 (the "Act"). Section 302 of the Act requires the CEO
and CFO of the Company to (i) certify that the annual and quarterly reports
filed with the Securities and Exchange Commission are accurate and (ii)
acknowledge that they are responsible for establishing, maintaining and
periodically evaluating the effectiveness of the disclosure controls and
procedures. Section 404 of the Act requires management to report on internal
control over financial reporting. The SEC requires us to comply with Section 404
by the year ending December 31, 2006.
The Committee of Sponsoring Organizations (COSO) methodology may be
used to document and test the internal controls pertaining to the accuracy of
Company issued financial statements and related disclosures. COSO requires a
review of the control environment (including anti-fraud and audit committee
effectiveness), risk assessment, control activities, information and
communication, and ongoing monitoring.
15
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion and analysis is intended to provide a better
understanding of the consolidated financial condition and results of operations
of Berkshire Bancorp Inc., a Delaware corporation. References herein to
"Berkshire", the "Company" or "we" and similar pronouns, shall be deemed to
refer to the Company and its consolidated subsidiaries unless the context
otherwise requires. References herein to per share amounts refer to diluted
shares. References herein to per share amounts for the three months ended March
31, 2004 have been revised to reflect the one-for-ten reverse stock split and
thirty-for- one forward stock split in the form of a stock dividend which
occurred on May 18, 2004. References to Notes herein are references to the
"Notes to Consolidated Financial Statements" of the Company located in Item 1
herein.
Critical Accounting Policies, Judgments and Estimates
The accounting and reporting policies of the Company conform with
accounting principles generally accepted in the United States of America and
general practices within the financial services industry. The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and the
assumptions that affect the amounts reported in the financial statements and the
accompanying notes. Actual results could differ from those estimates.
The Company considers that the determination of the allowance for loan
losses involves a higher degree of judgment and complexity than any of its other
significant accounting policies. The allowance for loan losses is calculated
with the objective of maintaining a reserve level believed by management to be
sufficient to absorb estimated credit losses. Management's determination of the
adequacy of the allowance is based on periodic evaluations of the loan portfolio
and other relevant factors. However, this evaluation is inherently subjective as
it requires material estimates, including, among others, expected default
probabilities, loss given default, the amounts and timing of expected future
cash flows on impaired loans, mortgages, and general amounts for historical loss
experience. The process also considers economic conditions, uncertainties in
estimating losses and inherent risks in the loan portfolio. All of these factors
may be susceptible to significant change. To the extent actual outcomes differ
from management estimates, additional provisions for loan losses may be required
that would adversely impact earnings in future periods.
With the adoption of SFAS No. 142 on January 1, 2002, the Company
discontinued the amortization of goodwill resulting from acquisitions. Goodwill
is now subject to impairment testing at least annually to determine whether
write-downs of the recorded balances are necessary. The Company tests for
impairment based on the goodwill maintained at each defined reporting unit. A
fair value is determined for each reporting unit based on at least one of three
various market valuation methodologies. If the fair values of the reporting
units exceed their book values, no write-down of recorded goodwill is necessary.
If the fair value of the reporting unit is less, an expense may be required on
the Company's books to write down the related goodwill to the proper carrying
value. As of December 31, 2004, the Company completed its transitional testing,
which determined that no impairment write-offs were necessary.
The Company recognizes deferred tax assets and liabilities for the
future tax effects of temporary differences, net operating loss carryforwards
and tax credits. Deferred tax assets are subject to management's judgment based
upon available evidence that future realization is more likely than not. If
management determines that the Company may be unable to realize all or part of
net deferred tax assets in the future, a direct charge to income tax expense may
be required to reduce the recorded value of the net deferred tax asset to the
expected realizable amount.
16
The following table presents the total dollar amount of interest income
from average interest-earning assets and the resultant yields, as well as the
interest expense on average interest-bearing liabilities, expressed in both
dollars and rates.
For The Three Months Ended March 31,
------------------------------------ -----------------------------------
2005 2004
------------------------------------ -----------------------------------
Interest Interest
Average and Average Average and Average
Balance Dividends Yield/Rate Balance Dividends Yield/Rate
------- --------- ---------- ------- --------- ----------
(Dollars in Thousands)
INTEREST-EARNING ASSETS:
Loans (1) $ 288,288 $ 4,694 6.51% $293,441 $4,849 6.61%
Investment securities 671,946 6,179 3.68 589,961 4,786 3.24
Other (2)(5) 16,683 94 2.25 2,081 3 0.58
---------- ------- ----- -------- ------ -----
Total interest-earning assets 976,917 10,967 4.49 885,483 9,638 4.35
----- -----
Noninterest-earning assets 42,516 37,710
---------- --------
Total Assets $1,019,433 $923,193
========== ========
INTEREST-BEARING LIABILITIES:
Interest bearing deposits 321,695 1,337 1.66% 259,195 898 1.39%
Time deposits 296,497 1,554 2.10 320,081 1,557 1.95
Other borrowings 240,470 1,923 3.20 194,709 1,265 2.60
---------- ------- ----- -------- ------ -----
Total interest-bearing
liabilities 858,662 4,814 2.24 773,985 3,720 1.92
------- ----- ------ -----
Demand deposits 43,708 37,199
Noninterest-bearing liabilities 6,656 7,348
Stockholders' equity (5) 110,407 104,661
---------- --------
Total liabilities and
stockholders' equity $1,019,433 $923,193
========== ========
Net interest income 6,153 5,918
======= ======
Interest-rate spread (3) 2.25% 2.43%
===== =====
Net interest margin (4) 2.52% 2.67%
===== =====
Ratio of average interest-earning
assets to average interest
bearing liabilities 1.14 1.14
========== ========
- ----------------------
(1) Includes nonaccrual loans.
(2) Includes interest-bearing deposits, federal funds sold and securities
purchased under agreements to resell.
(3) Interest-rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest bearing
liabilities.
(4) Net interest margin is net interest income as a percentage of average
interest-earning assets.
(5) Average balances are daily average balances except for the parent company
which have been calculated on a monthly basis.
17
Results of Operations
Results of Operations for the Three Months Ended March 31, 2005 Compared to the
Three Months Ended March 31, 2004.
General. Berkshire Bancorp Inc., a bank holding company registered under the
Bank Holding Company Act of 1956, has one wholly-owned banking subsidiary, The
Berkshire Bank, a New York State chartered commercial bank. The Bank is
headquartered in Manhattan and has nine branch locations, five branches in New
York City and four branches in Orange and Sullivan counties New York.
Net Income. Net income for the three-month period ended March 31, 2005 was $1.70
million, or $.25 per share, as compared to $1.95 million, or $.28 per share, for
the three-month period ended March 31, 2004.
The Company's net income is largely dependent on interest rate levels,
the demand for the Company's loan and deposit products and the strategies
employed to manage the interest rate and other risks inherent in the banking
business. From June 2003 through June 30, 2004, interest rates, as measured by
the prime rate, remained constant at 4.00%. On July 1, 2004, inflation fighting
actions taken by the Federal Reserve Board resulted in a 25 basis point increase
in the prime rate to 4.25%, the first such increase in more than four years.
Similar 25 basis point moves taken by the Federal Reserve Board in August,
September, November and December of 2004, and February and March 2005 have moved
the prime rate to its present level of 5.75%.
Net Interest Income. The Company's primary source of revenue is net interest
income, or the difference between interest income on earning assets, such as
loans and investment securities, and interest expense on interest-bearing
liabilities such as deposits and borrowings.
For the quarter ended March 31, 2005, net interest income increased by
$235,000, or 3.97%, to $6.15 million from $5.92 million for the quarter ended
March 31, 2004. The quarter over quarter increase in net interest income was the
result of the 10.33% growth in the average amount of interest-earning assets to
$976.92 million in 2005 from $885.48 million in 2004, partially offset by the
10.94% increase in the average amount of interest-bearing liabilities to $858.66
million in 2005 from $773.99 million in 2004, and further offset by the interest
rate spread, or the difference between the average yield on interest-earning
assets and the average cost of interest-bearing liabilities.
During the first quarter of 2005, the average yield on interest-earning
assets increased by 3.22% to 4.49% from 4.35% during the first quarter of 2004,
while the average cost of interest-bearing liabilities increased by 16.67% to
2.24% in 2005 from 1.92% in 2004. If interest rates remain at current levels or
increase slowly over time, we expect to see only moderate pressure on the
Company's interest-rate spread and net interest income. Investment securities in
our portfolio that have been sold, matured or called by the issuer during fiscal
2004 have been replaced with securities carrying somewhat lower yields and, by
design, shorter maturities to hedge against a rising interest rate environment.
Rates paid on deposit accounts are likely to increase in a rising rate
environment due to competition for deposits in the market place. The cost of
borrowed funds with floating rather than fixed interest rates will increase as
well.
Net Interest Margin. Net interest margin, or annualized net interest income as a
percentage of average interest-earning assets, declined by 15 basis points, or
5.62%, to 2.52% in the first quarter of fiscal 2005 from 2.67% in the first
quarter of fiscal 2004. We seek to secure and retain customer deposits with
competitive products and rates, while making strategic use of the prevailing
interest rate environment to borrow funds at what we believe to be attractive
rates. We invest such deposits and borrowed funds in a prudent mix of fixed and
adjustable rate loans, investment securities and short-term interest-earning
assets which provided an aggregate average yield of 4.49% and 4.35% during the
quarter ended March 31, 2005 and 2004, respectively.
18
The average amounts of loans decreased by $5.15 million, or 1.76%, to
$288.29 million in the three months ended March 31, 2005 from $293.44 million in
the three months ended March 31, 2004, as did the average yield on the loan
portfolio which declined to 6.51% from 6.61%. The principal amount of new loans
originated and principal repayments on existing loans during the first quarter
of 2005 was $12.32 million and $13.40 million, respectively.
The average amount of investment securities increased by $81.99
million, or 13.90% in the three months ended March 31, 2005 to $671.95 million
from $589.96 million in the three months ended March 31, 2004. The average yield
on investment securities improved by 44 basis points, to 3.68% in 2005 from
3.24% in 2004.
Interest Income. Total interest income for the quarter ended March 31, 2005
increased by $1.33 million, or 13.79%, to $10.97 million from $9.64 million for
the quarter ended March 31, 2004. The increase in total interest income was
primarily due to the growth in the average amount of total interest-earning
assets. Loans contributed $4.69 million of interest income in 2005, a decline of
$155,000 from the $4.85 million of interest income contributed in 2004.
Investment securities contributed $6.18 million of interest income in the first
quarter of 2005, an increase of $1.39 million, or 29.11%, over the $4.79 million
of interest income earned on investment securities in the first quarter of 2004.
-----------------------------------------------
Three Months Ended March 31,
-----------------------------------------------
2005 2004
--------------------- -------------------
Interest % of Interest % of
Income Total Income Total
(In thousands, except percentages)
Loans $ 4,694 42.81% $ 4,849 50.31%
Investment Securities 6,179 56.35 4,786 49.66
Other 94 0.84 3 0.03
------- ------ ------- ------
Total Interest Income $10,967 100.00% $ 9,638 100.00%
Loans, which are inherently risky and therefore command a higher return
than our conservative portfolio of invesment securities, declined to 29.51% of
our total average interest-earning assets during the three months ended March
31, 2005 from 33.14% of total average interest-earning assets during the three
months ended March 31, 2004. Investment securities increased to 68.78% from
66.63% of total average interest-earning assets during 2005 and 2004,
respectively. While we actively seek to originate new loans with qualified
borrowers who meet the Bank's underwriting standards, our strategy has been to
maintain those standards, sacrificing some current income to avoid possible
large future losses in the loan portfolio.
-----------------------------------------------
Three Months Ended March 31,
-----------------------------------------------
2005 2004
--------------------- -------------------
Average % of Average % of
Amount Total Amount Total
(In thousands, except percentages)
Loans $288,288 29.51% $293,441 33.14%
Investment Securities 671,946 68.78 589,961 66.63
Other 16,683 1.71 2,081 0.23
-------- ------ -------- ------
Total Interest-Earning Assets $976,917 100.00% $885,483 100.00%
19
Interest Expense. Total interest expense for the quarter ended March 31, 2005
increased by $1.09 million, or 29.41%, to $4.81 million from $3.72 million for
the quarter ended March 31, 2004. The increase in interest expense was due
primarily to the growth in the average amount of interest-bearing liabilities
and the increase in the average rates paid on such liabilities, 2.24% and 1.92%
in 2005 and 2004, respectively. As interest rates move higher, interest expense
will increase as we price our deposit products to meet the competition and the
adjustable rates paid on other borrowings increase as well. In May 2004, we sold
$15.46 million of floating rate junior subordinated denbentures which mature in
2034 and used the net proceeds to augment the Bank's capital to allow for
business expansion. The additional interest expense on these debentures, which
is included in other borrowings, was $206,000 during the three months ended
March 31, 2005.
-----------------------------------------------
Three Months Ended March 31,
-----------------------------------------------
2005 2004
--------------------- -------------------
Interest % of Interest % of
Income Total Income Total
(In thousands, except percentages)
Interest-Bearing Deposits $1,337 27.77% $ 898 24.14%
Time Deposits 1,554 32.28 1,557 41.85
Other Borrowings 1,923 39.95 1,265 34.01
------ ------ ------ ------
Total Interest Expense $4,814 100.00% $3,720 100.00%
-----------------------------------------------
Three Months Ended March 31,
-----------------------------------------------
2005 2004
--------------------- -------------------
Average % of Average % of
Amount Total Amount Total
(In thousands, except percentages)
Interest-Bearing Deposits $321,695 37.46% $259,195 33.49%
Time Deposits 296,497 34.53 320,081 41.35
Other Borrowings 240,470 28.01 194,709 25.16
-------- ------ -------- ------
Total Interest-Bearing Liabilities $858,662 100.00% $773,985 100.00%
20
Non-Interest Income. Non-interest income consists primarily of realized gains on
sales of marketable securities and service fee income. For the three months
ended March 31, 2005, total non-interest income decreased by $149,000, to
$269,000 from $418,000 for the three months ended March 31, 2004. The decrease
is largely due to the decrease in gains on sales of investment securities.
------------------------------------------------
Three Months Ended March 31,
------------------------------------------------
2005 2004
--------------------- ---------------------
Non-Interest % of Non-Interest % of
Income Total Income Total
(In thousands, except percentages)
Service Charges on Deposits $133 49.44% $127 30.38%
Investment Securities gains 6 2.23 93 22.25
Other 130 48.33 198 47.37
---- ------ ---- ------
Total Non-Interest Income $269 100.00% $418 100.00%
Non-Interest Expense. Non-interest expense includes salaries and employee
benefits, occupancy and equipment expenses, legal and professional fees and
other operating expenses associated with the day-to-day operations of the
Company. Total non-interest expense for the three months ended March 31, 2005
increased by $231,00 to $3.19 million from $2.96 million for the three months
ended March 31, 2004. The largest component of non-interest expense, 61% of the
total, are salaries and employee benefits which increased by $288,000 to $1.96
million in the 2005 quarter from $1.67 million in the 2004 quarter. The increase
is due to the addition of personnel in our internal control and compliance
departments.
------------------------------------------------
Three Months Ended March 31,
------------------------------------------------
2005 2004
--------------------- ---------------------
Non-Interest % of Non-Interest % of
Income Total Income Total
(In thousands, except percentages)
Salaries and Employee Benefits $1,955 61.23% $1,667 56.29%
Net Occupancy Expense 381 11.93 274 9.25
Equipment Expense 99 3.10 86 2.90
FDIC Assessment 69 2.16 22 0.74
Data Processing Expense 44 1.38 32 1.08
Other 645 20.20 881 29.74
------ ------ ------ ------
Total Non-Interest Expense $3,193 100.00% $2,962 100.00%
Provision for Income Tax. We recorded income tax expense of $1.49 million and
$1.38 million for the three-month periods ended March 31, 2005 and 2004,
respectively. The tax provisions for federal, state and local taxes represent
effective tax rates of 46.67% and 41.39%, respectively.
21
Common Stock Repurchases
On May 15, 2003, The Company's Board of Directors authorized the
purchase of up to an additional 450,000 shares of its Common Stock in the open
market, from time to time, depending upon prevailing market conditions, thereby
increasing the maximum number of shares which may be purchased by the Company
from 1,950,000 shares of Common Stock to 2,400,000 shares of Common Stock. Since
1990 through December 31, 2004, the Company has purchased a total of 1,848,909
shares of its Common Stock. At March 31, 2004, there were 551,091 shares of
Common Stock which may yet be purchased under our stock repurchase plan. The
following table sets forth information with respect to such purchases during the
periods indicated.
Fiscal Year 2005
Number of Average Price
Shares Paid Per
Purchased Share
--------- -------------
January - March -- --
Fiscal Year 2004
Number of Average Price
Shares Paid Per
Purchased Share
--------- -------------
January 4,263 $ 16.33
February -- --
March -- --
22
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Interest Rate Risk. Fluctuations in market interest rates can have a material
effect on the Company's net interest income because the yields earned on loans
and investments may not adjust to market rates of interest with the same
frequency, or with the same speed, as the rates paid by the Bank on its
deposits.
Most of the Bank's deposits are either interest-bearing demand deposits
or short term certificates of deposit and other interest-bearing deposits with
interest rates that fluctuate as market rates change. Management of the Bank
seeks to reduce the risk of interest rate fluctuations by concentrating on loans
and securities investments with either short terms to maturity or with
adjustable rates or other features that cause yields to adjust based upon
interest rate fluctuations. In addition, to cushion itself against the potential
adverse effects of a substantial and sustained increase in market interest
rates, the Bank has purchased off balance sheet interest rate cap contracts
which generally provide that the Bank will be entitled to receive payments from
the other party to the contract if interest rates exceed specified levels. These
contracts are entered into with major financial institutions.
As an additional interest rate management strategy, the Bank borrows
funds from the Federal Home Loan Bank, approximately $103.90 million at March
31, 2005, at fixed rates for a period of one to five years.
The Company seeks to maximize its net interest margin within an
acceptable level of interest rate risk. Interest rate risk can be defined as the
amount of the forecasted net interest income that may be gained or lost due to
favorable or unfavorable movements in interest rates. Interest rate risk, or
sensitivity, arises when the maturity or repricing characteristics of assets
differ significantly from the maturity or repricing characteristics of
liabilities.
23
In the banking industry, a traditional measure of interest rate
sensitivity is known as "gap" analysis, which measures the cumulative
differences between the amounts of assets and liabilities maturing or repricing
at various time intervals. The following table sets forth the Company's interest
rate repricing gaps for selected maturity periods:
Berkshire Bancorp Inc.
Interest Rate Sensitivity Gap at March 31, 2005
(in thousands, except for percentages)
-------------------------------------------------------------
3 Months 3 Through 1 Through Over
or Less 12 Months 3 Years 3 Years Total
------- --------- ------- ------- -----
Federal funds sold 9,000 -- -- -- 9,000
(Rate) 2.79% 2.79%
Interest bearing deposits in banks 1,267 -- -- -- 1,267
(Rate) 1.56% 1.56%
Loans (1)(2)
Adjustable rate loans 43,502 16,757 8,088 17,256 85,603
(Rate) 6.87% 4.90% 7.47% 6.51% 6.47%
Fixed rate loans 4,913 918 15,619 178,475 199,925
(Rate) 7.47% 6.80% 6.85% 6.29% 6.37%
-------- -------- --------- --------- ----------
Total loans 48,415 17,675 23,707 195,731 285,528
Investments (3)(4) 91,193 132,805 160,209 291,621 675,828
(Rate) 2.81% 2.66% 3.34% 4.80% 3.77%
-------- -------- --------- --------- ----------
Total rate-sensitive assets 140,875 150,480 183,916 487,352 962,623
-------- -------- --------- --------- ----------
Deposit accounts (5)
Savings and NOW 283,932 -- -- -- 283,932
(Rate) 1.61% 1.61%
Money market 20,904 -- -- -- 20,904
(Rate) 0.55% 0.55%
Time Deposits 82,738 147,913 68,825 2,080 301,556
(Rate) 1.80% 2.52% 2.94% 1.97% 2.41%
-------- -------- --------- --------- ----------
Total deposit accounts 387,574 147,913 68,825 2,080 606,392
Repurchase Agreements 68,509 34,739 33,000 -- 136,248
(Rate) 2.59% 3.08% 2.92% 2.79%
Other borrowings -- 2,263 61,620 55,478 119,361
(Rate) % 3.60% 3.55% 4.42% 3.96%
-------- -------- --------- --------- ----------
Total rate-sensitive liabilities 456,083 184,915 163,445 57,558 862,001
-------- -------- --------- --------- ----------
Interest rate caps 20,000 -- (20,000) --
Gap (repricing differences) (335,208) (34,435) 40,471 429,794 100,622
======== ======== ========= ========= ==========
Cumulative Gap (335,208) (369,643) (329,172) 100,622
======== ======== ========= =========
Cumulative Gap to Total Rate
Sensitive Assets (34.82)% (38.40)% (34.20)% 10.45%
======== ======== ========= =========
- ------------------------------
(1) Adjustable-rate loans are included in the period in which the interest
rates are next scheduled to adjust rather than in the period in which
the loans mature. Fixed-rate loans are scheduled according to their
maturity dates.
(2) Includes nonaccrual loans.
(3) Investments are scheduled according to their respective repricing
(variable rate loans) and maturity (fixed rate securities) dates.
(4) Investments are stated at book value.
(5) NOW accounts and savings accounts are regarded as readily accessible
withdrawal accounts. The balances in such accounts have been allocated
among maturity/repricing periods based upon The Berkshire Bank's
historical experience. All other time accounts are scheduled according
to their respective maturity dates.
24
Provision for Loan Losses. The Company maintains an allowance for loan losses at
a level deemed sufficient to absorb losses, which are inherent in the loan
portfolio at each balance sheet date. Management reviews the adequacy of the
allowance on at least a quarterly basis to ensure that the provision for loan
losses has been charged against earnings in an amount necessary to maintain the
allowance at a level that is appropriate based on management's assessment of
probable estimated losses. The Company's methodology for assessing the
appropriateness of the allowance for loan losses consists of several key
elements. These elements include a specific allowance for loan watch list
classified loans, an allowance based on historical trends, an additional
allowance for special circumstances, and an unallocated portion. The Company
consistently applies the following comprehensive methodology.
The allowance for loan watch list classified loans addresses those
loans maintained on the Company's loan watch list, which are assigned a rating
of substandard, doubtful, or loss. Substandard loans are those with a
well-defined weakness or a weakness, which jeopardizes the repayment of the
debt. A loan may be classified as substandard as a result of impairment of the
borrower's financial condition and repayment capacity. Loans for which repayment
plans have not been met or collateral equity margins do not protect the Company
may also be classified as substandard. Doubtful loans have the characteristics
of substandard loans with the added characteristic that collection or
liquidation in full, on the basis of presently existing facts and conditions, is
highly improbable. Although the possibility of loss is extremely high for
doubtful loans, the classification of loss is deferred until pending factors,
which might improve the loan, have been determined. Loans rated as doubtful in
whole or in part are placed in nonaccrual status. Loans which are classified as
loss are considered uncollectible and are charged to the allowance for loan
losses. There were no loans classified as loss as of March 31, 2005.
For the three month periods ended March 31, 2005 and 2004, we
recovered loans totaling $50,000 and $23,000, respectively, which amounts were
returned to the provision for loan losses. We did not charge-off any loans
during either of these two periods.
Loans on the loan watch list may also be impaired loans, which are
defined as nonaccrual loans or troubled debt restructurings, which are not in
compliance with their restructured terms. Each of the classified loans on the
loan watch list is individually analyzed to determine the level of the potential
loss in the loan under the current circumstances. The specific reserve
established for these criticized and impaired loans is based on careful analysis
of the loan's performance, the related collateral value, cash flow
considerations and the financial capability of any guarantor. The allowance for
loan watch list classified loans is equal to the total amount of potential
unconfirmed losses for the individual classified loans on the watch list. Loan
watch list loans are managed and monitored by assigned Senior Management.
The allowance based on historical trends uses charge-off experience of
the Company to estimate potential unconfirmed losses in the balances of the loan
and lease portfolios. The historical loss experience percentage is based on the
charge-off history. Historical loss experience percentages are applied to all
non-classified loans to obtain the portion of the allowance for loan losses
which is based on historical trends. Before applying the historical loss
experience percentages, loan balances are reduced by the portion of the loan
balances, which are subject to guarantees, by a government agency. Loan balances
are also adjusted for unearned discount on installment loans.
The Company also maintains an unallocated allowance. The unallocated
allowance is used to cover any factors or conditions which may cause a potential
loan loss but are not specifically identifiable. It is prudent to maintain an
unallocated portion of the allowance because no matter how detailed an analysis
of potential loan losses is performed these estimates by definition lack
precision. Management must make estimates using assumptions and information,
which is often subjective and changing rapidly.
25
Since all identified losses are immediately charged off, no portion of
the allowance for loan losses is restricted to any individual loan or groups of
loans, and the entire allowance is available to absorb any and all loan losses.
A loan is placed in a nonaccrual status at the time when ultimate
collectibility of principal or interest, wholly or partially, is in doubt. Past
due loans are those loans which were contractually past due 90 days or more as
to interest or principal payments but are well secured and in the process of
collection. Renegotiated loans are those loans which terms have been
renegotiated to provide a reduction or deferral of principal or interest as a
result of the deteriorating financial position of the borrower.
At March 31, 2005 and 2004, we had a total of $404,000 and $328,000,
respectively, of non-accrual loans, and no loans past due more than 90 days and
still accruing interest at either date. Based upon management's evaluations of
the overall analysis of the Bank's allowance for loan losses, the year over year
decrease in total loans to $285.53 million from $295.34 million and the economic
conditions in our market area, the provision for the three months ended March
31, 2005, including net recoveries which are added back to the provision,
increased to $3.02 million from $2.66 million in the year ago period.
Management believes that the allowance for loan losses and
nonperforming loans remains safely within acceptable levels.
The following table sets forth information with respect to activity in
the Company's allowance for loan losses during the periods indicated (in
thousands, except percentages):
Three Months Ended
March 31,
-----------------------------------------
2005 2004
---- ----
Average loans outstanding $288,288 $293,441
======== ========
Allowance at beginning of period 2,927 2,593
Charge-offs:
Commercial and other loans -- --
-------- --------
Total loans charged-off -- --
-------- --------
Recoveries:
Commercial and other loans 50 23
-------- --------
Total loans recovered 50 23
-------- --------
Net (charge-offs) recoveries 50 23
-------- --------
Provision for loan losses
charged to operating expenses 45 45
-------- --------
Allowance at end of period $ 3,022 $ 2,661
-------- --------
Ratio of net recoveries (charge-offs)
to average loans outstanding 0.02% 0.01%
======== ========
Allowance as a percent of total loans 1.06% 0.90%
======== ========
Total loans at end of period $285,528 $295,336
======== ========
26
Loan Portfolio.
Loan Portfolio Composition. The Company's loans consist primarily of mortgage
loans secured by residential and non-residential properties as well as
commercial loans which are either unsecured or secured by personal property
collateral. Most of the Company's commercial loans are either made to
individuals or personally guaranteed by the principals of the business to which
the loan is made. At March 31, 2005, we had total gross loans of $285.53
million, deferred loan fees of $756,000 and an allowance for loan losses of
$3.02 million. From time to time, the Bank may originate residential mortgage
loans and then sell them on the secondary market, normally recognizing fee
income in connection with the sale. During the three-month period ended March
31, 2005, the Bank sold approximately $505,000 of such loans and recorded in
other income a gain of approximately $7,000 on such sales.
The following tables set forth information concerning the Company's
loan portfolio by type of loan at the dates indicated:
March 31, December 31,
2005 2004
----------------------- ---------------------
Amount Amount
------ ------
(in thousands)
Commercial and professional loans $ 18,201 $ 16,498
Secured by real estate
1-4 family 152,687 155,079
Multi family 3,807 4,600
Non-residential (commercial) 108,974 109,597
Consumer 1,859 1,989
-------- --------
Total loans 285,528 287,763
Less:
Deferred loan fees (756) (864)
Allowance for loan losses (3,022) (2,927)
-------- --------
Loans, net $281,750 $284,052
======== ========
It is the Bank's policy to discontinue accruing interest on a loan when
it is 90 days past due or if management believes that continued interest
accruals are unjustified. The Bank may continue interest accruals if a loan is
more than 90 days past due if the Bank determines that the nature of the
delinquency and the collateral are such that collection of the principal and
interest on the loan in full is reasonably assured. When the accrual of interest
is discontinued, all accrued but unpaid interest is charged against current
period income. Once the accrual of interest is discontinued, the Bank records
interest as and when received until the loan is restored to accruing status. If
the Bank determines that collection of the loan in full is in reasonable doubt,
then amounts received are recorded as a reduction of principal until the loan is
returned to accruing status. At March 31, 2005 and 2004, we did not have any
loans past due more than 90 days and still accruing interest.
27
Capital Adequacy
Quantitative measures established by regulation to ensure capital
adequacy require the Company and the Bank to maintain minimum amounts and ratios
of total and Tier I capital (as defined in the regulations) to risk-weighted
assets (as defined), and Tier I capital (as defined) to average assets (as
defined). As of March 31, 2005, the most recent notification from the FDIC
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank must
maintain certain Total risk-based, Tier I risk-based, and Tier I leverage
ratios. There are no conditions or events since the notification that management
believes have changed the Bank's category.
The following tables set forth the actual and required regulatory
capital amounts and ratios of the Company and the Bank as of March 31, 2005 and
December 31, 2004 (dollars in thousands):
To be well
capitalized under
For capital prompt corrective
Actual adequacy purposes action provisions
------ ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
March 31, 2005
Total Capital (to Risk-Weighted Assets)
Company 112,359 28.8% 31,220 >=8.0% -- N/A
Bank 84,687 23.2% 29,173 >=8.0% 36,466 >=10.0%
Tier I Capital (to Risk-Weighted Assets)
Company 109,337 28.0% 15,610 >=4.0% -- N/A
Bank 81,665 22.4% 14,586 >=4.0% 21,879 >=6.0%
Tier I Capital (to Average Assets)
Company 109,337 10.7% 40,777 >=4.0% -- N/A
Bank 81,665 8.4% 39,044 >=4.0% 48,805 >=5.0%
To be well
capitalized under
For capital prompt corrective
Actual adequacy purposes action provisions
------ ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
December 31, 2004
Total Capital (to Risk-Weighted Assets)
Company $110,063 30.1% $29,234 >=8.0% -- N/A
Bank 82,970 24.1% 27,533 >=8.0% 34,416 >=10.0%
Tier I Capital (to Risk-Weighted Assets)
Company 107,136 29.3% 14,617 >=4.0% -- N/A
Bank 80,042 23.3% 13,766 >=4.0% 20,649 >=6.0%
Tier I Capital (to Average Assets)
Company 107,136 11.2% 38,250 >=4.0% -- N/A
Bank 80,042 8.6% 37,240 >=4.0% 46,550 >=5.0%
28
Liquidity
The management of the Company's liquidity focuses on ensuring that
sufficient funds are available to meet loan funding commitments, withdrawals
from deposit accounts, the repayment of borrowed funds, and ensuring that the
Bank and the Company comply with regulatory liquidity requirements. Liquidity
needs of the Bank have historically been met by deposits, investments in federal
funds sold, principal and interest payments on loans, and maturities of
investment securities.
For the Company, liquidity means having cash available to fund
operating expenses and to pay shareholder dividends, when and if declared by the
Company's Board of Directors and to pay the interest on the Debentures issued in
May 2004 and April 2005. The ability of the Company to meet all of its
obligations, including the payment of dividends, is not dependent upon the
receipt of dividends from the Bank. At March 31, 2005, the Company, excluding
the Bank, had cash and cash equivalents of $2.34 million and investment
securities available for sale of $12.80 million.
The Company maintains financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments, approximately $20.32 million at March 31, 2005,
include commitments to extend credit and stand-by letters of credit.
At March 31, 2005, the Company had outstanding commitments of
approximately $408.97 million. These commitments include $233.62 million that
mature or renew within one year, $131.89 million that mature or renew after one
year and within three years, $31.04 million that mature or renew after three
years and within five years and $12.41 million that mature or renew after five
years.
At March 31, 2005, the Company had one unconsolidated subsidiary,
Berkshire Capital Trust I, which was established in May 2004.
Impact of Inflation and Changing Prices
The Company's financial statements measure financial position and
operating results in terms of historical dollars without considering the changes
in the relative purchasing power of money over time due to inflation. The impact
of inflation is reflected in the increasing cost of the Company's operations.
The assets and liabilities of the Company are largely monetary. As a result,
interest rates have a greater impact on the Company's performance than do the
effects of general levels of inflation. In addition, interest rates do not
necessarily move in the direction, or to the same extent, as the price of goods
and services. However, in general, high inflation rates are accompanied by
higher interest rates, and vice versa.
ITEM 4 - CONTROLS AND PROCEDURES
Evaluation of the Company's Disclosure Controls and Internal Control. As of the
end of the period covered by this Quarterly Report on Form 10-Q, the Company
evaluated the effectiveness of the design and operation of its "disclosure
controls and procedures" as defined in Rule 13a-15(e) of the Securities Exchange
Act of 1934 ("Disclosure Controls"). This evaluation ("Controls Evaluation") was
done under the supervision and with the participation of the Company's
management, including the Chief Executive Officer ("CEO") who is also the Chief
Financial Officer ("CFO").
Limitations on the Effectiveness of Controls. The Company's management,
including the CEO/CFO, does not expect that its Disclosure Controls and/or its
"internal control over financial reporting" as defined in Rule 13(a)-15(f) of
the Securities Exchange Act of 1934 ("Internal Control") will prevent all error
and all fraud. A control system, no matter how well conceived and operated, can
29
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Further, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the Company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based in
part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, control may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
Conclusions. Based upon the Controls Evaluation, the CEO/CFO has concluded that,
subject to the limitations noted above, the Disclosure Controls are effective in
reaching a reasonable level of assurance that information required to be
disclosed by the Company is recorded, processed, summarized and reported within
the time period specified in the SEC's rules and forms. In accordance with SEC
requirements, the CEO/CFO notes that during the fiscal quarter ended March 31,
2005, no changes in Internal Control have occurred that have materially affected
or are reasonably likely to materially affect Internal Control.
PART II. OTHER INFORMATION
Item 6. Exhibits
Exhibit
Number Description
------ -----------
31 Certification of Principal Executive
and Financial Officer pursuant to
Section 302 Of The Sarbanes-Oxley Act
of 2002.
32 Certification of Principal Executive
and Financial Officer pursuant to
Section 906 Of The Sarbanes-Oxley Act
of 2002.
30
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BERKSHIRE BANCORP INC.
(Registrant)
Date: May 6, 2005 By: /s/ Steven Rosenberg
---------------- -----------------------
Steven Rosenberg
President and Chief
Financial Officer
31
EXHIBIT INDEX
Exhibit Sequential
Number Description Page Number
- ------ ----------- -----------
31 Certification of Principal Executive 33
and Financial Officer pursuant to
Section 302 Of The Sarbanes-Oxley Act
of 2002.
32 Certification of Principal Executive 34
and Financial Officer pursuant to
Section 906 Of The Sarbanes-Oxley Act
of 2002.
32