ITEM 1. BUSINESS - --------------------------------------------------------------------------------
General
Berkshire Hills Bancorp, Inc. (the "Company" or "Berkshire Hills"), a Delaware corporation, was organized in January 2000 to become the holding company for Berkshire Bank (the "Bank") upon the conversion of the Bank's former parent holding company, Berkshire Bancorp, from the mutual to stock form of organization, which occurred on June 27, 2000. The Company owns all of the outstanding shares of the Bank. The Company has no significant liabilities. Management of the Company and the Bank are substantially similar and the Company neither owns nor leases any property, but instead uses the premises, equipment and furniture of the Bank. Accordingly, the information set forth in this report, including the consolidated financial statements and related financial data, relates primarily to the Bank.
The Bank is regulated by the Massachusetts Division of Banks and the Federal Deposit Insurance Corporation (the "FDIC"). The Bank's deposits are insured to the maximum allowable amount by the Bank Insurance Fund (the "BIF") of the FDIC and the Depositors Insurance Fund (the "DIF"). Berkshire Bank has been a member of the Federal Home Loan Bank system since 1973.
Berkshire Bank is a community bank that accepts retail deposits from the general public in the areas surrounding its 11 full-service banking offices and uses those funds, together with funds generated from operations and borrowings, to originate residential mortgage loans, commercial business and real estate loans and consumer loans, primarily automobile loans and home equity lines of credit. Berkshire Bank primarily holds the loans that it originates for investment, but occasionally sells or securitizes some of its loans, including automobile and fixed-rate residential mortgage loans, in the secondary market. Berkshire Bank also invests in U.S. Government and Agency securities, mortgage- and asset-backed securities, including real estate mortgage investment conduits and collateralized mortgage obligations, debt and equity securities and other permissible investments. Berkshire Bank's revenues are derived principally from the generation of interest and fees on loans originated and, to a lesser extent, interest and dividends on its investment securities. Berkshire Bank's primary sources of funds are deposits, principal and interest payments on loans and securities and advances from the Federal Home Loan Bank of Boston.
Company Website and Availability of Securities and Exchange Commission Filings
The Company's Internet website is www.berkshirebank.com. The Company makes available free of charge on or through its website, its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission.
Market Area
Berkshire Bank is headquartered in Pittsfield, Massachusetts, in Berkshire County. Berkshire Bank's primary deposit gathering and lending areas are concentrated in the communities surrounding its 11 full-service banking offices located in Berkshire County. However, Berkshire Bank also makes loans throughout western Massachusetts, northern Connecticut, eastern New York and southern Vermont and occasionally other geographic areas.
Berkshire County, the western-most county in Massachusetts, is approximately two and one-half hours from both Boston and New York City. Berkshire County borders Vermont, Connecticut and New York. Berkshire County has experienced a shift in its economy as manufacturing jobs have been replaced with service-related jobs, primarily in tourism, social service and health care. Other than Berkshire Bank, the major employers in the area include Berkshire Life Insurance Company of America, Crane & Company, GE Plastics, Kay Bee Toys, Berkshire Health Systems, General Dynamics Defense Systems, Mead Corporation and several institutions of higher education.
Competition
The Bank faces intense competition for the attraction of deposits and origination of loans in its primary market area. As of June 30, 2003, according to information presented on the Federal Deposit Insurance Corporation's website, the Bank held approximately 32% of the deposits in Berkshire County, which was the largest share of deposits out of 12 financial institutions in the county. Berkshire Bank's most direct competition for deposits comes from one large credit union in the area, which has a competitive advantage as credit unions do not have to pay state or federal taxes. The Bank also competes with super-regional banks, such as Banknorth and Citizens Bank. These competitors have substantially greater resources and lending limits than the Bank does and offers services that the Bank does not provide. Additionally, Berkshire Bank faces competition for deposits from several commercial and savings banks operating in its primary market area and, to a lesser extent, from other financial institutions, such as brokerage firms, insurance companies and the mutual fund industry, as customers seek alternative sources of investment for
their funds. Berkshire Bank also faces significant competition for investors' funds due to its direct purchase of short-term money market securities and other corporate and government securities. Berkshire Bank faces competition for loans from a significant number of traditional financial institutions, primarily savings banks and commercial banks in its market area, as well as the mortgage companies and mortgage brokers operating in its primary market area. The increase of Internet-accessible financial institutions which solicit deposits and originate loans on a nationwide basis also increases competition for Berkshire Bank's customers. Additionally, competition has increased as a result of regulatory actions and legislative changes, most notably the enactment of the Gramm-Leach-Bliley Act of 1999. These changes have eased restrictions on interstate banking and the entrance into the financial services market by non-depository and non-traditional financial services providers, including insurance companies, securities brokerage and underwriting firms and specialty financial services companies (such as Internet-based providers).
Lending Activities
General. The types of loans that Berkshire Bank may originate are limited by federal and state laws and regulations. Interest rates charged by Berkshire Bank on loans are affected principally by Berkshire Bank's current asset/liability strategy, the demand for such loans, the supply of money available for lending purposes and the rates offered by competitors. These factors, in turn, are affected by general and economic conditions, monetary policies of the federal government, including the Federal Reserve Board, legislative tax policies and governmental budgetary matters.
Loan Portfolio Analysis. The following table sets forth the composition of Berkshire Bank's loan portfolio in dollar amounts and as a percentage of the portfolio at the dates indicated.
Real Estate Lending
One- to Four-Family Real Estate Loans. One of Berkshire Bank's primary lending activities is to originate loans secured by one- to four-family residences located in its primary market area. At December 31, 2003, $266.8 million, or 33.7%, of Berkshire Bank's total loans consisted of one- to four-family mortgage loans. Of the one- to four-family loans outstanding at that date, 49.0% were fixed-rate mortgage loans and 51.0% were adjustable-rate loans.
Berkshire Bank originates fixed-rate fully amortizing loans with maturities of 15, 20 and 30 years. Management establishes the loan interest rates based on market conditions. Berkshire Bank offers mortgage loans that conform to Fannie Mae and Freddie Mac guidelines. In addition, Berkshire Bank offers jumbo loan products, which presently are loans in amounts over
$333,700. Berkshire Bank generally originates loans for its own portfolio, but occasionally sells or securitizes some fixed-rate one- to four-family loans in the secondary market. The determination of whether to sell or securitize loans is reviewed periodically by management as a means of managing the Company's interest rate risk profile or providing liquidity.
Berkshire Bank also currently offers adjustable-rate mortgage loans, with an interest rate based on the one-year, three- year or five-year Constant Maturity Treasury index, which adjust every one, three or five years from the outset of the loan, with terms of up to 30 years. Interest rate adjustments on such loans range from 2% to 5% during any adjustment period and are limited to no more than 6% over the life of the loan.
Adjustable-rate mortgage loans help reduce Berkshire Bank's exposure to changes in interest rates. There are, however, unquantifiable credit risks resulting from the potential of increased costs due to changed rates to be paid by borrowers. During periods of rising interest rates, the risk of default on adjustable-rate mortgage loans increases as a result of repricing and the increased payments required to be made by borrowers. In addition, although adjustable-rate mortgage loans allow Berkshire Bank to increase the sensitivity of its asset base to changes in interest rates, the extent of this interest sensitivity is limited by the periodic and lifetime interest rate adjustment limits. Because of these considerations, Berkshire Bank has no assurance that yields on adjustable-rate mortgage loans will be sufficient to offset increases in Berkshire Bank's cost of funds during periods of rising interest rates. These risks have not had a material adverse effect on Berkshire Bank to date.
Berkshire Bank underwrites one- to four-family residential mortgage loans with loan-to-value ratios of up to 100% on a one- to two-family primary residence, up to 90% on a three- to four-family primary residence or a vacation home, and up to 75% on a condominium. A borrower is required to obtain private mortgage insurance on loans that exceed 80%, or 75% in the case of a condominium, of the appraised value or sales price, whichever is less, of the secured property. Berkshire Bank also generally requires fire, casualty, title, hazard insurance and, if appropriate, flood insurance to be maintained on all properties securing real estate loans made by Berkshire Bank. An independent licensed appraiser generally appraises all properties.
To provide financing for low- and moderate-income families, Berkshire Bank offers Federal Housing Authority, Veterans Administration and Massachusetts Housing Finance Agency residential mortgage loans to qualified individuals with adjustable- and fixed-rates of interest and terms of up to 30 years. Such loans may be secured by one- to four-family residential properties and are underwritten using modified underwriting guidelines. Berkshire Bank also participates in the Good Samaritan Home Ownership Program, which is a non-profit venture established to advise and assist low- and middle-income families in the purchase of their first home in Berkshire County. Qualified individuals can obtain a 30-year fixed-rate mortgage loan on a one- to four-family, owner occupied property.
Construction and Land Development Loans. At December 31, 2003, construction and land development loans totaled $34.7 million, or 4.4% of Berkshire Bank's total loan portfolio, of which $10.6 million were residential construction loans, $15.4 million were commercial construction loans and $8.7 million were commercial land development loans. At December 31, 2003, the unadvanced portion of construction and land development loans totaled $18.1 million.
Berkshire Bank originates construction and land development loans to individuals for the construction and acquisition of personal residences. Berkshire Bank's residential construction and land development loans generally provide for the payment of interest only during the construction phase, which is usually twelve months. At the end of the construction phase, the loan converts to a permanent mortgage loan. Loans can be made with a maximum loan to value ratio of 85%, provided that the borrower obtains private mortgage insurance if the loan balance exceeds 80% of the appraised value or sales price, whichever is less, of the secured property. At December 31, 2003, the largest outstanding residential construction and land development loan commitment was for $2.5 million. Construction and land development loans to individuals are generally made on the same terms as Berkshire Bank's one- to four-family mortgage loans.
Before making a commitment to fund a residential construction and land development loan, Berkshire Bank requires an appraisal of the property and planned improvements by an independent licensed appraiser. Berkshire Bank also reviews and inspects each property before disbursement of funds during the term of the construction and land development loan. Loan proceeds are disbursed after inspection based on the percentage of completion method.
Berkshire Bank also makes construction and land development loans for commercial development projects, including multi-family commercial properties, single-family subdivisions and condominiums. These loans generally have an interest only phase during construction then convert to permanent financing. Disbursement of funds is at the sole discretion of Berkshire Bank and is based on the progress of construction. The maximum loan to value ratio for these loans depends upon the type of commercial development project being undertaken, but generally will not exceed 80%. At December 31, 2003, the largest commercial construction and land development commitment was $4.5 million, of which $4.5 million was outstanding, to a locally headquartered company that develops residential subdivisions on a national scale, and is a long-time Berkshire Bank borrower. This loan is secured by a 1,075 acre, 892 lot residential subdivision in the Austin-San Antonio, Texas corridor. This loan was performing according to its terms at December 31, 2003.
Berkshire Bank also originates land loans to local contractors and developers for the purpose of making improvements thereon, or for the purpose of holding or developing the land for sale. Such loans are secured by a lien on the property, have loan to value ratios that are limited to 75% of the value of the land used for residential development and 80% of the value of the land used for commercial development (based on the lower of the acquisition price or the appraised value of the land). Land loans are offered with a term of three years in which only interest is required to be paid each month. A balloon payment for the principal plus any accrued interest is due at the end of the three-year period. Berkshire Bank's land loans are generally secured by property in its primary market area. Berkshire Bank generally requires title insurance and, if applicable, either a hazardous waste survey or environmental insurance coverage.
Construction and land development financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. If the estimate of construction cost proves to be inaccurate, Berkshire Bank may be required to advance funds beyond the amount originally committed to protect the value of the property. Additionally, if the estimate of value proves to be inaccurate, Berkshire Bank may be confronted with a completed project, having a value insufficient to assure full repayment.
Multi-Family and Commercial Real Estate Loans. Berkshire Bank originates multi-family and commercial real estate loans that are generally secured by five or more unit apartment buildings and properties used for business purposes such as small office buildings, industrial, healthcare, lodging or retail facilities predominantly located in Berkshire Bank's primary market area. Berkshire Bank's multi-family and commercial real estate loans may be made in amounts of up to 80% of the appraised value of the property or the selling price, whichever is less. Loans secured by single-family subdivisions and condominium projects may be made in amounts of up to 75% and 70%, respectively, of the appraised value of the property or selling price, whichever is less. Berkshire Bank's multi-family and commercial real estate loans may be made with terms of up to 20 years and substantially all of which are originated with interest rates that adjust periodically and are generally indexed to Berkshire Bank's base rate. In reaching its decision on whether to make a multi-family or commercial real estate loan, Berkshire Bank considers the net operating income and value of the property and the borrower's expertise, credit history and profitability. In addition, with respect to commercial real estate rental properties, Berkshire Bank will also consider the term of the lease and the quality of the tenants. Berkshire Bank generally requires that the properties securing these real estate loans have debt service coverage ratios (the ratio of available cash flows before debt service to debt service) of at least 1.25x. Environmental surveys or environmental insurance coverage are generally required for commercial real estate loans. Additionally, in larger real estate projects, it is recommended that a feasibility study be obtained. A feasibility study is particularly important with respect to multi-family housing projects, hotel/motel construction and health care facilities. Generally, multi-family and commercial real estate loans made to corporations, partnerships and other business entities require personal guarantees by the principals. The largest multi-family or commercial real estate loan relationship in Berkshire Bank's portfolio at December 31, 2003 consisted of four loans to related health care facilities in Massachusetts totaling $8.5 million. All loans were performing according to their terms at December 31, 2003.
Loans secured by multi-family and commercial real estate properties generally involve larger principal amounts and a greater degree of risk than one- to four-family residential mortgage loans. Because payments on loans secured by multi-family and commercial real estate properties are often dependent on the successful operation or management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy. Berkshire Bank seeks to minimize these risks through strict adherence to its underwriting standards.
Consumer Lending
Automobile Lending. At December 31, 2003, automobile loans totaled $103.7 million, or 13.1% of Berkshire Bank's total loans and 67.3% of consumer loans. The Bank offers fixed-rate automobile loans on a direct and indirect basis with terms of up to 72 months for new and recent model used cars and up to 66 months for older model used cars. Berkshire Bank generally will make such loans up to 100% of the retail value shown in the NADA Used Car Guide. The interest rates offered differ depending on the age of the automobile and current interest rates offered by competitors.
Berkshire Bank began offering indirect automobile loans through automobile dealers over ten years ago. Currently, Berkshire Bank maintains contractual relationships with over 90 new and used car dealers throughout western Massachusetts, northern Connecticut, eastern New York and southern Vermont. In 2001, management determined to decrease the Bank's emphasis on lower quality or sub-prime automobile loans and attempt to reduce the overall size of the automobile loan portfolio. This process was accelerated through the sale of $69.7 million of sub-prime automobile loans in 2002 and the sale of an additional $9.9 million of sub-prime automobile loans in 2003. At December 31, 2003, $1.4 million of lower quality or sub-prime automobile loans, representing 1.3% of automobile loans, or 0.2% of total loans, remained.
Home Equity Lines of Credit and Other Consumer Loans. Berkshire Bank offers home equity lines of credit secured by owner-occupied one- to four-family residences. At December 31, 2003, home equity lines of credit totaled $45.8 million, or 5.8% of Berkshire Bank's total loans and 29.7% of consumer loans. Additionally, at December 31, 2003, the unadvanced amounts of
home equity lines of credit totaled $45.5 million. The underwriting standards employed by Berkshire Bank for home equity lines of credit include a determination of the applicant's credit history, an assessment of the applicant's ability to meet existing obligations and payments on the proposed loan and the value of the collateral securing the loan. Home equity loans will not be made if the borrower's first mortgage payment, monthly real estate payment and amortized equity line payment exceed 25% of the borrower's gross monthly income. Additionally, the borrower's monthly debt service cannot exceed 35% of the borrower's gross monthly income. Home equity lines of credit have adjustable rates of interest which are indexed to the prime rate as reported in The Wall Street Journal. Generally, the maximum combined loan-to-value ratio on home equity lines of credit is 80% for loans up to $200,000 and 60% for loans greater than $200,000. A home equity line of credit may be drawn down by the borrower for an initial period of five years from the date of the loan agreement. During this period, the borrower has the option of paying, on a monthly basis, either principal and interest or only interest. If not renewed, the borrower has to pay back the amount outstanding under the line of credit over a term not to exceed ten years, beginning at the end of the five-year period.
Other consumer loans at December 31, 2003 amounted to $4.5 million, or 0.6% of Berkshire Bank's total loans and 2.9% of consumer loans. These loans include education, collateral, personal and unsecured loans, and second mortgage loans other than home equity lines of credit. Collateral loans are generally secured by a passbook account, a certificate of deposit or marketable securities. Unsecured loans generally have a maximum borrowing limitation of $10,000 and a maximum term of five years. Second mortgages are offered on owner-occupied primary or secondary residences and are adjustable-rate, either adjusting annually or with a five-year initial fixed period adjusting annually thereafter, with terms up to 30 years.
Loans secured by rapidly depreciable assets such as automobiles or that are unsecured entail greater risks than one- to four-family mortgage loans. In such cases, repossessed collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance, since there is a greater likelihood of damage, loss or depreciation of the underlying collateral. The remaining deficiency often does not warrant further substantial collection efforts against the borrower beyond obtaining a deficiency judgment. Further, collections on these loans are dependent on the borrower's continuing financial stability and, therefore, are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Finally, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans if a borrower defaults.
Commercial Lending
Commercial Loans. At December 31, 2003, Berkshire Bank had $166.5 million in commercial loans which amounted to 21.0% of total loans. In addition, at such date, Berkshire Bank had $49.4 million of unadvanced commercial lines of credit. Berkshire Bank makes commercial business loans primarily in its market area to a variety of professionals, sole proprietorships and small businesses. Berkshire Bank's largest commercial loan relationship was a $4.4 million loan to a long time customer secured by various types of business assets located in Berkshire County. This loan was performing according to its terms at December 31, 2003.
Berkshire Bank offers secured commercial term loans, which have maturities of greater than one year and the repayment of which is dependent on future earnings. The term for repayment will normally be limited to the lesser of the expected useful life of the asset being financed or a fixed amount of time, generally seven years or less. Berkshire Bank also offers loans originated to finance a business' equipment and machinery, lines of credit, letters of credit, time notes and Small Business Administration guaranteed loans. In addition, Berkshire Bank offers revolving lines of credit called operating loans that are secured by business assets other than real estate, such as business equipment, inventory and accounts receivable. Business lines of credit have adjustable rates of interest and are payable on demand, subject to annual review and renewal. Time notes are short-term loans, generally limited to 90 days which do not require payment of principal or interest until maturity.
When making commercial business loans, Berkshire Bank considers the financial statements of the borrower, the borrower's payment history of both corporate and personal debt, the debt service capabilities of the borrower, the projected cash flows of the business, the viability of the industry in which the customer operates and the value of the collateral. Commercial business loans are generally secured by a variety of collateral such as accounts receivable, inventory and equipment, and are generally supported by personal guarantees. Depending on the collateral used to secure the loans, commercial loans are generally made in amounts of up to 95% of the value of the collateral securing the loan. Berkshire Bank generally does not make unsecured commercial loans.
Unlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial loans are of higher risk and typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value.
Loans to One Borrower. The maximum amount that Berkshire Bank may lend to one borrower is limited by statute. At December 31, 2003, Berkshire Bank's statutory limit on loans to one borrower was $21.0 million. At that date, Berkshire Bank's largest amount of loans to one borrower, including the borrower's related interests, was approximately $10.3 million and consisted of ten loans secured by various types of business and real estate assets. These loans were performing according to their terms at December 31, 2003.
Maturity of Loan Portfolio. The following table shows the remaining contractual maturity of Berkshire Bank's total loans at December 31, 2003, excluding the effect of future principal prepayments, and contractual repricing.
The following table sets forth, at December 31, 2003, the dollar amount of loans contractually due after December 31, 2004, and whether such loans have fixed interest rates or adjustable interest rates.
Due After December 31, 2004 ---------------------------------------- Fixed Adjustable Total -------- -------- -------- (In thousands) Real estate loans: One- to four-family $130,530 $135,603 $266,133 Construction and land development -- 9,702 9,702 Commercial and multi-family 13,170 148,215 161,385 -------- -------- -------- Total real estate loans 143,700 293,520 437,220 Home equity lines of credit -- 44,016 44,016 Automobile 101,254 -- 101,254 Other consumer 1,938 2,024 3,962 Commercial loans 12,470 104,354 116,824 -------- -------- -------- Total loans $259,362 $443,914 $703,276 ======== ======== ========
Scheduled contractual principal repayments of loans do not reflect the actual life of the loans. The average life of a loan is substantially less than its contractual term because of prepayments. Automobile loans have relatively short average lives since they are fully amortizing with final maturities generally no longer than five years. In addition, due-on-sale clauses on loans generally give Berkshire Bank the right to declare loans immediately due and payable if, among other things, the borrower sells the real property with the mortgage and the loan is not repaid. The average life of a mortgage loan tends to increase, however, when current mortgage loan market rates are substantially higher than rates on existing mortgage loans and, conversely, tends to decrease when rates on existing mortgage loans are substantially higher than current mortgage loan market rates.
Loan Approval Procedures and Authority. Berkshire Bank's lending activities follow written, non-discriminatory, underwriting standards and loan origination procedures established by Berkshire Bank's Board of Directors and management. The Board of Directors has authorized the following persons and groups of persons to approve loans up to the amounts indicated: several retail lenders have been delegated authority to approve residential mortgage loans up to $300,000; home equity lines of
credit ranging from $50,000 to $300,000; unsecured consumer loans from $5,000 to $30,000; and secured consumer loans from $20,000 to $50,000. One- to four-family mortgage loans and home equity loans up to $300,000, secured consumer loans up to $50,000 and unsecured loans up to $30,000, may be approved by the President and the Senior Vice President-Retail Lending.
One- to four-family mortgage loans and home equity loans from $300,000 to $600,000 may be approved by a combination of individual officer authorities, provided that approval must include either the President or Senior Vice President-Retail Lending. Approvals from $600,000 to $1.5 million require approvals of both the President and the Senior Vice President-Retail Lending. All residential loans in excess of $1.5 million require the approval of the Loan and Investment Committee of the Board of Directors or the full Board of Directors.
The Board of Directors has delegated the authority to approve loans to the President, the Senior Commercial Lender and several commercial loan officers in amounts ranging up to $300,000 for secured commercial loans and in amounts ranging up to $175,000 for unsecured commercial loans. Loans in excess of these amounts require the approval of a majority of the members of Berkshire Bank's Senior Lending Committee, which consists of the Senior Commercial Lender and all commercial loan officers. The President, the Credit Administration Officer and the Loan Review Officer are non-voting members of the Senior Loan Committee. Delegated approval authorities may be combined. However, individual limits may be combined only up to $500,000 for commercial loan approvals without requiring approval of the Senior Lending Committee, provided that commercial loans approved by a combination of authorities must include the approval of either the President or the Senior Commercial Lender. All commercial loans in excess of $1.5 million require the approval of the Loan and Investment Committee of the Board of Directors or the full Board of Directors.
Loan Originations, Purchases and Sales. Berkshire Bank's lending activities are conducted by its salaried and commissioned loan personnel and through its relationships with automobile dealers. Currently, Berkshire Bank has contractual relationships with over 90 automobile dealers who originate automobile loans for Berkshire Bank. Such loans are only made following an underwriting review and acceptance by Berkshire Bank. These loans are closed by the automobile dealer and immediately assigned to Berkshire Bank, who then services the loans. On loans originated by its automobile dealers, Berkshire Bank compensates the originator an amount by which the interest rate paid on the loan exceeds a specified threshold, up to a maximum of four points. The compensation is paid at the time the loan is closed and assigned to Berkshire Bank. For the fiscal years 2003 and 2002, Berkshire Bank originated or purchased $60.2 million and $54.3 million of automobile loans, respectively, of which 90.6% and 87.4%, respectively, were originated indirectly through the automobile dealers.
From time to time, Berkshire Bank will purchase whole loans or participations in loans. These loans are underwritten according to Berkshire Bank's underwriting criteria and procedures and are generally serviced by the originating lender under terms of the applicable participation agreement. Berkshire Bank purchased $57.4 million of loans in 2003, of which $53.8 million were secured by first mortgage liens on residential real estate. Amounts outstanding related to loan participation interests purchased by Berkshire Bank totaled $50.9 million and $13.7 million at December 31, 2003 and December 31, 2002, respectively, and consisted primarily of loans secured by real estate.
At December 31, 2003, Berkshire Bank was servicing $7.2 million of automobile loans, $8.6 million of one- to four-family mortgage loans and $8.0 million of commercial loans sold to others. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent borrowers, supervising foreclosures and property dispositions when there 4are unremedied defaults, making insurance and tax payments on behalf of the borrowers and generally administering the loans. The gross servicing fee income from loans sold is generally 25 basis points for one- to four-family mortgage loans and 100 basis points for automobile loans of the total balance of the loan being serviced.
Berkshire Bank generally originates loans for its own portfolio but from time to time will sell or securitize loans in the secondary market based on prevailing market interest rate conditions and an analysis of the composition and risk of the loan portfolio, the Bank's interest rate risk profile and liquidity needs. Berkshire Bank sold or securitized fixed rate residential one- to four-family mortgages of $69.4 million in 2003 and has contracted to securitize an additional $39.6 million in January 2004. In addition, Berkshire Bank sold $9.9 million of sub-prime automobile loans in 2003.
The following table presents total loans originated, purchased, sold and repaid during the years indicated.
For the Years Ended December 31, ---------------------------------- 2003 2002 2001 -------- --------- -------- (In thousands)
Loans at beginning of year $723,181 $ 802,985 $793,389 -------- --------- -------- Originations: Real estate loans: One-to four-family 113,606 88,770 36,668 Construction and land development 32,246 30,678 22,170 Commercial 48,644 37,564 13,296 Multi-family 2,862 5,242 800 -------- --------- -------- Total real estate loans 197,358 162,254 72,934 -------- --------- -------- Consumer loans: Home equity lines of credit 15,380 16,361 6,887 Automobile 60,174 54,284 105,124 Other 3,466 4,613 4,527 -------- --------- -------- Total consumer loans 79,020 75,258 116,538
Commercial loans: Commercial 44,727 48,343 63,456 -------- --------- -------- Total loans originated 321,105 285,855 252,928 -------- --------- --------
Purchases: Real estate loans: Residential 53,814 -- -- Commercial real estate 3,041 2,724 4,042 -------- --------- -------- Total real estate loans 56,855 2,724 4,042 Consumer loans: Automobile -- -- 7,451 Commercial loans: Commercial 500 -- 2,000 -------- --------- -------- Total loans purchased 57,355 2,724 13,493 -------- --------- --------
Deduct: Principal loan repayments, prepayments and other, net 225,528 285,852 226,179 Loan sales 65,400 73,625 24,263 Securitization of loans 16,270 -- -- Net loan charge-offs 2,799 6,906 6,357 Transfers to real estate owned -- 2,000 26 -------- --------- -------- Total deductions 309,997 368,383 256,825 -------- --------- -------- Net increase (decrease) in loans 68,463 (79,804) 9,596 -------- --------- -------- Loans at end of year $791,644 $ 723,181 $802,985 ======== ========= ========
Loan Commitments. Berkshire Bank issues loan commitments to its prospective borrowers conditioned on the occurrence of certain events. Commitments are made in writing on specified terms and conditions and are generally honored for up to 60 days from approval. At December 31, 2003, Berkshire Bank had loan commitments and unadvanced loans and lines of credit totaling $143.0 million.
Loan Fees. In addition to interest earned on loans, Berkshire Bank receives income from fees derived from loan originations, loan modifications, late payments and for miscellaneous services related to its loans. Income from these activities varies from period to period depending upon the volume and type of loans made and competitive conditions.
Berkshire Bank charges loan origination fees which are calculated as a percentage of the amount borrowed. As required by applicable accounting principles, loan origination fees, discount points and certain loan origination costs are deferred and recognized over the contractual remaining lives of the related loans on a level yield basis. At December 31, 2003, Berkshire Bank had approximately $110,000 of net deferred loan fees and costs. Berkshire Bank amortized approximately $34,000 of net deferred loan fees and costs during the year ended December 31, 2003.
Nonperforming Assets, Delinquencies and Impaired Loans. When a borrower fails to make a required loan payment, Berkshire Bank attempts to cure the deficiency by mailing a past due notice on the 10th day after payment is due. In most cases, delinquencies are cured promptly. If a delinquency continues beyond the 15th day after the payment is due, the loan will appear on a delinquency list and the account officer will contact the borrower. If a delinquency continues beyond the 30th day, the borrower is again contacted and if it is determined that the late payment is not a short-term cash flow problem, the account is reported to the Senior Loan Officer. While Berkshire Bank generally prefers to work with borrowers to resolve problems, Berkshire Bank generally will initiate foreclosure or other proceedings no later than the 90th day of a delinquency, as necessary, to minimize any potential loss.
Management informs the Board of Directors monthly of the amount of loans delinquent more than 30 days, all loans in foreclosure, and all foreclosed and repossessed property that Berkshire Bank owns. Berkshire Bank generally ceases accruing interest on all commercial and residential loans when principal or interest payments are delinquent 90 days or more unless management determines the loan principal and interest to be fully-secured and in the process of collection. Once management determines that interest is uncollectible, the accrual of interest income on a loan is discontinued and all interest previously accrued is reversed against current period interest income. In 2001, to enhance its risk management practices, the Bank initiated a more conservative policy for automobile loans whereby all delinquent automobile loans remain on accrual status until they reach 120 days delinquent. At that time they are charged-off, except for those customers who are in bankruptcy proceedings with a secured loan, in which case the loan is transferred to nonaccrual status.
Berkshire Bank has adopted Statements of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No. 118 "Accounting by Creditors for Impairment of a Loan--an amendment to SFAS No. 114." At December 31, 2003 and December 31, 2002, Berkshire Bank had $388,000 and $727,000, respectively, recorded investment in impaired loans, which had no specific allowances and $2.0 million and $2.1 million in loans with specific valuation allowances of $267,000 and $295,000, respectively.
The following table sets forth information regarding nonperforming assets and loans that were 90 days or more past due and still accruing at the dates indicated.
- ---------- (1) Consists primarily of automobile loans.
(2) Reflects Bank's policy on delinquent automobile loans whereby all delinquent automobile loans remain on accrual status until they reach 120 days delinquent, at which time they are charged off. Previous to 2001, automobile loans past due 90 days or more were reported as nonaccrual.
Nonaccruing commercial loans and commercial real estate loans decreased to $2.4 million at December 31, 2003 from $2.9 million at December 31, 2002 primarily as the result of the return of two loans to accrual status, payments collected on accounts remaining on nonaccruing status and $157,000 in gross commercial loan charge-offs. The borrowers with loans in Berkshire Bank's nonaccruing commercial loan portfolio have been adversely affected by national and regional economic conditions.
Interest income that would have been recorded for the year ended December 31, 2003, had nonaccruing loans been current according to their original terms, amounted to $165,000. A total of $14,000 was included in interest income to reflect payments received on loans that had been paid off or brought up to date but were still classified as nonaccruing.
The following table sets forth the delinquencies in Berkshire Bank's loan portfolio as of the dates indicated.
- ---------- (1) Consists primarily of automobile loans.
Real Estate Owned. Real estate acquired by Berkshire Bank as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until sold. When property is acquired it is recorded at fair market value at the date of foreclosure, establishing a new cost basis. Holding costs and declines in fair value after acquisition are expensed. At December 31, 2003, Berkshire Bank had no foreclosed property.
Asset Classification. Regulators have adopted various regulations and practices regarding problem assets of financial institutions. Under such regulations, federal and state examiners have authority to identify problem assets during examinations and, if appropriate, require them to be classified. Berkshire Bank performs an internal analysis of its loan portfolio and assets to classify such loans and assets similar to the manner in which such loans and assets are classified by the federal banking regulators. In addition, Berkshire Bank regularly analyzes the losses inherent in its loan portfolio and its nonperforming loans to determine the appropriate level of the allowance for loan losses.
There are four classifications for problem assets: loss, doubtful, substandard and special mention. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted. If an asset or portion thereof is classified as loss, the insured institution establishes specific allowances for loan losses for the full amount of the portion of the asset classified as loss. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. All or a portion of general loan loss allowances established to cover probable losses related to assets classified as substandard or doubtful can be included in determining an institution's regulatory capital, while specific valuation allowances for loan losses generally do not qualify as regulatory capital. Assets that do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated "special mention."
The following table sets forth Berkshire Bank's classified assets at December 31, 2003.
At December 31, 2003, Berkshire Bank had four outstanding commercial loans with one borrower, which were adversely classified or identified as a problem credit, totaling $1.5 million. These loans were classified as substandard and were secured by a lien on the borrower's commercial real estate, accounts receivable, inventory and other commercial business assets. Based on management's collateral value estimates, $459,000 of Berkshire Bank's December 31, 2003 allowance for loan losses have been allocated to this borrowing relationship. Management believes that the current allocation is adequate. The aforementioned loans were not performing according to their terms on December 31, 2003. Berkshire Bank had no other classified loans greater than $500,000 which were not performing according to their terms on December 31, 2003.
Allowance for Loan Losses. In originating loans, Berkshire Bank recognizes that losses will be experienced on loans and that the risk of loss will vary with, among other things, the type of loan being made, the creditworthiness of the borrower over the term of the loan, general economic conditions and, in the case of a secured loan, the quality of the security for the loan. Berkshire Bank maintains an allowance for loan losses to absorb losses inherent in the loan portfolio. The allowance for loan losses represents management's estimate of probable losses based on information available as of the date of the financial statements. The allowance for loan losses is based on management's evaluation of the collectibility of the loan portfolio, including past loan loss experience, known and inherent risks in the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values and economic conditions.
The loan portfolio and other credit exposures are regularly reviewed by management to evaluate the adequacy of the allowance for loan losses. The methodology for assessing the appropriateness of the allowance includes comparison to actual losses, peer group comparisons, industry data and economic conditions. In addition, management employs an independent third party to perform an annual review of all of Berkshire Bank's commercial loan relationships exceeding $1.0 million, all material credits on Berkshire Bank's watch list or classified as substandard and a random sampling of new loans. The regulatory agencies, as an integral part of their examination process, also periodically review Berkshire Bank's allowance for loan losses. Such agencies may require Berkshire Bank to make additional provisions for estimated losses based upon judgments different from those of management.
In assessing the allowance for loan losses, loss factors are applied to various pools of outstanding loans and certain unused commitments. Berkshire Bank segregates the loan portfolio according to risk characteristics (i.e., mortgage loans, home equity, other consumer, commercial). Loss factors are derived using Berkshire Bank's historical loss experience and may be adjusted for significant factors that, in management's judgment, affect the collectibility of the portfolio as of the evaluation date.
All classified loans are reviewed for adequacy of their estimated supporting collateral values and guarantees. If a loan is determined to have a recovery value less than the loan balance after deducting the general reserve assigned to that loan based upon its classification, an additional specific reserve is assigned in an amount equal to the projected shortfall.
In addition, management assesses the allowance using factors that cannot be associated with specific credit or loan categories. These factors include management's subjective evaluation of local and national economic and business conditions, portfolio concentration and changes in the character and size of the loan portfolio. The allowance methodology reflects management's objective that the overall allowance appropriately reflects a margin for the imprecision necessarily inherent in estimates of expected credit losses.
Although management believes that it uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making its determinations. Furthermore, while Berkshire Bank believes it has established its existing allowance for loan losses in conformity with accounting principles generally accepted in the United States of America, there can be no assurance that regulators, in reviewing Berkshire Bank's loan portfolio, will not request Berkshire Bank to increase its allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect Berkshire Bank's financial condition and results of operations.
The following table presents an analysis of Berkshire Bank's allowance for loan losses for the years indicated.
- ---------- (1) Consists primarily of automobile loans.
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.
Investment Securities Activities
General. Under Massachusetts law, Berkshire Bank has authority to purchase a wide range of investment securities. As a result of changes in federal banking laws, however, financial institutions such as Berkshire Bank may not engage as principals in any activities that are not permissible for a national bank, unless the Federal Deposit Insurance Corporation has determined that the investments would pose no significant risk to the Bank Insurance Fund and Berkshire Bank is in compliance with applicable capital standards. In 1993, the Regional Director of the Federal Deposit Insurance Corporation approved a request by Berkshire Bank to acquire and retain certain listed stocks and/or registered stocks subject to certain conditions. The Company makes its investments through Berkshire Bank or one of the Bank's securities corporation subsidiaries and is generally not subject to any such restrictions on its investment authority. See "Regulation and Supervision."
Berkshire Bank's main source of income has been and will continue to be derived from its loan portfolio. The investment securities portfolio is primarily used to provide for Berkshire Bank's cash flow needs, to provide adequate liquidity to protect the safety of customer deposits and to earn a reasonable return on investment. The structure of the investment securities portfolio is based upon the composition and quality of the loan portfolio and Berkshire Bank's liquidity position and deposit structure.
Berkshire Bank's investment policy divides investments into two categories, fixed income and equity portfolios. The primary objectives of the fixed income portfolio are to: (1) maintain an adequate source of liquidity sufficient to meet regulatory and operating requirements, including funding for loans; (2) safeguard against deposit outflows, reduced loan amortization and increased loan demand; and (3) manage interest rate risk. The fixed income securities portfolio primarily consists of debt issues, including corporate and municipal bonds, U.S. Government and Agency obligations and mortgage-backed and asset-backed securities, including collateralized mortgage obligations and real estate mortgage investment conduits. A collateralized mortgage obligation is a mortgage-backed bond that separates mortgage pools into different maturities called "tranches." Tranches pay different rates of interest and can mature in a few months, or a few years. In return for a lower yield, collateralized mortgage obligations provide increased security over the life of the investment. However, in a declining interest rate risk environment, collateralized mortgage obligations tend to be repaid before their expected maturities as prepayments increase. This may result in Berkshire Bank having to reinvest the funds at a lower interest rate. Real estate mortgage investment conduits, a type of
collateralized mortgage obligation, are similar in that securities representing an undivided interest in such mortgages are issued. However, real estate mortgage investment conduits have more flexibility than other types of collateralized mortgage obligations as issuers can separate mortgage pools not only into different maturity classes but also into different risk classes. At present, 99.8% of Berkshire Bank's mortgage-backed securities are issued or guaranteed by agencies of the U.S. Government, which carry lower credit risk than mortgage-backed securities of a private issuer. Other types of asset-backed securities in which Berkshire Bank invests are typically collateralized by the cash flow from a pool of automobile loans, credit card receivables, consumer loans and other similar obligations. Both mortgage-backed and asset-backed securities carry the risk that changing market interest rates may cause a change in market value.
The marketable equity securities portfolio is currently managed to produce capital gains through price appreciation and lowering taxable income through deductions permitted for a portion of dividends received. However, Berkshire Bank continued restructuring its investment portfolio by placing less emphasis on equity securities. The marketable equity securities portfolio consists primarily of bank, utility and industrial stocks and is currently limited by the investment policy to 100% of Tier I capital. Berkshire Bank had $93.8 million of Tier 1 capital at December 31, 2003. Equities totaling $7.0 million were sold in 2003, resulting in a gain of $2.7 million. At December 31, 2003, equities, excluding Federal Home Loan Bank and Savings Bank Life Insurance stock, comprised 4.3% of the investment portfolio compared to 9.0% at December 31, 2002. The gross unrealized gains associated with the marketable equity securities portfolio were $8.4 million at December 31, 2003. At such date, there were no gross unrealized losses. The marketable equity securities portfolio carries equity price risk in that, if equity prices decline due to unfavorable market conditions or other factors, Berkshire Bank's capital would decrease.
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity Securities," requires that securities be categorized as "held-to-maturity," "trading securities" or "available-for-sale," based on management's intent as to the ultimate disposition of each security. SFAS No. 115 allows debt securities to be classified as "held-to-maturity" and reported in financial statements at amortized cost only if the reporting entity has the positive intent and ability to hold those securities to maturity. Securities that might be sold in response to changes in market interest rates, changes in the security's prepayment risk, increases in loan demand, or other similar factors cannot be classified as "held-to-maturity." Debt and equity securities held for current resale are classified as "trading securities." These securities are reported at fair value, and unrealized gains and losses on the securities would be included in earnings. Berkshire Bank does not currently use or maintain a trading account. Debt and equity securities not classified as either "held-to-maturity" or "trading securities" are classified as "available-for-sale." These securities are reported at fair value, and unrealized gains and losses on the securities are excluded from earnings and included in accumulated other comprehensive income, net of taxes.
The Loan and Investment Committee of the Board of Directors is responsible for developing and reviewing Berkshire Bank's investment policy. Investment decisions are made in accordance with Berkshire Bank's investment policy and are based upon the quality of a particular investment, its inherent risks, Berkshire Bank's liquidity needs, prospects for yield and/or appreciation and the potential tax consequences. While general investment strategies are developed and authorized by the Loan and Investment Committee, the execution of specific investment actions and the day-to-day oversight of Berkshire Bank's investment portfolio rests with the President and the Treasurer. These officers are authorized to execute investment transactions up to specified limits based on the type of security without the prior approval of the Loan and Investment Committee. However, such purchases require a review of the Loan and Investment Committee at their next scheduled meeting. The Board of Directors receives a monthly report of all securities transactions made during the previous month.
Berkshire Bank's investment policy allows the use of certain hedging strategies, including the purchase of options in an effort to increase the return and decrease the risk on the securities portfolio. Berkshire Bank has used covered call option strategies in the past and may continue to do so in the future. Berkshire Bank has not used interest rate futures or options on futures as part of its interest rate hedging strategies.
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.
- ---------- (1) Includes mutual funds.
The following table presents the amortized cost and fair value of Berkshire Bank's held for maturity securities, by type of security, at the dates indicated.
At December 31, 2003, Berkshire Bank did not own any investment or mortgage-backed securities of a single issuer, other than U.S. Treasury and U.S. Government Agency securities, which had an aggregate book value in excess of 10% of Berkshire Bank's capital at that date.
The following table presents the activity in the investment securities and mortgage-backed securities portfolios for the years indicated.
The following table presents certain information regarding the amortized cost, weighted average yields and estimated maturities or periods to repricing of Berkshire Bank's debt securities at December 31, 2003.
Deposit Activities and Other Sources of Funds
General. Deposits are the major source of funds for Berkshire Bank's lending and other investment activities. In addition, Berkshire Bank also generates funds internally from loan repayments, prepayments and sales and maturing investment securities. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are influenced significantly by general interest rates and money market conditions. Berkshire Bank uses borrowings from the Federal Home Loan Bank of Boston as an additional source of funding for loan and securities investment activity.
Deposit Accounts. Substantially all of Berkshire Bank's deposits are generated from the areas surrounding its branch offices. Berkshire Bank offers a wide variety of deposit accounts with a range of interest rates and terms. Berkshire Bank may periodically offer special interest rates and terms for limited periods of time. Berkshire Bank's deposit accounts consist of interest-bearing checking, noninterest-bearing checking, regular savings, money market savings and certificates of deposit. The initial maturities of Berkshire Bank's certificate of deposit accounts range from three months to ten years. In addition, Berkshire Bank offers retirement accounts, including Traditional IRAs, Roth IRAs, Simple IRAs, Self-Directed IRAs and Keogh accounts, simplified employee pension plan, profit-sharing qualified plan and money purchase pension plan accounts.
Berkshire Bank also offers a variety of deposit accounts designed for the businesses operating in its market area. Deposit account terms vary with the principal differences being the minimum balance deposit, early withdrawal penalties, limits on the number of transactions and the interest rate. Berkshire Bank's business banking deposit products include a commercial checking account that provides an earnings credit to offset monthly service charges and a checking account specifically designed for small businesses. Additionally, Berkshire Bank offers sweep accounts and money market accounts for businesses and IOLTA interest checking and escrow accounts. Berkshire Bank has sought to increase its commercial deposits through the offering of these products, particularly to its commercial borrowers and to the municipalities that participate in its government banking program.
Berkshire Bank reviews its deposit mix and pricing on a weekly basis and believes it offers competitive interest rates on its deposit products. Berkshire Bank determines the rates paid based on a number of factors, including rates paid by competitors, Berkshire Bank's need for funds and cost of funds, Berkshire Bank's current asset/liability structure, the amount of maturing deposits and movements of market interest rates. Berkshire Bank currently does not utilize brokers to obtain deposits but may choose to do so in the future.
In the unlikely event Berkshire Bank is liquidated, depositors will be entitled to full payment of their deposit accounts before any payment is made to Berkshire Hills as the sole stockholder of Berkshire Bank.
The following table presents the deposit activity of Berkshire Bank for the years indicated.
At December 31, 2003, Berkshire Bank had certificate of deposit accounts in amounts of $100,000 or more maturing as follows:
Weighted Maturity Average Period Amount Rate ----------------------------------------------------------- (Dollars in thousands) Three months or less $ 30,702 1.90% Over 3 months through 6 months 28,273 2.14 Over 6 months through 12 months 31,730 2.71 Over 12 months 50,388 4.75 -------- Total $141,093 3.14% ========
The following table presents information concerning average balances and weighted average interest rates on Berkshire Bank's deposit accounts for the years indicated.
- ---------- (1) Includes mortgagors' escrow accounts.
Certificates of Deposit by Rates and Maturities. The following table presents the amount of certificate accounts categorized by rates and maturities, for the periods and years indicated.
Borrowings. Berkshire Bank utilizes advances from the Federal Home Loan Bank of Boston to supplement its supply of lendable funds and to meet deposit withdrawal requirements. The Federal Home Loan Bank of Boston functions as a central reserve bank providing credit for savings banks and certain other member financial institutions. As a member of the Federal Home Loan Bank of Boston, Berkshire Bank is required to own capital stock in the Federal Home Loan Bank of Boston and may apply for advances on the security of the capital stock and certain of its mortgage loans and other assets, principally securities that are obligations of, or guaranteed by, the U.S. Government or its Agencies, provided certain creditworthiness standards have been met. Advances are made under several different credit programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based on the financial condition of the member institution and the adequacy of collateral pledged to secure the credit. At December 31, 2003, Berkshire Bank had the ability to borrow a total of approximately $374.8 million from the Federal Home Loan Bank of Boston. At that date, Berkshire Bank had outstanding advances of $251.5 million. In addition, Berkshire Bank had a $2.0 million repurchase agreement line of credit to be secured by securities or other assets of Berkshire Bank with the Depositors Insurance Fund, and a $50.0 million repurchase agreement line of credit with a nationally recognized broker-dealer. At December 31, 2003, Berkshire Bank had no outstanding borrowings against either of these agreements.
The following tables present certain information regarding Berkshire Bank's Federal Home Loan Bank advances during the periods and at the dates indicated.
For the Years Ended December 31, ------------------------------------ 2003 2002 2001 -------- -------- -------- (Dollars in thousands) Maximum amount of advances outstanding at any month end $251,465 $143,053 $140,115 Average advances outstanding 167,621 140,406 127,990 Weighted average rate paid on advances 2.91% 4.01% 5.17%
At December 31, ------------------------------------ 2003 2002 2001 -------- -------- -------- (Dollars in thousands) Balance outstanding at end of year $251,465 $133,002 $133,964 Weighted average rate on advances at end of year 2.61% 3.27% 4.26%
Berkshire Bank offers retail repurchase agreements to selected higher balance customers and certain municipalities. These agreements are direct obligations of Berkshire Bank to repay at maturity or on demand the purchase price of an undivided interest in a U.S. Government or agency security owned by Berkshire Bank. Since these agreements are not deposits, they are not insured by the Federal Deposit Insurance Corporation. At December 31, 2003, there were no such retail repurchase agreements.
The following tables represent certain information regarding Berkshire Bank's retail repurchase agreements during the years and at the dates indicated.
For the Years Ended December 31, ------------------------------------ 2003 2002 2001 -------- -------- -------- (Dollars in thousands) Maximum amount of retail repurchase agreements outstanding at any month end $ 500 $ 1,830 $ 2,340 Average retail repurchase agreements outstanding 88 1,349 1,584 Weighted average rate paid on retail repurchase agreements 1.24% 1.72% 3.78%
At December 31, ------------------------------------ 2003 2002 2001 -------- -------- -------- (Dollars in thousands) Balance outstanding at end of year -- $ 700 $ 1,890 Weighted average rate on retail repurchase agreements at end of year --% 1.59% 1.74%
Trust Services
Berkshire Bank maintains the Asset Management/Trust Group as a department within Berkshire Bank which primarily provides trust and investment services to individuals, partnerships, corporations and institutions and also acts as a fiduciary of estates and conservatorships and as a trustee under various wills, trusts and other plans. The trust department allows Berkshire Bank to provide investment opportunities and fiduciary services to both current and prospective customers. Consistent with Berkshire Bank's operating strategy, Berkshire Bank will continue to emphasize the growth of its trust service operations to grow assets and increase fee-based income. Berkshire Bank has implemented several policies governing the practices and procedures of the trust department, including policies relating to maintaining confidentiality of trust records, investment of trust property, handling conflicts of interest, and maintaining impartiality. At December 31, 2003, the trust department managed 792 accounts with aggregate assets of $287.7 million, of which the largest relationship totaled $20.0 million, or 7.0%, of the trust department's total assets. Trust fees totaled $2.1 million for 2003 and $1.8 million for 2002.
Government Banking
Berkshire Bank offers full-service government banking for cities, towns and municipal school districts in western Massachusetts and southern Vermont. Berkshire Bank offers municipalities all aspects of financial advisory services for the sale of notes and bonds, actively working with bond counsel, rating agencies, consulting agencies and bond buyers. Additionally, Berkshire Bank offers a wide range of municipal deposit products and checking accounts, as well as the origination of payroll accounts. At December 31, 2003, Berkshire Bank was working with approximately 63 municipal entities. For 2003, government banking generated $56,000 of net fee income compared to $180,000 for 2002.
Personnel
As of December 31, 2003, Berkshire Bank had 230 full-time employees and 34 part-time employees. The employees are not represented by a collective bargaining unit and the Bank will strive to continue its strong relationship with its employees.
Subsidiary Activities
The following are descriptions of Berkshire Bank's active subsidiaries, all of which are wholly-owned. All subsidiaries are incorporated in Massachusetts and are indirectly owned by Berkshire Hills.
North Street Securities Corporation. North Street Securities Corporation, ("North Street") originally named GBSB Leasing Corporation, was established in January 1984 to acquire and hold investment securities of a type that are permissible for banks to hold under applicable law. North Street is qualified as a "securities corporation" for Massachusetts income tax purposes. Income earned by a qualifying securities corporation is generally entitled to special tax treatment from Massachusetts income tax. As of December 31, 2003, North Street had assets totaling $105.6 million, consisting primarily of municipal bonds, corporate bonds, private label REMICs and common and preferred equity securities.
Gold Leaf Investment Services, Inc. Gold Leaf Investment Services, Inc., established in May 2000, began operations during the first quarter of 2001. Gold Leaf Investment Services offers access to a full range of security brokerage services, including financial planning, professional money management, stocks, bonds, mutual funds and annuities. These services are available through a partnership with UVEST Investment Services, a registered securities broker-dealer and member NASD/SIPC and are available in all of the Bank's branches.
Gold Leaf Insurance Agency, Inc. Gold Leaf Insurance Agency, Inc., established in May 2000, began operations during the third quarter of 2000. Gold Leaf Insurance Agency offers a full line of products including automobile, home, business and life insurance.
Gold Leaf Securities Corporation. Gold Leaf Securities Corporation was established in May 2003 to acquire and hold investment securities of a type that are permissible for banks to hold under applicable law. Gold Leaf Securities Corporation is qualified as a "securities corporation" for Massachusetts income tax purposes. As of December 31, 2003, Gold Leaf Securities Corporation had assets totaling $5.1 million, consisting primarily of Industrial Revenue Bonds.
Woodland Securities, Inc. Woodland Securities, Inc. ("Woodland"), originally named Woodland Realty, Inc., was established in April 1995 to purchase, own, sell, develop and lease real property and personal property of all types. Inactive for a number of years, Woodland converted to a Massachusetts "securities corporation" for Massachusetts income tax purposes in 2002. As of December 31, 2003, Woodland had assets of $210.0 million consisting primarily of agency mortgage-backed, callable agency securities and agency REMICs. The Bank has pledged all of its shares of Woodland to the Federal Home Loan Bank of Boston to secure its borrowing facility.
Excluding Berkshire Bank, the following are descriptions of Berkshire Hills' wholly-owned active subsidiaries. All of Berkshire Hills' subsidiaries, including Berkshire Bank, are incorporated in Massachusetts.
Berkshire Hills Funding Corporation. Berkshire Hills Funding Corporation was established in May 2000 as a general purpose funding vehicle for Berkshire Hills. Outside of cash, its sole asset is a loan to Berkshire Bank's Employee Stock Ownership Plan ("ESOP"). The proceeds of such loan were used to fund the ESOP trustee's purchase of Berkshire Hills common stock.
Berkshire Hills Technology, Inc. Berkshire Hills Technology, Inc. was established in May 2001 to invest, own and sell any type of business enterprise including, but not limited to, corporations and limited liability companies. In June 2001, along with a consortium of five other financial institutions, Berkshire Hills Technology, Inc. announced its investment of $4.7 million in EastPoint Technologies, LLC ("EastPoint"). The Company's equity interest in EastPoint equals 60.3%. EastPoint, headquartered in Bedford, New Hampshire, is a software and data processing provider for financial institutions.
Segment Reporting
Through its wholly-owned subsidiary, Berkshire Hills Technology, Inc., the Company owns a 60.3% equity interest in EastPoint. Prior to the acquisition of EastPoint, management monitored the revenue streams of the various products and services in evaluating the Company's operations and financial performance. Accordingly, all of the Company's operations were considered by management to be aggregated in one reportable operating segment. Subsequent to the acquisition of EastPoint, the Company's operations continue to be aggregated in one reportable segment, the Bank, except Berkshire Hills Technology, Inc., which is evaluated on a stand-alone basis.
Information about reportable segments, and the reconciliation of such information to the consolidated financial statements as of and for the years ended December 31, 2003, 2002 and 2001 follows:
At December 31, 2003 --------------------------------------------- Berkshire Hills Consolidated Bank Technology, Inc. Totals ----------- ---------------- ------------ (In thousands) Net interest income $ 37,566 $ -- $ 37,566 Depreciation and amortization 1,412 695 2,107 Provision for loan losses 1,460 -- 1,460 License fees -- 7,262 7,262 Minority interest -- (186) (186) Profit (loss) 9,247 (282) 8,965 Assets 1,210,890 7,658 1,218,548 Expenditures for additions to premises and equipment 1,386 80 1,466
At December 31, 2002 --------------------------------------------- Berkshire Hills Consolidated Bank Technology, Inc. Totals ----------- ---------------- ------------ (In thousands) Net interest income $ 40,700 $ -- $ 40,700 Depreciation and amortization 1,813 601 2,414 Provision for loan losses 6,180 -- 6,180 License fees -- 6,991 6,991 Minority interest -- (685) (685) Profit (loss) 3,937 (1,040) 2,097 Assets 1,037,376 8,571 1,045,947 Expenditures for additions to premises and equipment 1,044 424 1,468
At December 31, 2001 --------------------------------------------- Berkshire Hills Consolidated Bank Technology, Inc. Totals ----------- ---------------- ------------ (In thousands) Net interest income $ 42,236 $ -- $ 42,236 Depreciation and amortization 1,769 312 2,081 Provision for loan losses 7,175 -- 7,175 License fees -- 3,465 3,465 Minority interest -- (119) (119) Profit (loss) 8,868 43 8,911 Assets 1,021,623 9,078 1,030,701 Expenditures for additions to premises and equipment 735 1,609 2,344
The Company does not allocate income taxes to its segments, but rather, assigns all taxes to the Bank.
REGULATION AND SUPERVISION
General
As a savings and loan holding company, Berkshire Hills is required to file reports with, and otherwise comply with the rules and regulations of, the Office of Thrift Supervision ("OTS"). As a savings bank chartered by the Commonwealth of Massachusetts, Berkshire Bank is subject to extensive regulation, examination and supervision by the Massachusetts Commissioner of Banks, as its primary regulator, and the Federal Deposit Insurance Corporation, as the deposit insurer. Berkshire Bank is a member of the Federal Home Loan Bank system and, with respect to deposit insurance, of the Bank Insurance Fund managed by the Federal Deposit Insurance Corporation. Berkshire Bank must file reports with the Commissioner of Banks and the Federal Deposit Insurance Corporation concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other savings institutions. The Commissioner of Banks and /or the Federal Deposit Insurance Corporation conduct periodic examinations to test Berkshire Bank's safety and soundness and compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the Commissioner of Banks, the Federal Deposit Insurance Corporation or Congress, could have a material adverse impact on the Company, the Bank and their operations. Certain regulatory requirements applicable to Berkshire Bank and to the Company are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on Berkshire Bank and Berkshire Hills.
Massachusetts Banking Laws and Supervision
Massachusetts savings banks are regulated and supervised by the Massachusetts Commissioner of Banks. The Massachusetts Commissioner of Banks is required to regularly examine each state-chartered bank. The approval of the Massachusetts Commissioner of Banks is required to establish or close branches, to merge with another bank, to form a holding company, to issue stock or to undertake many other activities. Any Massachusetts bank that does not operate in accordance with the regulations, policies and directives of the Massachusetts Commissioner of Banks may be sanctioned. The Massachusetts Commissioner of Banks may suspend or remove directors or officers of a bank who have violated the law, conducted a bank's business in a manner that is unsafe, unsound or contrary to the depositors' interests, or been negligent in the performance of their duties. In addition, the Massachusetts Commissioner of Banks has the authority to appoint a receiver or conservator if it is determined that the bank is conducting its business in an unsafe or unauthorized manner, and under certain other circumstances.
All Massachusetts-chartered savings banks are required to be members of the Depositors Insurance Fund, a private deposit insurer, which insures all deposits in member banks in excess of Federal Deposit Insurance Corporation deposit insurance limits. Member banks are required to pay the assessments of the fund. In addition, the Mutual Savings Central Fund acts as a source of liquidity to its members in supplying them with low-cost funds, and purchasing qualifying obligations from them.
The powers that Massachusetts-chartered savings banks can exercise under these laws are summarized below.
Lending Activities. A Massachusetts-chartered savings bank may make a wide variety of mortgage loans including fixed-rate loans, adjustable-rate loans, variable-rate loans, participation loans, graduated payment loans, construction and development loans, condominium and co-operative loans, second mortgage loans and other types of loans that may be made in accordance with applicable regulations. Commercial loans may be made to corporations and other commercial enterprises with or without security. Consumer and personal loans may also be made with or without security. Loans to individual borrowers generally must be limited to 20% of the total of a bank's capital accounts and stockholders' equity.
Investments Authorized. Massachusetts-chartered savings banks have broad investment powers under Massachusetts law, including so-called "leeway" authority for investments that are not otherwise specifically authorized. The investment powers authorized under Massachusetts law are restricted by federal law to permit, in general, only investments of the kinds that would be permitted for national banks. Berkshire Bank has authority to invest in all of the classes of loans and investments that are permitted by its existing loan and investment policies.
Payment of Dividends. A savings bank may only pay dividends on its capital stock if such payment would not impair the bank's capital stock. No dividends may be paid to stockholders of a bank if such dividends would reduce stockholders' equity of the bank below the amount of the liquidation account required by the Massachusetts conversion regulations. Additionally, the Massachusetts Commissioner of Banks may restrict the payment of dividends by a bank if it is determined that such payment would result in safety and soundness concerns.
Parity Regulation. Effective November 19, 2002, Massachusetts law was amended to increase the powers of Massachusetts banks under certain conditions. As a result of such amendment, a Massachusetts bank may engage in any activity or offer any product or service if the activity, product or service is engaged in or offered in accordance with regulations promulgated by the Massachusetts Commissioner of Banks and has been authorized for national banks, federal thrifts or state banks in a state other than Massachusetts; provided that the activity is permissible under applicable federal and Massachusetts law and subject to the same limitations and restrictions imposed on the national bank, federal thrift or out-of-state bank that had previously been granted the power.
Assessments. Savings banks are required to pay assessments to the Commissioner of Banks to fund operations. Assessments paid by Berkshire Bank for the fiscal year ended December 31, 2003 totaled $150,254.
Federal Regulations
Capital Requirements. Under Federal Deposit Insurance Corporation regulations, federally insured state-chartered banks that are not members of the Federal Reserve System ("state non-member banks"), such as Berkshire Bank, are required to comply with minimum leverage capital requirements. For an institution determined by the Federal Deposit Insurance Corporation to not be anticipating or experiencing significant growth and to be in general a strong banking organization, rated composite 1 under the Uniform Financial Institutions Rating System established by the Federal Financial Institutions Examination Council, the minimum capital leverage requirement is a ratio of Tier 1 capital to total assets of 3%. For all other institutions, the minimum leverage capital ratio is not less than 4%. Tier 1 capital is the sum of common stockholders' equity, noncumulative perpetual preferred stock (including any related surplus) and minority investments in certain subsidiaries, less intangible assets (except for certain servicing rights and credit card relationships) and a percentage of certain nonfinancial equity investments.
Berkshire Bank must also comply with the Federal Deposit Insurance Corporation risk-based capital guidelines. The Federal Deposit Insurance Corporation guidelines require state non-member banks to maintain certain levels of regulatory capital in relation to regulatory risk-weighted assets. The ratio of regulatory capital to regulatory risk-weighted assets is referred to as Berkshire Bank's "risk-based capital ratio." Risk-based capital ratios are determined by allocating assets and specified off-balance sheet items to four risk-weighted categories ranging from 0% to 100%, with higher levels of capital being required for the categories perceived as representing greater risk. For example, under the Federal Deposit Insurance Corporation's risk-weighting system, cash and securities backed by the full faith and credit of the U.S. Government are given a 0% risk weight, loans secured by one- to four-family residential properties generally have a 50% risk weight and commercial loans have a risk weighting of 100%.
State non-member banks must maintain a minimum ratio of total capital to risk-weighted assets of at least 8%, of which at least one-half must be Tier 1 capital. Total capital consists of Tier 1 capital plus Tier 2 or supplementary capital items, which include allowances for loan losses in an amount of up to 1.25% of risk-weighted assets, cumulative preferred stock, a portion of the net unrealized gain on equity securities and other capital instruments. The includable amount of Tier 2 capital cannot exceed the amount of the institution's Tier 1 capital.
The Federal Deposit Insurance Corporation Improvement Act required each federal banking agency to revise its risk-based capital standards for insured institutions to ensure that those standards take adequate account of interest rate risk, concentration of credit risk, and the risk of nontraditional activities, as well as to reflect the actual performance and expected risk of loss on multi-family residential loans. The Federal Deposit Insurance Corporation, along with the other federal banking agencies, has adopted a regulation providing that the agencies will take into account the exposure of a bank's capital and economic value to changes in interest rate risk in assessing a bank's capital adequacy.
As a savings and loan holding company regulated by the Office of Thrift Supervision, Berkshire Hills is not, under current law, subject to any separate regulatory capital requirements.
The following is a summary of Berkshire Bank's regulatory capital at December 31, 2003:
GAAP Capital to Total Assets 10.11% Total Capital to Risk-Weighted Assets 12.57% Tier I Leverage Ratio 7.87% Tier I to Risk-Weighted Assets 11.07%
Standards for Safety and Soundness. The federal banking agencies adopted regulations and Interagency Guidelines Establishing Standards for Safety and Soundness to implement safety and soundness standards. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. The guidelines address internal controls and information systems, an internal audit system, credit underwriting, loan documentation, interest rate risk exposure, asset growth, asset quality, earnings and compensation, and fees and benefits. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the
guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard.
Investment Activities
Under federal law, all state-chartered Federal Deposit Insurance Corporation insured banks, including savings banks, have generally been limited to activities as principal and equity investments of the type and in the amount authorized for national banks, notwithstanding state law. The Federal Deposit Insurance Corporation Improvement Act and the Federal Deposit Insurance Corporation permit exceptions to these limitations. For example, state chartered banks, such as Berkshire Bank, may, with Federal Deposit Insurance Corporation approval, continue to exercise grandfathered state authority to invest in common or preferred stocks listed on a national securities exchange or the NASDAQ National Market and in the shares of an investment company registered under federal law. In addition, the Federal Deposit Insurance Corporation is authorized to permit such institutions to engage in state authorized activities or investments that do not meet this standard (other than non-subsidiary equity investments) for institutions that meet all applicable capital requirements if it is determined that such activities or investments do not pose a significant risk to the Bank Insurance Fund. All non-subsidiary equity investments, unless otherwise authorized or approved by the Federal Deposit Insurance Corporation, must have been divested by December 19, 1996, under a Federal Deposit Insurance Corporation-approved divestiture plan, unless such investments were grandfathered by the Federal Deposit Insurance Corporation. Berkshire Bank received grandfathering authority from the Federal Deposit Insurance Corporation in February 1993 to invest in listed stocks and/or registered shares. The maximum permissible investment is 100% of Tier 1 capital, as specified by the Federal Deposit Insurance Corporation's regulations, or the maximum amount permitted by Massachusetts Banking Law, whichever is less. The Federal Deposit Insurance Corporation also required that Berkshire Bank provide prior notice to the agency if it increases the holdings of listed stock and/or registered shares as a percentage of Tier 1 equity capital by 25%. Such grandfathering authority may be terminated upon the Federal Deposit Insurance Corporation's determination that such investments pose a safety and soundness risk to Berkshire Bank or if Berkshire Bank converts its charter or undergoes a change in control. As of December 31, 2003, Berkshire Bank had marketable equity securities including money market preferred stocks with a market value of $14.9 million which were held under such grandfathering authority.
Interstate Banking and Branching
Beginning June 1, 1997, the Interstate Banking Act permitted the responsible federal banking agencies to approve merger transactions between banks located in different states, regardless of whether the merger would be prohibited under the law of the two states. The Interstate Banking Act also permitted a state to "opt in" to the provisions of the Interstate Banking Act before June 1, 1997, and permitted a state to "opt out" of the provisions of the Interstate Banking Act by adopting appropriate legislation before that date. Accordingly, beginning June 1, 1997, the Interstate Banking Act permitted a bank, such as Berkshire Bank, to acquire an institution by merger in a state other than Massachusetts unless the other state had opted out of the Interstate Banking Act. The Interstate Banking Act also authorizes de novo branching into another state if the host state enacts a law expressly permitting out of state banks to establish such branches within its borders.
Prompt Corrective Regulatory Action
Federal law requires, among other things, that federal bank regulatory authorities take "prompt corrective action" with respect to banks that do not meet minimum capital requirements. For these purposes, the law establishes five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.
The Federal Deposit Insurance Corporation has adopted regulations to implement the prompt corrective action legislation. An institution is deemed to be "well capitalized" if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a leverage ratio of 5% or greater. An institution is "adequately capitalized" if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater and generally a leverage ratio of 4% or greater. An institution is "undercapitalized" if it has a total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital ratio of less than 4%, or generally a leverage ratio of less than 4% (3% or less for institutions with the highest examination rating). An institution is deemed to be "significantly undercapitalized" if it has a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, or a leverage ratio of less than 3%. An institution is considered to be "critically undercapitalized" if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2%. As of December 31, 2003, Berkshire Bank met the conditions to be classified a "well capitalized" institution.
"Undercapitalized" banks must adhere to growth, capital distribution (including dividend) and other limitations and are required to submit a capital restoration plan. No institution may make a capital distribution, including payment as a dividend, if it would be "undercapitalized" after the payment. A bank's compliance with such plan is required to be guaranteed by any company that controls the undercapitalized institution in an amount equal to the lesser of 5% of the institution's total assets when deemed undercapitalized or the amount necessary to achieve the status of adequately capitalized. If an "undercapitalized" bank fails to submit an acceptable plan, it is treated as if it is "significantly undercapitalized." "Significantly undercapitalized" banks must comply with one or more of a number of additional restrictions, including but not limited to an order by the Federal Deposit
Insurance Corporation to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and cease receipt of deposits from correspondent banks or dismiss directors or officers, and restrictions on interest rates paid on deposits, compensation of executive officers and capital distributions by the parent holding company. "Critically undercapitalized" institutions must comply with additional sanctions including, subject to a narrow exception, the appointment of a receiver or conservator within 270 days after it obtains such status.
Transactions with Affiliates
Under current federal law, transactions between depository institutions and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. In a holding company context, at a minimum, the parent holding company of a savings bank and any companies which are controlled by such parent holding company are affiliates of the savings bank. Generally, Section 23A limits the extent to which the savings bank or its subsidiaries may engage in "covered transactions" with any one affiliate to 10% of such savings bank's capital stock and surplus, and contains an aggregate limit on all such transactions with all affiliates to 20% of capital stock and surplus. The term "covered transaction" includes, among other things, the making of loans or other extensions of credit to an affiliate and the purchase of assets from an affiliate. Section 23A also establishes specific collateral requirements for loans or extensions of credit to, or guarantees, acceptances on letters of credit issued on behalf of an affiliate. Section 23B requires that covered transactions and a broad list of other specified transactions be on terms substantially the same, or no less favorable, to the savings bank or its subsidiary as similar transactions with non-affiliates.
Further, federal law restricts an institution with respect to loans to directors, executive officers, and principal stockholders ("insiders"). Loans to insiders and their related interests may not exceed, together with all other outstanding loans to such persons and affiliated entities, the institution's total capital and surplus. Loans to insiders above specified amounts must receive the prior approval of the board of directors. Further, loans to insiders must be made on terms substantially the same as offered in comparable transactions to other persons, except that such insiders may receive preferential loans made under a benefit or compensation program that is widely available to Berkshire Bank's employees and does not give preference to the insider over the employees. Federal law places additional limitations on loans to executive officers.
Enforcement
The Federal Deposit Insurance Corporation has extensive enforcement authority over insured savings banks, including Berkshire Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease and desist orders and to remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and unsafe or unsound practices.
The Federal Deposit Insurance Corporation has authority under federal law to appoint a conservator or receiver for an insured bank under limited circumstances. The Federal Deposit Insurance Corporation is required, with certain exceptions, to appoint a receiver or conservator for an insured state non-member bank if that bank was "critically undercapitalized" on average during the calendar quarter beginning 270 days after the date on which the institution became "critically undercapitalized." See "Prompt Corrective Regulatory Action." The Federal Deposit Insurance Corporation may also appoint itself as conservator or receiver for an insured state non-member institution under specific circumstances on the basis of the institution's financial condition or upon the occurrence of other events, including: (1) insolvency; (2) substantial dissipation of assets or earnings through violations of law or unsafe or unsound practices; (3) existence of an unsafe or unsound condition to transact business; and (4) insufficient capital, or the incurring of losses that will deplete substantially all of the institution's capital with no reasonable prospect of replenishment without federal assistance.
Insurance of Deposit Accounts
The Federal Deposit Insurance Corporation has adopted a risk-based insurance assessment system. The Federal Deposit Insurance Corporation assigns an institution to one of three capital categories based on the institution's financial information consisting of (1) well capitalized, (2) adequately capitalized or (3) undercapitalized, and one of three supervisory subcategories within each capital group. The supervisory subgroup to which an institution is assigned is based on a supervisory evaluation provided to the Federal Deposit Insurance Corporation by the institution's primary federal regulator and information which the Federal Deposit Insurance Corporation determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance funds. An institution's assessment rate depends on the capital category and supervisory category to which it is assigned. Assessment rates for insurance fund deposits currently range from 0 basis points for the strongest institution to 27 basis points for the weakest. Bank Insurance Fund members are also required to assist in the repayment of bonds issued by the Financing Corporation in the late 1980s to recapitalize the Federal Savings and Loan Insurance Corporation. Effective January 1, 2000, full pro rata sharing of the payments between Bank Insurance Fund and Savings Association Insurance Fund members commenced. The Federal Deposit Insurance Corporation is authorized to raise the assessment rates. The Federal Deposit Insurance Corporation has exercised this authority several times in the past and may raise insurance premiums in the future. If the Federal Deposit Insurance Corporation takes such action, it could have an adverse effect on the earnings of Berkshire Bank.
The Federal Deposit Insurance Corporation may terminate insurance of deposits if it finds that the institution is in an unsafe or unsound condition to continue operations, has engaged in unsafe or unsound practices, or has violated any applicable law, regulation, rule, order or condition imposed by the Federal Deposit Insurance Corporation. The management of the Bank does not know of any practice, condition or violation that might lead to termination of deposit insurance.
Berkshire Bank, as a member of the Depositors Insurance Fund, is also subject to its assessments. See "- Massachusetts Banking Laws and Supervision."
Federal Reserve System
The Federal Reserve Board regulations require depository institutions to maintain noninterest-earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The Federal Reserve Board regulations currently require that reserves be maintained against aggregate transaction accounts as follows: for that portion of transaction accounts aggregating $45.4 million less an exemption of $6.6 million (which may be adjusted by the Federal Reserve Board) the reserve requirement is 3%; and for accounts greater than $45.4 million, the reserve requirement is 10% (which may be adjusted by the Federal Reserve Board between 8% and 14%) of the portion in excess of $45.4 million. Berkshire Bank is in compliance with these requirements.
Community Reinvestment Act
Under the Community Reinvestment Act, as implemented by Federal Deposit Insurance Corporation regulations, a state non-member bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate-income neighborhoods. The Community Reinvestment Act neither establishes specific lending requirements or programs for financial institutions nor limits an institution's discretion to develop the types of products and services that it believes are best suited to its particular community. The Community Reinvestment Act requires the Federal Deposit Insurance Corporation, in connection with its examination of an institution, to assess the institution's record of meeting the credit needs of its community and to consider such record when it evaluates applications made by such institution. The Community Reinvestment Act requires public disclosure of an institution's Community Reinvestment Act rating. Berkshire Bank's latest Community Reinvestment Act rating received from the Federal Deposit Insurance Corporation was "Outstanding."
Berkshire Bank is also subject to similar obligations under Massachusetts Law, which has an additional CRA rating category. The Massachusetts Community Reinvestment Act requires the Massachusetts Banking Commissioner to consider a bank's Massachusetts Community Reinvestment Act rating when reviewing a bank's application to engage in certain transactions, including mergers, asset purchases and the establishment of branch offices or automated teller machines, and provides that such assessment may serve as a basis for the denial of such application. Berkshire Bank's latest Massachusetts Community Reinvestment Act rating received from the Massachusetts Division of Banks was "Outstanding."
Federal Home Loan Bank System
The Bank is a member of the Federal Home Loan Bank system, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. Berkshire Bank, as a member of the Federal Home Loan Bank of Boston, is required to acquire and hold shares of capital stock in the Federal Home Loan Bank of Boston in an amount equal to at least 1% of the aggregate principal amount of its unpaid residential mortgage loans and similar obligations at the beginning of each year, or 1/20 of its advances (borrowings) from the Federal Home Loan Bank of Boston, whichever is greater. Berkshire Bank was in compliance with this requirement with an investment in Federal Home Loan Bank of Boston stock at December 31, 2003 of $12.9 million.
The Federal Home Loan Banks are required to provide funds for certain purposes including contributing funds for affordable housing programs. These requirements could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. For the years ended 2003, 2002, 2001, 2000, and 1999, cash dividends from the Federal Home Loan Bank of Boston to Berkshire Bank amounted to approximately $249,211, $283,300, $303,600, $332,700 and $180,900, respectively. Further, there can be no assurance that the impact of recent or future legislation on the Federal Home Loan Banks will not also cause a decrease in the value of the Federal Home Loan Bank stock held by the Bank.
Holding Company Regulation
Federal law allows a state savings bank that qualifies as a "Qualified Thrift Lender," discussed below, to elect to be treated as a savings association for purposes of the savings and loan holding company provisions of federal law. Such election allows its holding company to be regulated as a savings and loan holding company by the Office of Thrift Supervision rather than as a bank holding company by the Federal Reserve Board. Berkshire Bank made such election and the Company is a non-
diversified unitary savings and loan holding company within the meaning of federal law. As such, the Company is registered with the Office of Thrift Supervision and has adhered to the Office of Thrift Supervision's regulations and reporting requirements. In addition, the Office of Thrift Supervision may examine and supervise the Company and the Office of Thrift Supervision has enforcement authority over the Company and its non-savings institution subsidiaries. Among other things, this authority permits the Office of Thrift Supervision to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution. Additionally, Berkshire Bank is required to notify the Office of Thrift Supervision at least 30 days before declaring any dividend to the Company. By regulation, the Office of Thrift Supervision may restrict or prohibit the Bank from paying dividends.
As a unitary savings and loan holding company, the Company is generally not restricted under existing laws as to the types of business activities in which it may engage. The Gramm-Leach-Bliley Act of 1999 expanded the authority of bank holding companies to affiliate with other financial services companies such as insurance companies and investment banking companies. The Gramm-Leach-Bliley Act, however, provided that unitary savings and loan holding companies may only engage in activities permitted to a financial holding company under the legislation and those permitted for a multiple savings and loan holding company. Unitary savings and loan companies existing prior to May 4, 1999, such as the Company, were grandfathered as to the unrestricted activities. Upon any non-supervisory acquisition by the Company of another savings association as a separate subsidiary, the Company would become a multiple savings and loan holding company. Federal law limits the activities of a multiple savings and loan holding company and its non-insured institution subsidiaries primarily to activities permissible for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act, provided the prior approval of the Office of Thrift Supervision is obtained, to other activities authorized by Office of Thrift Supervision regulation and to those permitted for financial holding companies. Multiple savings and loan holding companies are generally prohibited from acquiring or retaining more than 5% of a non-subsidiary company engaged in activities other than those permitted by federal law.
Federal law prohibits a savings and loan holding company from, directly or indirectly, acquiring more than 5% of the voting stock of another savings association or savings and loan holding company or from acquiring such an institution or company by merger, consolidation or purchase of its assets, without prior written approval of the Office of Thrift Supervision. In evaluating applications by holding companies to acquire savings associations, the Office of Thrift Supervision considers the financial and managerial resources and future prospects of the Company and the institution involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors.
The Office of Thrift Supervision is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, except for (1) interstate supervisory acquisitions by savings and loan holding companies, and (2) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions.
To be regulated as a savings and loan holding company by the Office of Thrift Supervision (rather than as a bank holding company by the Federal Reserve Board), the Bank must qualify as a Qualified Thrift Lender. To qualify as a Qualified Thrift Lender, the Bank must maintain compliance with the test for a "domestic building and loan association," as defined in the Internal Revenue Code, or with a Qualified Thrift Lender Test. Under the Qualified Thrift Lender Test, a savings institution is required to maintain at least 65% of its "portfolio assets" (total assets less: (1) specified liquid assets up to 20% of total assets; (2) intangibles, including goodwill; and (3) the value of property used to conduct business) in certain "qualified thrift investments" (primarily residential mortgages and related investments, including certain mortgage-backed and related securities) in at least 9 months out of each 12 month period. As of December 31, 2003, Berkshire Bank maintained 93.1% of its portfolio assets in qualified thrift investments. Berkshire Bank also met the QTL test in each of the prior twelve months and, therefore, met the QTL Test.
Acquisition of the Company. Under the Federal Change in Bank Control Act, a notice must be submitted to the Office of Thrift Supervision if any person (including a company), or group acting in concert, seeks to acquire "control" of a savings and loan holding company. Under certain circumstances, a change in control may occur, and prior notice is required, upon the acquisition of 10% or more of the Company's outstanding voting stock, unless the Office of Thrift Supervision has found that the acquisition will not result in a change of control of the Company. Under the Change in Bank Control Act, the Office of Thrift Supervision has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that acquires control would then be subject to regulation as a savings and loan holding company.
Massachusetts Holding Company Regulation. In addition to the federal holding company regulations, a bank holding company organized or doing business in Massachusetts must comply with any regulation under the Massachusetts law. The term "bank holding company," for the purposes of Massachusetts law, is defined generally to include any company which, directly or indirectly, owns, controls or holds with power to vote more than 25% of the voting stock of each of two or more banking institutions, including commercial banks and state co-operative banks, savings banks and savings and loan associations and national banks, federal savings banks and federal savings and loan associations. In general, a holding company controlling, directly or indirectly, only one banking institution will not be deemed to be a bank holding company for the purposes of Massachusetts law. Under Massachusetts law, the prior approval of the Board of Bank Incorporation is required before: any
company may become a bank holding company; any bank holding company acquires direct or indirect ownership or control of more than 5% of the voting stock of, or all or substantially all of the assets of, a banking institution; or any bank holding company merges with another bank holding company. Although the Company is not a bank holding company for purposes of Massachusetts law, any future acquisition of ownership, control, or the power to vote 25% or more of the voting stock of another banking institution or bank holding company would cause it to become such. The Company has no current plan or arrangement to acquire ownership or control, directly or indirectly, of 25% or more of the voting stock of another banking institution.
Federal Securities Laws
The Company's common stock is registered with the Securities and Exchange Commission under the Exchange Act. The Company is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Exchange Act.
The registration under the Securities Act of shares of common stock does not cover the resale of such shares. Shares of the common stock purchased by persons who are not affiliates of the Company may be resold without registration. The resale restrictions of Rule 144 under the Securities Act govern shares purchased by an affiliate of the Company. If the Company meets the current public information requirements of Rule 144 under the Securities Act, each affiliate of the Company who complies with the other conditions of Rule 144 (including those that require the affiliate's sale to be aggregated with those of other persons) would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of (1) 1% of the outstanding shares of the Company or (2) the average weekly volume of trading in such shares during the preceding four calendar weeks. Future provision may be made by the Company to permit affiliates to have their shares registered for sale under the Securities Act under specific circumstances.
FEDERAL AND STATE TAXATION ON INCOME
Federal Income Taxation
General. The Company and Berkshire Bank report their income on a calendar year basis using the accrual method of accounting. The federal income tax laws apply to the Company and Berkshire Bank in the same manner as to other corporations with some exceptions, including particularly Berkshire Bank's reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to Berkshire Bank or the Company. Berkshire Bank's federal income tax returns have been either audited or closed under the statute of limitations through tax year 1999. For its 2003 tax year, Berkshire Bank's maximum federal income tax rate was 34%.
Bad Debt Reserves. For fiscal years beginning before December 31, 1995, thrift institutions which qualified under certain definitional tests and other conditions of the Internal Revenue Code of 1986, as amended, were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad debt reserve. A reserve could be established for bad debts on qualifying real property loans, generally secured by interests in real property improved or to be improved, under the percentage of taxable income method or the experience method. The reserve for non-qualifying loans was computed using the experience method.
Federal legislation enacted in 1996 repealed the reserve method of accounting for bad debts and the percentage of taxable income method for tax years beginning after 1995 and required savings institutions to recapture or take into income certain portions of their accumulated bad debt reserves. Approximately $844,000 of the Bank's accumulated bad debt reserves will not be recaptured into taxable income unless the Bank makes a "nondividend distribution" to the Company as described below.
Distributions. If the Bank makes "nondividend distributions" to the Company, they will be considered to have been made from the Bank's unrecaptured tax bad debt reserves, including the balance of its reserves as of December 31, 1987, to the extent of the "nondividend distributions," and then from the Bank's supplemental reserve for losses on loans, to the extent of those reserves, and an amount based on the amount distributed, but not more than the amount of those reserves, will be included in the Bank's taxable income. Nondividend distributions include distributions in excess of the Bank's current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock, and distributions in partial or complete liquidation. Dividends paid out of the Bank's current or accumulated earnings and profits will not be included in the Bank's taxable income.
The amount of additional taxable income triggered by a nondividend distribution is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Therefore, if the Bank makes a nondividend distribution to the Company, approximately one and one-half times the amount of the distribution not in excess of the amount of the reserves would be includable in income for federal income tax purposes, assuming a 35% federal corporate income tax rate. The Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserves.
State Taxation
Massachusetts Taxation. The Massachusetts excise tax rate for savings banks is currently 10.5% of federal taxable income, adjusted for certain items. Taxable income includes gross income as defined under the Internal Revenue Code, plus interest from bonds, notes and evidences of indebtedness of any state, including Massachusetts, less deductions, but not the credits, allowable under the provisions of the Internal Revenue Code, except no deduction is allowed for taxes paid to the state which are based on income. Carryforwards and carrybacks of net operating losses are not allowed.
A financial institution or business corporation is generally entitled to special tax treatment as a "securities corporation," provided that: (a) its activities are limited to buying, selling, dealing in or holding securities on its own behalf and not as a broker; and (b) it has applied for, and received, classification as a "securities corporation" by the Commissioner of the Massachusetts Department of Revenue. A securities corporation that is also a bank holding company under the Code must pay a tax equal to 0.33% of its gross income. A securities corporation that is not a bank holding company under the Code must pay a tax equal to 1.32% of its gross income. Three of the Bank's subsidiaries, North Street Securities Corporation, Gold Leaf Securities Corporation and Woodland Securities, Inc., are Massachusetts securities corporations.
In June 2003, the Company reached a settlement with the Massachusetts Department of Revenue (the "DOR") with respect to the DOR's tax assessment resulting from the DOR's disallowance of the Company's deduction of certain dividend distributions received by the Bank from Gold Leaf Capital Corporation, its majority-owned real estate investment trust (the "REIT"). As a result, the Company paid approximately $398,000 to the DOR representing one-half of the assessment plus interest and obtained the DOR's release from liability for the remaining half assessed. The Company dissolved the REIT during the third quarter of 2003.
Delaware Taxation. As a Delaware holding company not earning income in Delaware, the Company is exempt from Delaware corporate income tax but is required to file an annual report with and pay an annual franchise tax to the State of Delaware.
ITEM 1A.
ITEM 1A. EXECUTIVE OFFICERS OF THE REGISTRANT - --------------------------------------------------------------------------------
The following table sets forth certain information regarding the executive officers of Berkshire Hills and Berkshire Bank.
- -------------------- (1) As of December 31, 2003
The executive officers are elected annually and hold office until their successors have been elected and qualified or until they are removed or replaced.
Biographical Information
Michael P. Daly serves as President and Chief Executive Officer of the Company and Berkshire Bank. Prior to this position, Mr. Daly served as Executive Vice President of the Company and Bank from January 2000 to October 2002 and as Senior Vice President of Commercial Lending from October 1997 until January 2000.
Wayne F. Patenaude has served as Senior Vice President, Chief Financial Officer and Treasurer of the Company and Berkshire Bank since February 2003. Mr. Patenaude served as Executive Vice President, Chief Financial Officer and Treasurer of American Savings Bank, located in New Britain, Connecticut, from 1999 until American Savings Bank's acquisition by Banknorth, N.A. on February 14, 2003. Mr. Patenaude served as Chief Financial Officer of Bancorp Connecticut from December 1998 to 1999 when he joined American Savings Bank.
Gayle P. Fawcett has been Senior Vice President of Retail Banking and Operations of the Company and Berkshire Bank since October 2002. Prior to this position, Ms. Fawcett served as Senior Vice President of Systems and Operations of Berkshire Bank since May 1999.
ITEM 2.
ITEM 2. PROPERTIES - --------------------------------------------------------------------------------
The Company and the Bank currently conduct their business through the main office located in Pittsfield, Massachusetts, and 11 other full service banking offices and one other facility listed below. The Company and the Bank believe their facilities are adequate to meet their present and immediately foreseeable needs.
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(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.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS - --------------------------------------------------------------------------------
Periodically, there have been various claims and lawsuits involving Berkshire Bank, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Bank's business. However, neither the Company nor the Bank is a party to any pending legal proceedings that it believes would have a material adverse effect on the financial condition or operations of the Company, taken as a whole.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - --------------------------------------------------------------------------------
None.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - --------------------------------------------------------------------------------
The common stock is traded on the American Stock Exchange under the symbol "BHL." As of February 26, 2004, the Company had approximately 951 holders of record. The following table sets forth, for the quarters indicated, the daily closing high and low sales price for the common stock and the dividends paid. The Company is subject to the requirements of Delaware law, which generally limits dividends to an amount equal to the excess of the net assets of the Company (the amount by which total assets exceed total liabilities) over its statutory capital or, if there is no excess, to its net profits for the current and/or immediately preceding fiscal year.
For the Year Ended December 31, 2003 ----------------------------------------------------- 4th Quarter 3rd Quarter 2nd Quarter 1st Quarter ----------- ----------- ----------- ----------- High $ 37.40 $ 33.90 $ 28.40 $ 24.00
Low $ 33.55 $ 28.10 $ 23.10 $ 21.86
Dividend Paid $ 0.12 $ 0.12 $ 0.12 $ 0.12
For the Year Ended December 31, 2002 ----------------------------------------------------- 4th Quarter 3rd Quarter 2nd Quarter 1st Quarter ----------- ----------- ----------- -----------
High $ 25.25 $ 27.25 $ 26.20 $ 22.08
Low $ 22.94 $ 20.99 $ 21.98 $ 19.65
Dividend Paid $ 0.12 $ 0.12 $ 0.12 $ 0.12
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA - --------------------------------------------------------------------------------
The Company has derived the following selected consolidated financial and other data of the Company and Berkshire Bank in part from the consolidated financial statements and notes appearing elsewhere in this Form 10-K. The data as of and for the years ended December 31, 2003, 2002, 2001 and 2000 are derived from the audited consolidated financial statements for Berkshire Hills and Berkshire Bank. The data as of and for the year ended December 31, 1999 is derived from the audited consolidated financial statements of Berkshire Bancorp and Berkshire Bank.
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(1) Includes mortgagors' escrow accounts.
(2) Consists primarily of Berkshire Hills Technology's revenues in 2003, 2002 and 2001. Berkshire Hills Technology was formed in May 2001.
(3) Regulatory Capital and Asset Quality Ratios are end of period ratios. Performance Ratios are based on daily averages.
(4) Difference between weighted average yield on interest-earning assets and weighted average cost of interest-bearing liabilities.
(5) Net interest income as a percentage of average interest-earning assets.
(6) Net income divided by average total assets.
(7) Net income divided by average total equity.
(8) Dividends per share divided by basic earnings per share. Comparable figures for 2000 and 1999 are not available as the Company began paying dividends in the fourth quarter of 2000.
(9) Operating expenses divided by net interest income plus other income, less gain on sale of securities plus losses on sale of sub-prime loans. For purposes of the 2002 computation, severance payments of $6.9 million were deducted from operating expenses.
(10) Nonperforming loans consist of nonaccrual loans.
(11) Nonperforming assets consist of nonaccrual loans and real estate owned.
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - --------------------------------------------------------------------------------
General
Management's discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the consolidated financial statements and accompanying notes contained in this report.
Forward-Looking Statements
This Annual Report on Form 10-K contains certain forward-looking statements that are based on certain assumptions and describe future plans, strategies and expectations of the Company. These forward-looking statements are generally identified by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project" or similar expressions. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to, changes in interest rates, general economic conditions, legislative/regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality or composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Company's market area and accounting principles and guidelines. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. The Company does not undertake -- and specifically disclaims any obligation -- to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
Critical Accounting Policies
The Company has established various accounting policies, which govern the application of generally accepted accounting principles in the preparation of the financial statements. Certain accounting policies involve significant judgments and assumptions by management that have a material impact on the carrying value of certain assets and liabilities. Management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances. Because of the nature of the judgments and assumptions made by management, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of assets and liabilities and the results of operations of the Company. The Company believes the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in the preparation of the Consolidated Financial Statements. Refer to Footnote 1 to the Consolidated Financial Statements, "Summary of Significant Accounting Policies" and the allowance for loan loss discussion in Item 1. Business, for a detailed description of the estimation processes and methodology related to the allowance for loan losses.
Operating Strategy
The Bank is an independent, community-oriented savings bank, delivering quality customer service and offering a wide range of deposit, loan and investment products to its customers. In recent years, the Bank's strategy has been to enhance profitability through controlled balance sheet growth by emphasizing the origination of real estate mortgages, commercial loans and home equity loans, increasing sources of noninterest income and by improving operating efficiencies while managing its capital position and limiting its credit and interest rate risk exposure. The Company has established profitability goals of a return on assets of 1.0%, a return on equity of 10.0% and an efficiency ratio of under 60%, which it expects to achieve by 2005. Earnings growth is always a priority for a public company and good balance of this with community involvement and employee retention is paramount to the Company's management.
The Bank is primarily a lending institution, which does a good job of cross-selling products in an effort to "own" the "whole customer." While it does not overpay for deposits, it has still achieved strong growth in its core deposit base. In addition, being vigilant in expense control through efficiency efforts, including the implementation of Six Sigma, is critical and we believe those efforts will help earnings. To accomplish these objectives, the Bank has sought to:
o Operate as a full-service community bank by expanding the services and products it offers.
o Provide superior customer service through an attention to detail and a focus on building customer relationships.
o Provide innovative products by increasing the functionality of its ATM network and expanding the capability of its call center.
o Increase fee income by broadening non-depository product offerings and services.
o Continue to increase its emphasis on high quality consumer and commercial loans.
o Control credit risk by continuing to employ conservative underwriting standards to minimize the level of new problem assets.
o Improve asset quality by exiting the indirect sub-prime automobile loan business.
o Manage interest rate risk by emphasizing investments in shorter-term loans and investment securities, engaging in the sale, securitization and purchase of loans and by managing the Company's sources of borrowed funds, such as, its ability to borrow from the FHLB of Boston.
o Limit equity price risk and reductions to capital with decreases in its equity securities portfolio by selling a portion of its marketable equity securities portfolio.
o Operate more efficiently by: (1) increasing core deposits through aggressive cross-selling of products and using a disciplined approach to deposit pricing; and (2) utilizing "Six Sigma" process improvement infrastructure, which is designed to improve the Company's operating efficiencies.
o Invest primarily in debt instruments that provide adequate liquidity to meet cash flow needs and to earn a reasonable return on investment.
As global and local economies continue to improve, the Company will strive to take advantage of growth opportunities, both organic and through non-dilutive acquisitions. While industry consolidation continues to increase acquisition multiples making them increasingly more difficult to achieve, the Company will prudently continue to explore opportunities that will improve its franchise and be accretive to shareholders.
Fourth Quarter Events and Recent Developments
In December 2003, as part of the Bank's effort to improve its credit risk profile, the Bank accelerated its strategy to exit the sub-prime automobile loan business by selling $9.9 million of such loans, which resulted in the reversal of approximately $1.0 million of previously provided loan loss provision. At December 31, 2003, the Bank held $1.4 million of sub-prime automobile loans. The Bank will continue to invest in automobile loans, but will no longer originate or acquire sub-prime automobile loans.
To prepare for a volatile and potentially rising interest rate environment, $55.0 million of one- to four-family fixed rate residential mortgages were securitized, of which $16.3 million settled in December 2003, and the remaining $38.7 million settled in January 2004.
Total commercial loans increased $20.1 million, or at an annualized rate of 22.8%, from September 30, 2003. The majority of this increase was in commercial real estate loans, which increased $22.3 million from September 30, 2003 as several new loans were added to the portfolio, of which the largest loan was $2.5 million, while commercial loans declined $2.2 million for the same period.
Core deposits, which the Company considers to be all deposits other than certificates of deposit, increased $8.5 million, or at an annualized rate of 6.8%, from September 30, 2003. The Bank had the largest increase in demand deposits, which increased $6.3 million, or 6.5%. NOW accounts increased $2.9 million, or 3.2%, and money market accounts increased $1.4 million, or 1.0%. The Bank continues to aggressively pursue deposits through customer cross-selling efforts and other marketing campaigns.
Comparison of Financial Condition at December 31, 2003 and 2002
Total assets were $1.22 billion at December 31, 2003, an increase of $172.6 million, or 16.5%, from $1.05 billion at December 31, 2002. The Company's investment portfolio, excluding FHLB and SBLI stock, increased 58.4% to $344.3 million at the end of 2003 from $217.4 million at the end of 2002 as the Company purchased securities with attractive yields relative to the rates paid on a corresponding increase in borrowings from the Federal Home Loan Bank of Boston. These purchases were primarily in securities with durations averaging three to five years. Short-term investments totaled $1.9 million at December 31, 2003, a decrease of $41.5 million from December 31, 2002, reflecting the investment of the proceeds from the December 2002 sale of sub-prime automobile loans in purchased one-to four-family residential mortgage loans. Loans totaled $783.2 million at December 31, 2003, an increase of $70.5 million, or 9.9%, from the year ended December 31, 2002. Organic loan growth, which excludes purchases, securitization and sales of loans, increased $88.1 million, or 12.2%, from December 31, 2002. Automobile loans decreased $9.6 million, or 8.5%, to $104.0 million at December 31, 2003 from December 31, 2002 as the Bank sold $9.9 million of its sub-prime automobile loans to a third party. At December 31, 2003, $1.4 million of sub-prime automobile loans remained with an allocated reserve of $623,000, or 44.8%. Construction and land development loans increased $17.1 million, or 97.0%, to $34.7 million at December 31, 2003 from $17.6 million at December 31, 2002. Commercial real estate totaled $154.2 million at December 31, 2003, an increase of $35.0 million, or 29.4%, from December 31, 2002, while residential one- to four-family loans increased $19.8 million, or 8.0%, to $266.8 million at December 31, 2003 from December 31, 2002. The increases reflect the Bank's expansion into new commercial loan markets, primarily in the eastern New York area, and a strong local real estate loan market primarily driven by a low interest rate environment. Commercial loans remained relatively flat with an increase of $1.0 million, or 0.6%, to $166.5 million at December 31, 2003 from $165.4 million at December 31, 2002.
Nonperforming loans totaled $3.2 million at December 31, 2003, a decrease of $542,000, or 14.5%, from $3.7 million at December 31, 2002. Commercial and commercial real estate nonaccruing loans totaled $2.4 million at the end of 2003 compared to $2.9 million at the end of 2002, primarily as the result of the return of two loans to accrual status, payments collected on accounts remaining on nonaccruing status and $156,000 in gross commercial loan charge-offs. Nonaccruing consumer loans totaled $468,000 at the end of 2003, down from $661,000 at the end of 2002. Automobile loans of $306,000 were 90 days or more past due and still accruing interest at the end of 2003, compared to $590,000 at the end of 2002. The ratio of nonperforming loans to total loans at December 31, 2003 and 2002 was 0.40% and 0.52%, respectively.
The Bank executed a single premium Bank Owned Life Insurance ("BOLI") contract in June of 2003, totaling $7.5 million. This transaction is expected to earn a tax-equivalent return in excess of other earning assets with similar risk characteristics. The income earned on BOLI is recorded as an increase in noninterest income. BOLI totaled $7.7 million at December 31, 2003.
Interest-bearing liabilities increased $150.7 million, or 18.2%, to $978.9 million at December 31, 2003 from $828.2 million at December 31, 2002, primarily due to a $118.5 million, or 89.1%, increase in FHLB borrowings. Borrowings totaled $251.5 million at December 31, 2003, increasing from $133.0 million at December 31, 2002, as the Bank utilized lower cost borrowings to fund asset growth. Interest-bearing deposits increased $32.2 million, or 4.6%, to $727.5 million at the end of 2003 from $695.2 million at the end of 2002. Money market and NOW accounts increased $27.9 million and savings accounts
increased $13.3 million, while certificates of deposit decreased $8.8 million. Noninterest bearing demand deposits grew $15.6 million to $102.8 million at December 31, 2003 from $87.1 million at December 31, 2002.
Stockholders' equity totaled $123.2 million at December 31, 2003, an increase of $2.6 million, or 2.2%, from December 31, 2002. This increase was primarily due to net income of $9.0 million, partially offset by the repurchase of 285,116 shares at a cost of $7.1 million, the exercise of 71,064 shares of stock options and the payment of cash dividends of $0.48 per share amounting to $2.6 million.
Comparison of Operating Results for the Years Ended December 31, 2003 and 2002
Net Income. Net income totaled $9.0 million for the year ended December 31, 2003, an increase of $6.9 million, or 327.5%, from $2.1 million for the year ended December 31, 2002. Net income for 2003 includes $437,000 in charges related to a non-recurring retirement benefit while net income for 2002 includes $8.3 million in charges in connection with the restructuring of the Company's senior management and the reorganizing of the Company's long-term business strategy. Basic and diluted earnings per share for the year ended December 31, 2003 were $1.70 and $1.57, respectively, compared to basic and diluted earnings of $0.39 and $0.36 for the year ended December 31, 2002.
Net Interest Income. Net interest income is the largest component of the Company's revenue stream and is the difference between the interest and dividends earned on the loan and investment portfolios and the interest paid on the Company's funding sources, primarily customer deposits and advances from the Federal Home Loan Bank of Boston. Net interest income decreased $3.1 million, or 7.7%, to $37.6 million in 2003 from $40.7 million in 2002 as the relatively low market interest rate environment led to a high number of loan prepayments and refinancings, which had a negative impact on earnings, and due to the reinvestment of the proceeds from the December 2002 sale of sub-prime automobile loans in lower yielding loans. Average earning assets increased $63.9 million, or 6.5%, to $1.05 billion in 2003 from $987.9 million in 2002, while the yield on average earnings assets declined to 5.35% from 6.49% for the twelve-month period ended December 31, 2003. Partially offsetting the decline in the yield on average earning assets was a 75 basis point decrease in the rate paid on average interest-bearing liabilities from the same period last year. As a result, the Company's net interest margin for the twelve months ended December 31, 2003 and 2002 were 3.57% and 4.12%, respectively.
Interest and dividend income declined $7.8 million, or 12.2%, to $56.3 million for 2003 from $64.1 million for 2002 as interest earned on the Bank's loan portfolio decreased $9.2 million, or 16.2%, from $56.9 million for 2002 due to the sale of $69.7 million of higher rate sub-prime automobile loans in December 2002 and the impact of lower market interest rates resulting from comparatively stronger loan refinance activity. The lower loan interest income also reflects the forfeiture of $65,000 in accrued interest and a write-down of $180,000 of dealer reserve related to the December 2003 sale of $9.9 million of sub-prime automobile loans. Interest and dividend income on the Company's investment portfolio, including FHLB and SBLI stock, equaled $8.5 million in 2003, an increase of $1.8 million, or 25.9%, from $6.8 million earned in 2002 as higher average balances were able to offset lower average yields earned.
The decrease in interest and dividend income was partially offset by a decrease in interest expense which decreased $4.7 million, or 20.0%, to $18.7 million for the year ended December 31, 2003 from $23.4 million for the year ended December 31, 2002 due to lower rates paid, particularly on the Bank's deposit accounts. Interest expense on deposits totaled $13.9 million for the twelve months ended December 31, 2003, a decrease of $3.9 million, or 22.0%, from $17.8 million for the twelve months ended December 31, 2002. Average interest-bearing deposit balances increased $44.3 million to $723.5 million in 2003 from $679.2 million in 2002, but were more than offset by a lower average rate of 1.92% paid in 2003 compared to 2.62% in 2002. Interest expense on FHLB advances and other borrowings totaled $4.9 million this year, a decrease of $771,000, or 13.7%, from $5.7 million last year, due to lower rates paid, as new lower-cost borrowings replaced maturing higher cost advances and as a result of the Bank's prepayment of higher cost advances in December 2002.
Provision for Loan Losses. The provision for loan losses decreased $4.7 million, or 76.4%, to $1.5 million in 2003 from $6.2 million in 2002. The sale of $9.9 million of sub-prime automobile loans in December 2003 resulted in the reversal of approximately $1.0 million of previously provided loan loss provision. In assessing the provision for the twelve months ended December 31, 2003, management took into consideration an $18.2 million decrease in sub-prime automobile loans from December 31, 2002. The Company also considered net loan charge-offs which decreased $4.1 million, to $2.8 million in 2003, from $6.9 million last year. Foremost in this decrease were gross consumer loan charge-offs which declined $4.9 million in 2003 and consisted mainly of sub-prime automobile loans. Additionally, management considered the level of delinquent loans, which declined from 1.40% of total loans at December 31, 2002, to 0.67% at December 31, 2003.
At December 31, 2003, the allowance for loan losses was $9.0 million and represented 1.13% of total loans and 280.37% of nonperforming loans compared to $10.3 million, 1.43% and 275.54%, respectively, at December 31, 2002. The decline in the allowance is consistent with improvement in the Company's credit risk profile, particularly in consideration of the significant reduction in sub-prime automobile loans.
Provisions for loan losses are charges to earnings to bring the total allowance for loan losses to a level considered by management as adequate to provide for estimated loan losses based on management's evaluation of the collectibility of the loan portfolio. Management assesses the adequacy of the allowance for loan losses based on known and inherent risks in the loan portfolio and upon management's continuing analysis of the factors underlying the quality of the loan portfolio. While management believes that, based on information currently available, Berkshire Bank's allowance for loan losses is sufficient to cover losses inherent in the Bank's loan portfolio at this time, no assurances can be given that Berkshire Bank's level of allowance for loan losses will be sufficient to cover future loan losses incurred by the Bank or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance for loan losses. Management may increase its level of allowance for loan losses as a percentage of total loans and nonperforming loans if the level of commercial real estate, multi-family, commercial, construction and development or consumer loans as a percentage of its total loan portfolio increases. In addition, various regulatory agencies, as an integral part of their examination process, periodically review Berkshire Bank's allowance for loan losses. These agencies may require Berkshire Bank to provide additions to the allowance based upon judgments different from management.
Noninterest Income. Noninterest income totaled $13.7 million for the twelve months ended December 31, 2003, an increase of $292,000, or 2.2%, over $13.4 million for 2002. Noninterest income for 2003 includes a $3.1 million gain on the sale of securities, which was nearly offset by $2.4 million in charges relating to the sale of sub-prime automobile loans and the valuation adjustment in repossessed automobiles. EastPoint license maintenance and processing fees and license sales and other fees increased $271,000, or 3.9%, to $7.3 million for the twelve months ended December 31, 2003 as compared to $7.0 million for the same period last year. Noninterest income for 2002 includes several items related to the reorganizing of the Company's long-term business strategy that took place in the fourth quarter of 2002. A $14.8 million gain on the sale of equity securities was nearly offset by $13.4 million in charges relating to the sale of sub-prime automobile loans, the write-down of one security, the write-down of repossessed automobiles, and the prepayment penalty on FHLB advances. In addition, trust department fees increased $294,000, or 16.4%, in 2003 due to an increase of $42.0 million, or 17.0%, in trust assets under management.
Noninterest Expenses. Noninterest (operating) expenses totaled $35.8 million for the year ended December 31, 2003 compared to $45.3 million for the year ended December 31, 2002. Salaries and benefits expense declined $7.3 million for the twelve months ended December 31, 2003 compared to the same period last year, as expenses for 2002 included $6.9 million of severance payments for three executive officers and one senior vice president, and the retirement of seven directors. Expenses for EastPoint, which are recorded in various noninterest expense categories, totaled $7.8 million for the twelve months ended December 31, 2003 as compared to $8.2 million for the same period last year, a decrease of $464,000, or 5.6%. This decrease from 2002 was attributable to a $500,000 increase in EastPoint's allowance for uncollectible debt in December 2002. EastPoint had no such increases in 2003. Expenses pertaining to foreclosed real estate and other loans decreased $2.2 million to $1.0 million for the year ended December 31, 2003 compared to $3.3 million for the year ended December 31, 2002, primarily due to a decrease in the expenses associated with the inventory and sale of repossessed automobiles.
Income Taxes. Income taxes for the year ended December 31, 2003 were $5.1 million, an increase of $4.5 million from $531,000 for the year ended December 31, 2002, due to increased income before taxes as well as an increase in the effective tax rate to 36.1% for 2003 from 20.2% for 2002. The increase in the effective tax rate for 2003 was largely due to the disallowance by Massachusetts of the dividend received deduction from the Bank's REIT. The lower rate paid in 2002 was primarily due to a higher level of qualifying dividends received to pretax income in 2002 compared to 2003.
Comparison of Operating Results for the Years Ended December 31, 2002 and 2001
Net Income. Net income totaled $2.1 million for the year ended December 31, 2002, a decrease of $6.8 million, or 80.1%, from $8.9 million for the year ended December 31, 2001. Net income for 2002 includes $8.3 million in charges in connection with the restructuring of the Company's senior management and the reorganizing of the Company's long-term business strategy while net income for 2001 includes a one-time gain of $2.2 million from the dissolution of the Bank's defined benefit pension plan. Basic and diluted earnings per share for the year ended December 31, 2002 were $0.39 and $0.36, respectively, compared to basic and diluted earnings of $1.42 and $1.35 for the year ended December 31, 2001.
Net Interest Income. Net interest income decreased $1.5 million, or 3.6%, to $40.7 million in 2002 from $42.2 million in 2001 as the relatively low market interest rate environment led to a high number of loan prepayments and refinancings which had a negative impact on earnings. The average yield on interest bearing assets declined 131 basis points to 6.49% for the year ended December 31, 2002 compared to 7.80% for the year ended December 31, 2001 and more than offset a $16.2 million increase in average interest bearing assets to $987.9 million for 2002 compared to $971.7 million for 2001. Average interest bearing liabilities increased $31.3 million to $821.0 million in 2002 from $789.7 million in 2001, but were more than offset by a lower average rate paid of 2.85% in 2002 compared to 4.25% in 2001 reflecting the low market interest rate environment. As a result, the Company's net interest margin for the twelve months ended December 31, 2002 and 2001 were 4.12% and 4.35%, respectively.
Interest and dividend income fell $11.7 million, or 15.4%, to $64.1 million for 2002 from $75.8 million for 2001 as interest earned on the Bank's loan portfolio dropped $11.4 million, or 16.7%, from $68.3 million for 2001 as the average balance of the Bank's loans fell to $791.3 in 2002 from $815.1 for last year and the average rate earned equaled 7.19% in 2002 compared to 8.38% for 2001. The lower loan interest income also reflects the forfeiture of $492,000 in accrued interest related to the December sale of sub-prime automobile loans. Interest and dividend income on the Company's investment portfolio, including FHLB and SBLI stock, equaled $6.8 million in 2002, a decrease of $330,000, or 4.7%, from $7.1 million earned in 2001. Higher average balances were not enough to offset the decrease in average rate earned on the investment portfolio. The average balance of the investment portfolio increased $24.0 million to $168.7 million in 2002 while the average rate earned dropped 89 basis points to 4.01% in 2002.
The decrease in interest and dividend income was mostly offset by a decrease in interest expense as interest expense dropped $10.1 million, or 30.2%, to $23.4 million for the year ended December 31, 2002 from $33.6 million for the year ended December 31, 2001 due to lower rates paid, particularly on the Bank's deposit accounts. Interest paid on deposits totaled $17.8 million for the twelve months ended December 31, 2002, a decrease of $8.9 million, or 33.4%, from $26.7 million for the twelve months ended December 31, 2001. Average interest bearing deposit balances increased $21.7 million to $679.2 million in 2002 from $657.5 million in 2001, but were more than offset by a lower average rate paid of 2.62% in 2002 compared to 4.06% in 2001. Interest paid on borrowings also decreased due to lower interest rates paid as interest on FHLB advances and securities sold under agreements to repurchase totaled $5.7 million this year, a decrease of $1.2 million, or 17.8%, from $6.9 million last year, even though borrowings only declined $2.2 million, or 1.6%, from last year.
Provision for Loan Losses. The provision for loan losses decreased $1.0 million, or 13.9%, to $6.2 million in 2002 from $7.2 million in 2001 as a greater number of charge-offs in 2002 were more than offset by a higher number of recoveries and a decrease in the balance of sub-prime automobile loans. Total charge-offs were $10.0 million in 2002, an increase of $3.0 million, or 42.0%, from $7.1 million last year. This increase was due to the higher consumer loan charge-offs which rose $3.1 million in 2002. However, this increase was somewhat offset by the Bank's strong efforts in 2002 to recover charged-off loans. Recoveries totaled $3.1 million in 2002, an increase of $2.4 million over $705,000 in 2001. Net charge-offs were $6.9 million for the year ended December 31, 2002 compared to $6.4 million last year, an increase of $549,000, or 8.6%.
The provision for 2002 also includes $1.5 million added in the fourth quarter of 2002 to cover losses inherent in the remaining sub-prime automobile loan portfolio. At December 31, 2002, the allowance for loan losses was $10.3 million and represented 1.43% of total loans and 275.54% of nonperforming loans compared to $11.0 million at December 31, 2001, which represented 1.37% of total loans and 408.36% of nonperforming loans.
Noninterest Income. Noninterest income totaled $13.4 million for the twelve months ended December 31, 2002, an increase of $2.9 million, or 27.2%, over $10.6 million for 2001. Noninterest income for 2002 includes several items related to the reorganizing of the Company's long-term business strategy that took place in the fourth quarter of 2002. A $14.8 million gain on the sale of equity securities was nearly offset by $13.4 million in charges relating to the sale of sub-prime automobile loans, the write-down of one security, the write-down of repossessed automobiles, and the prepayment penalty on FHLB advances. Noninterest income also increased in 2002 due to the recording of a full year's worth of fees earned from the operations of EastPoint Technologies, LLC versus only six months last year, a difference of $3.5 million. In addition, customer service fees increased $423,000, or 23.4%, due to increased ATM and checking account fees. Noninterest income for 2001 includes a one-time gain of $2.2 million on the curtailment of the Bank's defined benefit pension plan.
Noninterest Expense. Noninterest (operating) expenses increased $13.0 million, or 40.1%, to $45.3 million for the year ended December 31, 2002 from $32.3 million for the year ended December 31, 2001 as expenses for 2002 included charges related to the restructuring of the Company's senior management and the retirement of several directors. In the fourth quarter of 2002, the Company and the Bank restructured their management team, which resulted in $6.6 million of charges, consisting of the payment to or accrual of severance payments for three executive officers and one senior vice president under existing contractual obligations. Additionally, seven directors retired from the Boards of the Company and the Bank and, as a result, the Company incurred a $300,000 charge in the fourth quarter to fund retirement plan benefits. Expenses pertaining to foreclosed real estate and other loans increased $1.0 million to $3.3 million as the Bank wrote down the value of one commercial property by $500,000. As was the case with noninterest income, noninterest expenses also increased due to the recognition of a full year's worth of expenses of EastPoint compared to only six months last year. The increase attributable to EastPoint totaled $4.8 million.
Income Taxes. Income taxes for the year ended December 31, 2002 were $531,000, a decrease of $3.8 million from $4.3 million for the year ended December 31, 2001. The effective tax rate for 2002 and 2001 were 20.2% and 32.8%, respectively. The lower rate paid in 2002 was due to the increase in the ratio of tax exempt income and qualifying dividends received to pretax income.
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.
- ---------------- (1) Average balances include nonaccrual loans.
(2) Includes mortgagors' escrow accounts.
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.
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations of a short-term nature. The Bank further defines liquidity as the ability to respond to the needs of depositors and borrowers, as well as maintaining the flexibility to take advantage of investment opportunities. The Bank's primary sources of funds consist of deposit inflows, loan repayments, maturities, loan sales, paydowns of mortgage-backed securities, sales/calls of investments and borrowings from the Federal Home Loan Bank of Boston. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit outflows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.
The Bank's primary investing activities are: (1) originating residential one- to four-family mortgage loans, commercial business and real estate loans, multi-family loans, home equity lines of credit and consumer loans, and (2) investing in mortgage- and asset-backed securities, U.S. Government and agency obligations, and debt securities. These activities are funded primarily by principal and interest payments on loans, proceeds from sales of loans and investment securities, maturities of securities, deposits and Federal Home Loan Bank of Boston advances. During the years ended December 31, 2003 and 2002, Berkshire Bank's loan originations totaled $321.1 million and $285.9 million, respectively. At December 31, 2003 and 2002, the Bank's investments in investment securities totaled $344.3 million and $217.4 million, respectively. The Bank experienced a net increase in total deposits of $47.9 million and $39.6 million for the years ended December 31, 2003 and 2002, respectively. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by the Bank and its local competitors and other factors. The Bank closely monitors its liquidity position on a daily basis. If the Bank should require funds beyond its ability to generate them internally, additional sources of funds are available through advances or a line of credit with the Federal Home Loan Bank and through repurchase agreement lines of credit with the Depositors Insurance Fund and a nationally recognized broker-dealer.
Outstanding commitments for all loans and unadvanced construction loans and lines of credit totaled $139.6 million at December 31, 2003. Management of Berkshire Bank anticipates that it will have sufficient funds available to meet its current loan commitments. Certificates of deposit that are scheduled to mature in one year or less from December 31, 2003 totaled $219.6 million. The Bank relies primarily on competitive rates, customer service and long-standing relationships with customers to retain deposits. Occasionally, the Bank will also offer special competitive promotions to its customers to increase retention and promote deposit growth. Based upon the Bank's historical experience with deposit retention, management believes that, although it is not possible to predict future terms and conditions upon renewal, a significant portion of such deposits will remain with the Bank.
The Bank must satisfy various regulatory capital requirements administered by the federal and state banking agencies including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At December 31, 2003, Berkshire Bank exceeded all of its regulatory capital requirements with Tier 1 capital to average assets of $93.8 million, or 7.87% of average assets, which is above the required level of $47.7 million, or 4.0%, and total capital to risk-weighted assets of $106.6 million, or 12.57% of risk-weighted assets, which is above the required level of $67.8 million, or 8.0%. The Bank meets the conditions to be considered "well capitalized" under regulatory guidelines.
The primary source of funding for Berkshire Hills is dividend payments from Berkshire Bank, and, to a lesser extent, earnings on deposits held by Berkshire Hills. Dividend payments by Berkshire Bank have primarily been used to fund stock repurchase programs and pay dividends to Berkshire Hills' shareholders. The Bank's ability to pay dividends and other capital distributions to Berkshire Hills is generally limited by the Massachusetts banking regulations and regulations of the Federal Deposit Insurance Corporation. See "Regulation and Supervision - Massachusetts Regulation." Additionally, the Massachusetts Commissioner of Banks and Federal Deposit Insurance Corporation may prohibit the payment of dividends which are otherwise permissible by regulation for safety and soundness reasons. Any dividend by the Bank beyond its current year's earnings and prior two years' retained net income would require the approval of the Massachusetts Commissioner of Banks, and notification to or approval of the Federal Deposit Insurance Corporation and the Office of Thrift Supervision. To the extent the Bank were to apply for a dividend distribution to Berkshire Hills in excess of the regulatory permitted dividend amount, no assurances can be made such application would be approved by the regulatory authorities.
Berkshire Hills is currently engaged in its sixth stock repurchase program. To date, all purchases have been open market purchases. In the current program, 112,700 shares out of an announced 300,000 have been purchased at a cost of $3.1 million through December 31, 2003. The Company has sufficient funds available to complete the repurchase program without having a material adverse effect on liquidity.
Contractual Obligations. The following table sets forth, at December 31, 2003, the dollar amount of the Bank's contractual obligations and their subsequent time period.
- --------------------- (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
For a discussion of the Company's off-balance sheet arrangements, see Footnote 13, "Off-Balance Sheet Activities" in the Notes to the Consolidated Financial Statements.
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented in this Form 10-K have been prepared in conformity with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike many industrial companies, substantially all of the assets and liabilities of Berkshire Bank are monetary in nature. As a result, interest rates have a more significant impact on Berkshire Bank's performance than the general level of inflation. Over short periods of time, interest rates may not necessarily move in the same direction or in the same magnitude as inflation.
Impact of New Accounting Standards
Accounting for Goodwill and Other Intangible Assets. The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets," effective January 1, 2002. Accordingly, goodwill is no longer subject to amortization over its estimated useful life, but is subject to at least an annual assessment for impairment by applying a fair value based test. Additionally, under SFAS No. 142, acquired intangible assets (such as core deposit intangibles) are separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented, or exchanged, and amortized over their useful life. Branch acquisition transactions were outside the scope of SFAS No. 142 and, accordingly, intangible assets related to such transactions continued to amortize upon the adoption of SFAS No. 142.
As required by SFAS No. 142, the Company completed the annual impairment test on goodwill assets and has concluded that the amount of recorded goodwill was not impaired as of December 31, 2003. On October 31, 2002, the Company adopted SFAS No. 147, "Acquisitions of Certain Financial Institutions." This Statement amends (except for transactions between two or more mutual enterprises) previous interpretive guidance on the application of the purchase method of accounting to acquisitions of financial institutions, and requires the application of SFAS No. 141, "Business Combinations" and SFAS No. 142 to branch acquisitions if such transactions meet the definition of a business combination. This Statement amends SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," to include in its scope core deposit intangibles of financial institutions. Accordingly, such intangibles are subject to a recoverability test based on undiscounted cash flows, and to the impairment recognition and measurement provisions that are required for other long-lived assets that are held and used. SFAS No. 141 requires that the Company evaluate its intangible assets and goodwill that were acquired in a prior purchase business combination, and to make any necessary reclassifications in order to conform with the new criteria for recognition apart from goodwill. No reclassifications or adjustments were made as a result of adopting this statement.
Consolidation of Variable Interest Entities. In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, "Consolidation of Variable Interest Entities," (FIN 46) which establishes guidance for determining when an entity should consolidate another entity that meets the definition of a variable interest entity. FIN 46 requires a variable interest entity to be consolidated by a company if that company will absorb a majority of the expected losses, will receive a majority of the expected residual returns, or both. Transferors to qualified special-purpose entities ("QSPEs") and certain other interests in a QSPE are not subject to the requirements of FIN 46. On December 17, 2003, the FASB deferred the effective date of FIN 46 to no later than the end of the first reporting period that ends after March 15, 2004, however, for special-purpose entities the Company would be required to apply FIN 46 as of December 31, 2003. The interpretation had no effect on the Company's consolidated financial statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - --------------------------------------------------------------------------------
Management of Interest Rate Risk and Market Risk Analysis
Qualitative Aspects of Market Risk. The Bank's most significant form of market risk is interest rate risk. The principal objectives of Berkshire Bank's interest rate risk management are to evaluate the interest rate risk inherent in certain balance sheet accounts, determine the level of risk appropriate given its business strategy, operating environment, capital and liquidity requirements and performance objectives, and manage the risk consistent with its established policies. Berkshire Bank maintains an Asset/Liability Committee that is responsible for reviewing its asset/liability policies and interest rate risk position, which meets quarterly and reports trends and interest rate risk position to the Board of Directors on a quarterly basis. The Asset/Liability Committee consists of six senior officers of the Bank and the Senior Financial Analyst. The extent of the movement of interest rates is an uncertainty that could have a negative impact on the earnings of Berkshire Bank.
In recent years, Berkshire Bank has managed interest rate risk by:
o emphasizing the origination and purchase of adjustable-rate loans and, from time to time, selling a portion of its longer term fixed-rate loans as market interest rate conditions dictate;
o securitizing a portion of the Bank's long-term, fixed rate mortgages;
o originating shorter-term commercial and consumer loans;
o investing in high quality liquid investment securities that provide adequate liquidity and flexibility to take advantage of opportunities that may arise from fluctuations in market interest rates, the overall maturity and duration of which is monitored in relation to the repricing of its loan and funding portfolios;
o promoting lower cost liability accounts such as core deposits; and
o using Federal Home Loan Bank advances to better structure maturities of its interest rate sensitive liabilities.
Berkshire Bank's market risk also includes equity price risk. Berkshire Bank's marketable equity securities portfolio had gross unrealized gains of $8.4 million at December 31, 2003 and no gross unrealized losses which are included, net of taxes, in accumulated other comprehensive income, a separate component of Berkshire Bank's shareholders' equity. If equity securities prices decline due to unfavorable market conditions or other factors, Berkshire Bank's and Berkshire Hills' capital would decrease. Management decided to decrease the amount of equity securities it holds by selling a portion of its existing portfolio each quarter during 2003.
Quantitative Aspects of Market Risk. Berkshire Hills uses a simulation model to measure the potential change in net interest income, incorporating various assumptions regarding the shape of the yield curve, the pricing characteristics of loans, deposits and borrowings, prepayments on loans and securities and changes in the balance sheet mix. The model assumes the yield curve is derived from the interpolated Treasury yield curve and that an instantaneous increase or decrease of market interest rates would cause a simultaneous parallel shift along the entire yield curve. Loans, deposits and borrowings are expected to reprice at the new market rate on the contractual review or maturity date. The Company closely monitors its loan prepayment trends and uses prepayment guidelines set forth by Freddie Mac and Fannie Mae and other market sources, as well as Company generated data where applicable. All prepayments are assumed to roll over into new loans originated in the same loan category at the new market rate. Berkshire Hills further assumes that its securities' cash flows, especially its mortgage-backed securities cash flows, are such that they will generally follow industry standards and that prepayments will be reinvested in the same category at the prevailing market rate. Finally, the model assumes that its balance sheet mix will remain relatively unchanged throughout the next calendar year.
The tables below set forth, as of December 31, 2003 and 2002, estimated net interest income and the estimated changes in Berkshire Hills' net interest income for the next twelve-month period which may result given instantaneous increases or decreases in market interest rates of 100 and 200 basis points.
Increase/(Decrease) in At December 31, 2003 Market Interest Rates in -------------------------------------- Basis Points (Rate Shock) Amount $ Change % Change - ------------------------- -------- -------- --------- (Dollars in thousands)
200 $ 37,144 $ (1,757) (4.52%) 100 38,162 (739) (1.90) Static 38,901 -- -- (100) 39,478 577 1.48 (200) 37,116 (1,785) (4.59)
Increase/(Decrease) in Market At December 31, 2002 Interest Rates in Basis Points -------------------------------------- (Rate Shock) Amount $ Change % Change - ------------------------------ -------- -------- --------- (Dollars in thousands) 200 $ 34,583 $ (1,027) (2.88%) 100 34,741 (869) (2.44) Static 35,610 -- -- (100) 35,162 (448) (1.26) (200) 32,908 (2,702) (7.59)
In the event of a sudden and sustained decrease in prevailing market interest rates of 100 and 200 basis points, the December 31, 2003 table indicates that net interest income would be expected to increase $577,000 and decrease $1.8 million, respectively. This result is due to the fact that the Company is slightly liability sensitive and in a 100 basis point decrease many non-maturity deposit account rates would decrease significantly and reach Company determined floors. In a negative 200 basis point scenario, many of these deposit accounts would have reached their floors and the Company would become asset sensitive. These results compare to the December 31, 2002 table, which indicates that in the event of a sudden and sustained decrease of 100 and 200 basis points in prevailing market interest rates, net interest income would be expected to decrease by $448,000 and $2.7 million, respectively. The primary reason for the differences between the models for the two years is that many deposit accounts have lower Company determined floors now than they did one year ago.
In the event of a sudden and sustained increase in prevailing market interest rates of 100 and 200 basis points, the December 31, 2003 table indicates that net interest income would be expected to decrease $739,000 and $1.8 million, respectively, compared to the December 31, 2002 table, which indicates that net interest income would decrease by $869,000 and $1.0 million, respectively. The primary reason for the difference in the up 200 basis point scenario was that at December 31, 2002, the Company had a larger amount of securities, including overnight federal funds, repricing or maturing in the next year than it had on December 31, 2003. Partially offsetting this was Management's expectation that the rates paid on the Company's interest-bearing non-maturity deposits were less sensitive to changes in prevailing market interest rates at year-end 2003 than at year-end 2002. After examining the historic rates paid on interest-bearing non-maturity deposits compared to the then prevailing market interest rates, Management determined during 2003 that the rates paid or the cost of these deposits would not have to increase as much in a rising interest rate environment than what was anticipated at year-end 2002.
Computation of prospective effects of hypothetical interest rate changes are based on a number of assumptions including the level of market interest rates, the degree to which certain assets and liabilities with similar maturities or periods to repricing react to changes in market interest rates, the expected prepayment rates on loans and investments, the degree to which early withdrawals occur on certificates of deposit and other deposit flows. As a result, these computations should not be relied upon as indicative of actual results. Further, the computations do not reflect any actions that management may undertake in response to changes in interest rates.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - --------------------------------------------------------------------------------
PAGE
INDEPENDENT AUDITORS' REPORT 62
CONSOLIDATED BALANCE SHEETS AS OF 63 DECEMBER 31, 2003 AND 2002
CONSOLIDATED STATEMENTS OF INCOME FOR THE 64 YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
CONSOLIDATED STATEMENTS OF CHANGES IN 65 STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR 66 THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 68
WOLF Certified Public Accountants & COMPANY, P.C. and Business Consultants - --------------------------------------------------------------------------------
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of Berkshire Hills Bancorp, Inc.
We have audited the accompanying consolidated balance sheets of Berkshire Hills Bancorp, Inc. and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Berkshire Hills Bancorp, Inc. and subsidiaries as of December 31, 2003 and 2002 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.
/s/ Wolf & Company, P.C.
Boston, Massachusetts January 23, 2004
99 High Street o Boston, Massachusetts o 02110-2320 o Phone 617-439-9700 o Fax 617-542-0400 1500 Main Street o Suite 1908 o Springfield, Massachusetts o 01115 o Phone 413-747-9042 o Fax 413-739-5149 www.wolfandco.com
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2003 and 2002
The accompanying notes are an integral part of these consolidated financial statements.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended December 31, 2003, 2002 and 2001
The accompanying notes are an integral part of these consolidated financial statements.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
Years Ended December 31, 2003, 2002 and 2001
The accompanying notes are an integral part of these consolidated financial statements.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2003, 2002 and 2001
(continued)
The accompanying notes are an integral part of these consolidated financial statements.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONCLUDED)
Years Ended December 31, 2003, 2002 and 2001
The accompanying notes are an integral part of these consolidated financial statements.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2003, 2002 and 2001
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - --------------------------------------------------------------------------------
Basis of presentation and consolidation
Berkshire Hills Bancorp, Inc. (the "Company") is a Delaware corporation and the holding company for Berkshire Bank (the "Bank"), a state-chartered savings bank headquartered in Pittsfield, Massachusetts. These consolidated financial statements include the accounts of Berkshire Hills Bancorp, Inc. and its wholly-owned subsidiaries, Berkshire Bank, Berkshire Hills Funding Corporation and Berkshire Hills Technology, Inc., which was formed during 2001 for the purpose of acquiring a controlling interest in EastPoint Technologies, LLC. The Bank's wholly-owned subsidiaries are North Street Securities Corporation, Gold Leaf Insurance Company, Gold Leaf Investment Services, Gold Leaf Securities Corporation and Woodland Securities Corporation, Inc. North Street Securities Corporation, Gold Leaf Securities Corporation, and Woodland Securities Corporation, Inc. hold title to certain investment securities. Gold Leaf Insurance Company and Gold Leaf Investment Services were formed in 2000 and offer insurance and investment products to customers. Berkshire Hills Funding Corporation was established and funded to loan funds to the Bank's Employee Stock Ownership Plan. During 2001, the Bank established a majority-owned subsidiary, Gold Leaf Capital Corporation, which held real estate mortgages prior to being dissolved during 2003. All significant intercompany balances and transactions have been eliminated in consolidation.
On June 29, 2001, the Company, through its wholly-owned subsidiary, Berkshire Hills Technology, Inc., purchased a controlling interest in EastPoint Technologies, LLC ("EastPoint"), which on the same date acquired all of the domestic operations and service contracts of M&I EastPoint Technology, Inc., Bedford, New Hampshire, a software and data processing provider for financial institutions, as well as substantially all of the operations and service contracts of Preferred Financial Systems, Inc., Arden Hills, Minnesota, a data processing service provider, both of which utilized the EastPoint Technology, Inc. software. The Company's equity interest in EastPoint at December 31, 2003 and 2002 is 60.3% and represents a total investment of $4.7 million. During 2001 the Company's ownership percentage decreased from 93.6% to 60.3% as other investor financial institutions obtained regulatory approval to invest in EastPoint Technologies, LLC. The change in ownership percentage is shown as an adjustment to additional paid-in capital. This acquisition was accounted for under the purchase method of accounting.
Business
The Company provides a variety of financial services to individuals, municipalities and businesses through its offices in Berkshire County. Its primary deposit products are savings, checking accounts and term certificate accounts and its primary lending products are residential and commercial mortgage loans, commercial loans and automobile loans. In addition, trust services and insurance products are offered to individuals and small businesses in the Berkshire County area.
Use of estimates
In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the consolidated balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and deferred taxes.
Reclassifications
Certain amounts in the 2002 and 2001 consolidated financial statements have been reclassified to conform to the 2003 presentation.
Cash and cash equivalents
For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash, balances due from banks and short-term investments, all of which mature within ninety days.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Short-term investments
Short-term investments mature within ninety days and are carried at cost, which approximates fair value.
Securities
Debt securities that management has the positive intent and ability to hold to maturity are classified as "held-to-maturity" and recorded at amortized cost. Securities not classified as held-to-maturity, including equity securities with readily determinable fair values, are classified as "available-for-sale" and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income.
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held-to-maturity and available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Federal Home Loan Bank of Boston ("FHLB") stock is reflected at cost. Savings Bank Life Insurance Company of Massachusetts ("SBLI") stock was recorded at fair value at acquisition as determined by an appraisal performed by independent investment consultants retained by SBLI.
Loans
The Bank grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans in Berkshire County. The ability of the Bank's debtors to honor their contracts is dependent upon the local economy and the local real estate market.
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.
Interest on loans, excluding automobile loans, is generally not accrued on loans which are ninety days or more past due unless the loan is well-secured and in the process of collection. Past due status is based on contractual terms of the loan. Automobile loans continue accruing to one hundred and twenty days delinquent at which time they are charged off, unless the customer is in bankruptcy proceedings. All interest accrued but not collected for loans that are placed on non-accrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Allowance for loan losses
The allowance for loan losses is established through a provision for loan losses charged to earnings as losses are estimated to have occurred. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by management and is based upon management's periodic review of the collectibility of the loans in light of historical experience, the composition and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general losses in the portfolio.
A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impaired loans are generally maintained on a non-accrual basis. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan's effective interest rate, or the fair value of the collateral if the loan is collateral dependent. Substantially all of the Bank's loans that have been identified as impaired have been measured by the fair value of existing collateral.
Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer loans or residential mortgage loans for impairment disclosures.
Loans held for sale
Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.
Foreclosed and repossessed assets
Assets acquired through, or in lieu of, loan foreclosure or repossession are held for sale and are initially recorded at the lower of the investment in the loan or fair value less estimated cost to sell at the date of foreclosure or repossession, establishing a new cost basis. Subsequently, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in net expenses from foreclosed real estate and repossessed assets.
Premises and equipment
Land is carried at cost. Buildings and improvements and equipment are carried at cost, less accumulated depreciation and amortization computed on the straight-line method over the estimated useful lives of the assets or terms of the leases, if shorter.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Goodwill and other intangibles
Goodwill and other intangibles includes goodwill associated with the acquisition of EastPoint which is evaluated for impairment on an annual basis. Intangible assets refer to customer relationships acquired in association with the EastPoint Technologies purchase, which are being amortized on a straight-line basis over three years, as well as the Company's purchase of two branches from another financial institution in 1991 and three branches in 1998. The branch acquisition costs are evaluated for impairment on an annual basis.
Securities sold under agreements to repurchase
The Company enters into repurchase agreements with commercial customers. The funds are invested in an overnight sweep account and deposited back in customers' accounts on a daily basis. These agreements are secured by pledged securities in the Bank's investment portfolio.
Transfers of financial assets
Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Income taxes
Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted accordingly through the provision for income taxes. The Bank's base amount of its federal income tax reserve for loan losses is a permanent difference for which there is no recognition of a deferred tax liability. However, the loan loss allowance maintained for financial reporting purposes is a temporary difference with allowable recognition of a related deferred tax asset, if it is deemed realizable.
Stock compensation plans
Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation," encourages all entities to adopt a fair value based method of accounting for employee stock compensation plans, whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. However, it also allows an entity to continue to measure compensation cost for those plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees," whereby compensation cost is the excess, if any, of the quoted market price of the stock at the grant date (or other measurement date) over the amount an employee must pay to acquire the stock. Stock options issued under the Company's stock option plans have no intrinsic value at the grant date, and under Opinion No. 25 no compensation cost is recognized for them.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Stock compensation plans (concluded)
At December 31, 2003, the Company maintains stock-based compensation plans, which are described more fully in Note 16. The Company has elected to continue with the accounting methodology in APB No. 25 and, as a result, has provided pro forma disclosures of net income and earnings per share, as if the fair value based method of accounting had been applied. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
Earnings per common share
Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company related to outstanding stock awards and stock options, and are determined using the treasury stock method.
Earnings per common share have been computed based upon the following:
Employee stock ownership plan ("ESOP")
Compensation expense is recognized as ESOP shares are committed to be released. Allocated and committed to be released ESOP shares are considered outstanding for earnings per share calculations. Other ESOP shares are excluded from earnings per share calculations. Dividends declared on allocated ESOP shares are charged to retained earnings. Dividends declared on unallocated ESOP shares are used to satisfy debt service. The value of unearned shares to be allocated to ESOP participants for future services not yet performed is reflected as a reduction of stockholders' equity.
Stock awards
The fair market value of the stock awards, based on the market price at date of grant, is recorded as unearned compensation. Unearned compensation is amortized over the vesting period. Stock award shares are considered outstanding for basic earnings per share in the period that they vest. Stock award shares not vested are considered in the calculation of diluted earnings per share.
Advertising costs
Advertising costs are charged to earnings when incurred.
Trust assets
Trust assets held in a fiduciary or agent capacity are not included in the accompanying consolidated balance sheets because they are not assets of the Company.
Comprehensive income
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the consolidated balance sheet, such items, along with net income, are components of comprehensive income.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (concluded)
Comprehensive income (concluded)
The components of other comprehensive income and related tax effects are as follows for the years ended December 31, 2003, 2002 and 2001:
Accounting changes
The Company adopted SFAS No. 142, "Goodwill and Other Intangible Assets," effective January 1, 2002. Accordingly, goodwill is no longer subject to amortization over its estimated useful life, but is subject to at least an annual assessment for impairment by applying a fair value based test. Additionally, under SFAS No. 142, acquired intangible assets (such as core deposit intangibles) are separately recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed, rented or exchanged, and amortized over their useful life. Branch acquisition transactions were outside the scope of SFAS No. 142 and, accordingly, intangible assets related to such transactions continued to amortize upon the adoption of SFAS No. 142. On October 31, 2002, the Company adopted SFAS No. 147, "Acquisitions of Certain Financial Institutions." This Statement amends (except for transactions between two or more mutual enterprises) previous interpretive guidance on the application of the purchase method of accounting to acquisitions of financial institutions, and requires the application of SFAS No. 141, "Business Combinations" and SFAS No. 142 to branch acquisitions if such transactions meet the definition of a business combination. This Statement amends SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets," to include in its scope core deposit intangibles of financial institutions. Accordingly, such intangibles are subject to a recoverability test based on undiscounted cash flows, and to the impairment recognition and measurement provisions that are required for other long-lived assets that are held and used.
SFAS No. 141 requires that the Company evaluate its intangible assets and goodwill that were acquired in a prior purchase business combination, and to make any necessary reclassifications in order to conform with the new criteria for recognition apart from goodwill. No reclassifications or adjustments were made as a result of adopting this statement. As required by SFAS No. 142 the Company completed the annual impairment test on goodwill assets and has concluded that the amount of recorded goodwill was not impaired as of December 31, 2003.
Recent accounting pronouncements
In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46), which establishes guidance for determining when an entity should consolidate another entity that meets the definition of a variable interest entity. FIN 46 requires a variable interest entity to be consolidated by a company if that company will absorb a majority of the expected losses, will receive a majority of the expected residual returns, or both. Transferors to qualified special-purpose entities ("QSPEs") and certain other interests in a QSPE are not subject to the requirements of FIN 46. On December 17, 2003, the FASB deferred the effective date of FIN 46 to no later than the end of the first reporting period that ends after March 15, 2004, however, for special-purpose entities the Company would be required to apply FIN 46 as of December 31, 2003. The interpretation had no effect on the Company's consolidated financial statements.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2. RESTRICTIONS ON CASH AND AMOUNTS DUE FROM BANK - --------------------------------------------------------------------------------
The Bank is required to maintain cash reserve balances with the Federal Reserve Bank based upon a percentage of certain deposits. At December 31, 2003 and 2002, cash and due from banks included $1,129,000 and $972,000, respectively, to satisfy such reserve requirements.
3. SHORT-TERM INVESTMENTS - --------------------------------------------------------------------------------
Short-term investments consist of the following at December 31, 2003 and 2002:
2003 2002 ------- ------- (In thousands)
Federal funds sold $ -- $17,000 FHLB overnight deposits 1,859 1,397 BIF Liquidity Fund -- 25,000 ------- ------- $ 1,859 $43,397 ======= =======
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. SECURITIES - --------------------------------------------------------------------------------
The amortized cost and estimated fair value of securities, with gross unrealized gains and losses, follows:
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (continued)
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (continued)
The amortized cost and estimated fair value of debt securities by contractual maturity at December 31, 2003 was as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
At December 31, 2003 and 2002, the Company has pledged securities with an amortized cost of $1,000,000 and $6,032,000, respectively, and a fair value of $1,021,500 and $6,185,000, respectively, as collateral for repurchase agreements, and for its treasury tax and loan account.
For the years ended December 31, 2003, 2002 and 2001, proceeds from the sales of securities available-for-sale amounted to $20,349,000, $28,255,000 and $3,965,000, respectively. Gross realized gains amounted to $3,371,000, $16,111,000 and $440,000, respectively. Gross realized losses amounted to $294,000, $968,000 and $172,000, respectively.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SECURITIES (concluded)
Information pertaining to securities with gross unrealized losses at December 31, 2003, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
At December 31, 2003, two debt securities, representing 0.11% of total assets, have unrealized losses with aggregate depreciation of 25.8% from the Company's amortized cost basis. The unrealized losses are in asset-backed securities that derive their payment of principal and interest from mortgages on manufactured housing. At December 31, 2003, these securities had aggregate investment grade ratings of "A" from nationally recognized rating agencies. Additionally, the market value on the securities has improved since mid-2003.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. LOANS - --------------------------------------------------------------------------------
A summary of the balances of loans follows at December 31, 2003 and 2002:
2003 2002 --------- --------- (In thousands)
One-to four-family mortgage $ 266,753 $ 246,938 Commercial mortgage 154,244 119,198 Multi-family mortgage 15,514 14,920 Construction and land development 34,719 17,627 Home equity lines of credit 45,783 40,713 Consumer 108,180 118,338 Commercial 166,451 165,447 --------- --------- Total loans 791,644 723,181
Allowance for loan losses (8,969) (10,308) Unamortized discount on purchased loans 473 (200) Net deferred loan costs 110 41 --------- ---------
Loans, net $ 783,258 $ 712,714 ========= =========
At December 31, 2003 and 2002, there were no loans held for sale.
An analysis of the allowance for loan losses for the years ended December 31, 2003, 2002 and 2001 follows:
2003 2002 2001 -------- -------- -------- (In thousands)
Balance at beginning of year $ 10,308 $ 11,034 $ 10,216 Provision for loan losses 1,460 6,180 7,175 Loans charged-off (4,364) (10,028) (7,062) Recoveries 1,565 3,122 705 -------- -------- -------- Balance at end of year $ 8,969 $ 10,308 $ 11,034 ======== ======== ========
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
LOANS (concluded)
The following is a summary of information pertaining to impaired and non-accrual loans at December 31, 2003 and 2002:
2003 2002 -------- -------- (In thousands)
Impaired loans with no valuation allowance $ 388 $ 727 Impaired loans with a valuation allowance 1,994 2,123 -------- -------- Total impaired loans $ 2,382 $ 2,850 ======== ======== Specific valuation allowance allocated to impaired loans $ 267 $ 295 ======== ======== Non-accrual loans $ 3,199 $ 3,741 ======== ======== Total loans past due ninety days or more and still accruing $ 306 $ 590 ======== ========
No additional funds are committed to be advanced in connection with impaired loans.
For the years ended December 31, 2003, 2002 and 2001, the average recorded investment in impaired loans amounted to $2,693,000, $2,308,000 and $1,344,000, respectively. The Company recognized $14,000, $85,000 and $14,000, respectively, of interest income on impaired loans, during the period that they were impaired, on the cash basis.
The Bank has sold loans in the secondary market and has retained the servicing responsibility and receives fees for the services provided. Mortgage loans sold and serviced for others amounted to $24,878,000 and $3,702,000 at December 31, 2003 and 2002, respectively, which includes $16,270,000 in securitized mortgages. Consumer loans sold and serviced for others amounted to $7,159,000 and $19,476,000 at December 31, 2003 and 2002, respectively.
Substantially all loans serviced for others were sold without recourse provisions and are not included in the accompanying consolidated balance sheets. However, one commercial participation loan sale during 2002 included recourse provisions amounting to $473,000 and $1,201,000 at December 31, 2003 and 2002. This loan and the recourse provisions are included in the accompanying consolidated balance sheets.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
6. PREMISES AND EQUIPMENT - --------------------------------------------------------------------------------
A summary of the cost and accumulated depreciation and amortization of premises and equipment and their estimated useful lives follows at December 31, 2003 and 2002:
Estimated 2003 2002 Useful Lives -------- -------- ------------ (In thousands)
Banking premises: Land $ 1,558 $ 1,558 Buildings and improvements 18,448 17,848 5-50 years Equipment 11,467 10,948 2-38 years Construction in process 550 203 -------- -------- 32,023 30,557 Accumulated depreciation and amoritization (19,397) (17,290) -------- -------- $ 12,626 $ 13,267 ======== ========
The majority of construction in process in 2003 related to computer conversion costs and renovations to the Great Barrington branch. The Company is expecting additional costs of $262,000 to complete the computer conversion project, of which $155,000 has been committed. Expected and committed costs to complete branch renovations are $958,000.
Construction in process in 2002 includes a renovation project at the West Stockbridge branch. During 2003, this project was completed and costs were transferred to the applicable categories.
Depreciation and amortization expense for the years ended December 31, 2003, 2002 and 2001 amount to $2,107,000, $2,414,000 and $2,081,000, respectively.
7. OTHER ASSETS - --------------------------------------------------------------------------------
Other assets consist of the following at December 31, 2003 and 2002:
2003 2002 ------- ------- (In thousands)
Prepaid dealer reserves $ 3,196 $ 3,517 Repossessed vehicles 352 838 Cash surrender values, life insurance 5,425 4,952 Other 5,107 4,008 ------- -------
Total other assets $14,080 $13,315 ======= =======
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
8. GOODWILL AND OTHER INTANGIBLES - --------------------------------------------------------------------------------
Goodwill and other intangibles include goodwill associated with the acquisition of EastPoint, which is evaluated for impairment on an annual basis. Intangible assets refer to customer relationships acquired in association with the EastPoint purchase, which are being amortized on a straight-line basis over three years as well as the Company's purchase of two branches from another financial institution in 1991 and three branches in 1998. The branch acquisition costs are being evaluated for impairment on an annual basis.
There have been no changes in carrying amounts of goodwill for the years ended December 31, 2003 and 2002. The balance is $4,369,000 for both years.
A summary of other intangible assets at December 31 is as follows:
The amortization expense on other intangible assets amounted to $203,000, $203,000 and $599,000, respectively, for the years ended December 31, 2003, 2002 and 2001. The remaining amortization of customer relationships will be expensed during 2004.
A reconciliation of reported income before income taxes to adjusted income before income taxes excluding the impacts of goodwill amortization for the years ended December 31 are as follows:
2003 2002 2001 -------- -------- -------- (In thousands)
Income before income taxes $ 14,030 $ 2,628 $ 13,260 Add: Goodwill amortization -- -- 228 -------- -------- --------
Adjusted income before income taxes $ 14,030 $ 2,628 $ 13,032 ======== ======== ========
The adoption of SFAS 147 in 2002 resulted in increases to goodwill of $497,000, deferred taxes of $169,000 and $328,000 in retained earnings.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
9. DEPOSITS - --------------------------------------------------------------------------------
A summary of deposit balances, by type, was as follows at December 31, 2003 and 2002:
2003 2002 -------- -------- (In thousands)
Demand $102,788 $ 87,149 NOW 94,606 92,245 Savings 171,139 157,852 Money market 139,897 114,309 Other 464 616 -------- -------- Total non-certificate accounts 508,894 452,171 -------- --------
Term certificates less than $100,000 180,257 194,635 Term certificates of $100,000 or more 141,093 135,554 -------- -------- Total certificate accounts 321,350 330,189 -------- --------
Total deposits $830,244 $782,360 ======== ========
A summary of certificate accounts by maturity is as follows at December 31, 2003 and 2002:
2003 2002 --------------------- ---------------------- Weighted Weighted Average Average Amount Rate Amount Rate --------- --------- --------- --------- (Dollars in thousands)
Within 1 year $ 219,622 2.20% $ 215,199 3.07% Over 1 year to 3 years 55,084 3.61 79,122 4.08 Over 3 years 46,644 5.04 35,868 5.43 --------- ---------
$ 321,350 2.85% $ 330,189 3.57% ========= =========
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
10. FEDERAL HOME LOAN BANK ADVANCES - --------------------------------------------------------------------------------
A summary of outstanding advances from the Federal Home Loan Bank of Boston, by maturity, is as follows at December 31, 2003 and 2002:
2003 2002 ---------------------- ---------------------- Weighted Weighted Average Average Amount Rate Amount Rate --------- --------- --------- --------- (Dollars in thousands) Fixed rate advances maturing: 2003 $ -- --% $ 62,000 1.76% 2004 125,000 1.43 10,000 2.83 2005 17,670 2.68 12,597* 3.02 2006 25,627 2.81 627 5.67 2007 34,397* 3.43 9,000 4.74 2008 5,000 1.25 -- -- 2009 7,000 5.40 7,000 5.40 2010 20,000 5.84 20,000 5.84 2011 10,610 4.47 5,610 4.95 2013 6,000 5.18 6,000 5.19 2022 161* 2.00 168* 2.00 --------- ---------
Total FHLB advances $ 251,465 2.61% $ 133,002 3.27% ========= =========
* Amortizing advances requiring monthly principal and interest payments.
Certain FHLB advances are callable in the amount of $52,000,000 during 2004.
The Bank maintains a line-of-credit with the Federal Home Loan Bank of Boston, which carries interest at a rate that adjusts daily. Borrowings under the line are limited to 2% of the Bank's total assets. All borrowings from the Federal Home Loan Bank of Boston are secured by a blanket lien on certain qualified collateral, defined principally as 75% of the carrying value of certain first mortgage loans on owner-occupied residential property and 90% of the market value of U.S. Government and federal agency securities pledged to the Federal Home Loan Bank. No amounts were outstanding under this line during 2003 and 2002.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
11. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE - --------------------------------------------------------------------------------
Securities sold under agreements to repurchase ("repurchase agreements") are funds borrowed from customers on an overnight basis that are secured by investment securities.
A summary of repurchase agreements was as follows for the years ended December 31, 2003 and 2002:
2003 2002 ------ ------ (Dollars in thousands)
Balance at year end $ -- $ 700 Fair value of securities underlying the agreements at year end -- 2,542 Interest rate on year end balance -- 1.59%
Average amount outstanding during year 88 1,349 Maximum amount outstanding at any month-end 500 1,830 Weighted average interest rate during the year 1.24% 1.72%
The Bank also has a repurchase agreement line of credit with the Depositors Insurance Fund of up to $2.0 million and a $50.0 million repurchase agreement line of credit with a major broker-dealer to be secured by securities or other assets of the Bank. As of December 31, 2003 and 2002, there were no outstanding borrowings against either agreement.
12. INCOME TAXES - --------------------------------------------------------------------------------
Allocation of federal and state income taxes between current and deferred portions is as follows for the years ended December 31, 2003, 2002 and 2001:
2003 2002 2001 -------- -------- -------- (In thousands)
Current tax provision: Federal $ 3,210 $ 644 $ 3,496 State 767 149 245 -------- -------- -------- 3,977 793 3,741 -------- -------- -------- Deferred tax provision (benefit): Federal 848 (171) 531 State 240 (91) 77 -------- -------- -------- 1,088 (262) 608 -------- -------- -------- $ 5,065 $ 531 $ 4,349 ======== ======== ========
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
INCOME TAXES (continued)
The reasons for the differences between the statutory federal income tax rate and the effective tax rates is summarized as follows for the years ended December 31, 2003, 2002 and 2001:
2003 2002 2001 -------- -------- -------- (In thousands)
Statutory tax rate 34.0% 34.0% 34.0% Increase (decrease) resulting from: State taxes, net of federal tax benefit 4.7 1.5 1.6 Dividends received deduction (1.1) (8.1) (1.9) Tax exempt income (0.9) (6.1) (1.0) Other, net (0.6) (1.1) 0.1 -------- -------- --------
Effective tax rate 36.1% 20.2% 32.8% ======== ======== ========
The components of the net deferred tax assets are as follows at December 31, 2003 and 2002:
2003 2002 -------- -------- (In thousands)
Deferred tax liability: Federal $ 3,879 $ 3,587 State 419 1,098 -------- -------- 4,298 4,685 -------- --------
Deferred tax asset: Federal (4,789) (5,332) State (1,234) (1,369) -------- -------- (6,023) (6,701) -------- --------
Net deferred tax asset $ (1,725) $ (2,016) ======== ========
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
INCOME TAXES (concluded)
The tax effects of each type of income and expense item that give rise to deferred taxes are as follows at December 31, 2003 and 2002:
2003 2002 -------- -------- (In thousands) Investments: Net unrealized gain on securities available for sale $ 2,963 $ 3,760 Other 350 164 Depreciation 7 (9) Allowance for loan losses (3,671) (3,999) Employee benefit plans (1,000) (732) Charitable contribution carryover (824) (1,219) Other 450 19 -------- --------
Net deferred tax asset $ (1,725) $ (2,016) ======== ========
A summary of the change in the net deferred tax (asset) liability was as follows for the years ended December 31, 2003, 2002 and 2001:
There is a contribution carryover that was generated during the year ended 2000, which expires in 2005. Management believes that the deferred tax assets related to this contribution carryover and other deductible temporary differences will be realized. As a result, no valuation reserve has been established at December 31, 2003, December 31, 2002 or December 31, 2001.
The federal income tax reserve for loan losses at the Bank's base year is $844,000. If any portion of the reserve is used for purposes other than to absorb the losses for which established, approximately 150% of the amount actually used (limited to the amount of the reserve) would be subject to taxation in the year in which used. As the Bank intends to use the reserve only to absorb loan losses, a deferred income tax liability of $346,000 has not been provided.
In June 2003, the Company reached a settlement with the Massachusetts Department of Revenue ("DOR") with respect to the DOR's tax assessment resulting from the DOR's disallowance of the Company's deduction of certain dividend distributions received by the Bank from its Real Estate Investment Trust majority-owned subsidiary Gold Leaf Capital Corporation (the "REIT"). As a result, the Company paid approximately $398,000 to the DOR representing one-half of the assessment plus interest and obtained the DOR's release from liability for the remaining half assessed. The Company dissolved the REIT during the third quarter of 2003.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
13. OFF-BALANCE SHEET ACTIVITIES - --------------------------------------------------------------------------------
In the normal course of business, there are outstanding commitments and contingencies that are not reflected in the accompanying consolidated financial statements.
Credit related financial instruments
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the accompanying consolidated balance sheets.
The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument is represented by the contractual amount of these commitments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments. A summary of financial instruments outstanding whose contract amounts represent credit risk was as follows at December 31, 2003 and 2002:
2003 2002 -------- -------- (In thousands)
Commitments to grant loans $ 26,854 $ 30,815 Unused funds on commercial lines-of-credit 49,380 47,900 Unadvanced funds on home equity and reddi-cash lines of credit 46,904 42,671 Unadvanced funds on construction loans 18,069 19,161 Standby letters of credit 1,811 1,894
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's credit worthiness on a case-by-case basis. Funds to be disbursed for loans and home equity lines of credit are collateralized by real estate. Commercial lines of credit are generally secured by business assets and securities. Reddi-cash lines of credit are unsecured.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. These letters of credit are primarily issued to support borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
OFF-BALANCE SHEET ACTIVITIES (concluded)
Operating lease commitments
Pursuant to the terms of noncancelable lease agreements in effect at December 31, 2003, pertaining to premises and equipment, future minimum rent commitments are as follows:
Years Ending December 31, (In thousands) ------------
2004 $ 474 2005 428 2006 353 2007 353 2008 352 Thereafter 2,830 -------
$ 4,790 =======
The leases contain options to extend for periods up to twenty years. The cost of such rental options is not included above. Total rent expense for the years ended December 31, 2003, 2002 and 2001 amounted to $371,000, $391,000 and $375,000, respectively.
Employment and change in control agreements
The Company and the Bank have each entered into an employment agreement with one senior executive that generally provides for a specified minimum annual compensation, participation in stock benefit plans and the continuation of benefits currently received. The original terms of the agreements are for three years and automatically extend unless either party gives notice to the contrary. However, such agreements may be terminated for cause, as defined, without incurring any continuing obligations.
The Bank has also entered into change in control agreements with certain officers, all of whom are not covered by an employment agreement. The change in control agreements generally provide a severance payment if the officer is terminated following a "change in control," as defined in the agreements.
Legal claims
Various legal claims also arise from time to time in the normal course of business which, in the opinion of management, will have no material effect on the Company's consolidated financial statements.
Mortgage securitization
On December 2, 2003, the Company entered into an agreement to securitize mortgages with Fannie Mae in the aggregate of $55,900,000, plus or minus 5% of total principal balance, which would be securitized and transferred back to the Company. At December 31, 2003, the Company had an outstanding commitment to securitize mortgage loans under the agreement of $39,600,000.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
14. STOCKHOLDERS' EQUITY - --------------------------------------------------------------------------------
Minimum regulatory capital requirements
The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's and the Bank's consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting, and other factors. Prompt corrective action provisions are not applicable to savings and loan holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital to average assets (as defined). Management believes, as of December 31, 2003 and 2002, that the Bank met the capital adequacy requirements.
As of December 31, 2003, Berkshire Bank met the conditions to be classified as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following tables.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCKHOLDERS' EQUITY (continued)
The Company and Bank's actual capital amounts and ratios as of December 31, 2003 and 2002 are presented in the following table.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCKHOLDERS' EQUITY (concluded)
Minimum regulatory capital requirements (concluded)
Common stock
On March 28, 2001, the Board of Directors approved a dividend reinvestment plan and authorized its implementation. The plan, which is available to all shareholders of record of the Company's common stock, permits the reinvestment of all cash dividends, the deposit of shares for safekeeping and the sale and gifting of shares held under the plan. Common shares purchased pursuant to this plan were 7,504 shares. All shares are purchased in open market transactions.
During 2002 and 2001, the Company repurchased approximately 312,516 and 1,249,000 shares of outstanding common stock. The Company announced in July 2003 that its Board of Directors approved a sixth repurchase program for 298,886 shares, or 5%, of its outstanding common stock and at December 31, 2003, the Company had 186,186 shares remaining to be purchased in the latest 5% repurchase. During 2003, a total of 112,700 shares were repurchased relating to the sixth stock repurchase program.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
15. EMPLOYEE BENEFIT PLANS - --------------------------------------------------------------------------------
Defined benefit pension plan
The Company terminated its defined benefit pension plan, effective February 24, 2001. During the second quarter of 2001, the Company recorded a loss of $168,000 from the curtailment of its defined benefit pension plan. The final plan settlement was approved by the IRS in the fourth quarter of 2001. The settlement gain was $2,341,000.
Defined contribution pension plan
The Company has a qualified savings plan under Section 401(k) of the Internal Revenue Code. Each employee reaching the age of 21 and having completed at least 1,000 hours of service in a twelve-month period, beginning with such employee's date of employment, automatically becomes a participant in the 401(k) Plan. Employees may contribute a portion of their compensation subject to certain limits based on federal tax laws. The Company made matching contributions which amounted to $603,000, $640,000 and $528,000, respectively, for the years ended December 31, 2003, 2002 and 2001.
Supplemental executive retirement plan
The Company has a nonqualified supplemental executive retirement plan for the benefit of a certain senior executive. Benefits generally commence no earlier than age sixty and continue for the life of the senior executive. As of December 31, 2003 and 2002, the Company has an accrued expense payable in the amount of $1,007,000 and $760,000, respectively, representing the present value of future payments under the supplemental retirement plan. Supplemental retirement expense for this plan for the year ended December 31, 2003, was $247,000. There was no expense for the years ended December 31, 2002 and 2001. In some instances, the Company has also entered into split-dollar life insurance agreements with senior executives to provide supplemental retirement benefits.
Incentive plan
The Company has an incentive plan (the "Plan") whereby all management and staff members are eligible to receive a bonus, tied to performance. The structure of the Plan is to be reviewed on an annual basis by the Corporate Governance Committee. The Plan year end is December 31. Incentive compensation expense for the years ended December 31, 2003, 2002 and 2001 amounted to $925,000, $620,000 and $600,000, respectively.
Other benefits
The Company has in the past offered its retirees optional medical insurance coverage. All participating retirees are required to contribute in part to the cost of this coverage. The retiree medical plan was terminated on December 31, 1996. Any retiree participating in the plan at that time will continue to be covered for life, however, no new retirees can participate in this plan. At December 31, 2003 and 2002, the Company had an accrued liability in the amount of $428,000 and $487,000, respectively, for payment of future premiums under this plan.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
16. STOCK-BASED INCENTIVE PLAN AND EMPLOYEE STOCK OWNERSHIP PLAN - --------------------------------------------------------------------------------
Stock options
Under the Company's Stock-Based Incentive Plan, the Company may grant options to its directors, officers and employees for up to 767,366 shares of common stock. Both incentive stock options and non-statutory stock options may be granted under the plan. The exercise price of each option equals the market price of the Company's stock on the date of grant and an option's maximum term is ten years. Options vest at 20% per year. In 2003, the Company's shareholders approved the 2003 Equity Compensation Plan. Under this Plan the Company may grant up to 300,000 options or stock awards to its directors, officers and employees. No options or awards were granted under this Plan in 2003.
A summary of the status of the Company's stock options for the years ended December 31, 2003, 2002 and 2001 are presented below:
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCK-BASED INCENTIVE PLAN AND EMPLOYEE STOCK OWNERSHIP PLAN (continued)
Stock options (concluded)
The fair value of each option grant is estimated on the date of grant using the Modified Roll Geske option-pricing model with the following weighted-average assumptions:
Years Ended December 31, ------------------------- 2003 2001 -------- --------
Dividend yield 1.85% 2.12% Expected life in years 10 years 10 years Expected volatility 20.34% 18.01% Risk-free interest rate 3.85% 5.12%
No options were granted during the year ended December 31, 2002.
Information pertaining to options outstanding at December 31, 2003 are as follows:
Options Outstanding Options Exercisable -------------------------- ------------------------- Weighted Average Weighted Remaining Average Number Contractual Number Exercise Grant Period Outstanding Life Exercisable Price - -------------------------- ----------- ----------- ----------- 2001 529,784 7.08 years 189,081 $ 16.75 2003 120,143 9.10 years -- 22.44
Stock awards
Under the Company's Stock-Based Incentive Plan, the Company may grant stock awards to its directors, officers and employees for up to 306,950 shares of common stock. The Company applies APB Opinion No. 25 and related Interpretations in accounting for stock awards. The stock awards vest at 20% per year. The fair market value of the stock allocations, based on the market price at date of grant, is recorded as unearned compensation. Unearned compensation is amortized over the periods to be benefited. The Company recorded compensation cost related to the stock awards of approximately $1,066,000, $1,165,000 and $1,000,000 in 2003, 2002 and 2001, respectively.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCK-BASED INCENTIVE PLAN AND EMPLOYEE STOCK OWNERSHIP PLAN (continued)
Stock awards (concluded)
A summary of the status of the Company's stock awards is presented below:
Employee Stock Ownership Plan
The Bank has established an Employee Stock Ownership Plan (the "ESOP") for the benefit of each employee that has reached the age of 21 and has completed at least 1,000 hours of service in the previous twelve-month period. As part of the conversion, Berkshire Hills Funding Corporation provided a loan to the Berkshire Bank Employee Stock Ownership Plan Trust which was used to purchase 8%, or 613,900 shares, of the Company's outstanding stock in the open market. The loan bears interest equal to 9.5% and provides for quarterly payments of interest and principal.
At December 31, 2003, the remaining principal balance is payable as follows:
Years Ending December 31, (In thousands) ------------
2004 $ 294 2005 325 2006 356 2007 392 2008 429 Thereafter 4,458 -------
$ 6,254 =======
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
STOCK-BASED INCENTIVE PLAN AND EMPLOYEE STOCK OWNERSHIP PLAN (concluded)
Employee Stock Ownership Plan (concluded)
The Bank has committed to make contributions to the ESOP sufficient to support the debt service of the loan. The loan is secured by the shares purchased, which are held in a suspense account for allocation among the participants as the loan is paid. Total compensation expense applicable to the ESOP amounted to $1,094,000, $887,000 and $773,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
Shares held by the ESOP include the following at December 31, 2003 and 2002:
2003 2002 ---------- ----------
Allocated 114,188 83,954 Committed to be allocated 37,853 37,853 Unallocated 454,240 492,093 ---------- ----------
606,281 613,900 ========== ==========
Cash dividends received on allocated shares are allocated to participants and cash dividends received on shares held in suspense are applied to repay the outstanding debt of the ESOP. The fair value of these shares was approximately $16,443,000 and $11,589,000 at December 31, 2003 and 2002, respectively.
17. RELATED PARTY TRANSACTIONS - --------------------------------------------------------------------------------
In the ordinary course of business, the Company has granted loans to directors and officers and their affiliates. All loans and commitments included in such transactions were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons. All loans to directors and officers of the Company and their affiliates are performing in accordance with the contractual terms of the loans as of December 31, 2003.
An analysis of activity of such loans that aggregate more than $60,000 on an individual basis to directors and executive officers of the Company and their affiliates is as follows:
Years Ended December 31, --------------------------- 2003 2002 ---------- ---------- (In thousands)
Balance at beginning of year $ 5,740 $ 6,089 Additions 1,127 658 Repayments (4,662) (1,007) ---------- ----------
Balance at end of year $ 2,205 $ 5,740 ========== ==========
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
18. RESTRICTIONS ON DIVIDENDS, LOANS AND ADVANCES - --------------------------------------------------------------------------------
Federal and state banking regulations place certain restrictions on dividends paid and loans or advances made by the Bank to the Company. The total amount of dividends which may be paid at any date is generally limited to the retained earnings of the Bank, and loans or advances are limited to 10% of the Bank's capital stock and surplus on a secured basis.
At December 31, 2003 and 2002, the Bank's retained earnings available for the payment of dividends was $67,827,000 and $61,544,000, respectively, and funds available for loans or advances amounted to $10,656,000 and $10,426,000, respectively.
In addition, dividends paid by the Bank to the Company would be prohibited if the effect thereof would cause the Bank's capital to be reduced below applicable minimum regulatory capital requirements.
In conjunction with Massachusetts conversion regulations, the Bank established a liquidation account for eligible account holders, which at the time of conversion amounted to approximately $70 million. In the event of a liquidation of the Bank, the eligible account holders will be entitled to receive their pro-rata share of the net worth of the Bank prior to conversion. However, as qualifying deposits are reduced, the liquidation account will also be reduced in an amount proportionate to the reduction in the qualifying deposit accounts.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
19. FAIR VALUE OF FINANCIAL INSTRUMENTS - --------------------------------------------------------------------------------
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company's various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS 107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.
The following methods and assumptions were used by the Company in estimating fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts of these instruments approximate fair values.
Securities: Fair values for securities, excluding FHLB and SBLI stock, are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. The carrying value of FHLB stock approximates fair value based on the redemption provisions of the Federal Home Loan Bank and SBLI stock was recorded at fair value at acquisition as determined by an appraisal performed by independent investment consultants retained by SBLI.
Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for all other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.
Deposits: The fair values for non-certificate accounts and tax escrow are, by definition, equal to the amount payable on demand at the reporting date which is their carrying amounts. Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Federal Home Loan Bank advances: The fair values of Federal Home Loan Bank advances are estimated using discounted cash flow analyses based on the Bank's current incremental borrowing rates for similar types of borrowing arrangements.
Securities sold under agreements to repurchase: The carrying amount of repurchase agreements approximates fair value. Repurchase agreements generally mature or "roll over" on a daily basis.
Accrued interest: The carrying amounts of accrued interest approximate fair value.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
FAIR VALUE OF FINANCIAL INSTRUMENTS (concluded)
Off-balance-sheet instruments: Fair values for off-balance-sheet lending commitments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The fair values of off-balance sheet instruments are immaterial.
The carrying amounts and estimated fair values of the Company's financial instruments are as follows at December 31, 2003 and 2002:
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
20. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY - --------------------------------------------------------------------------------
Condensed financial information pertaining only to the parent company, Berkshire Hills Bancorp, Inc., is as follows:
CONDENSED BALANCE SHEETS
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (continued)
CONDENSED STATEMENTS OF INCOME
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY (concluded)
CONDENSED STATEMENTS OF CASH FLOWS
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
21. SEGMENT REPORTING - --------------------------------------------------------------------------------
The Company has one reportable segment, the Bank, and two operating segments, the Bank and Berkshire Hills Technology, Inc. Each segment is described in Note 1 under business.
Information about reportable segments, and reconciliation of such information to the consolidated financial statements as of and for the years ended December 31, follows:
The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on profit or loss from operations before income taxes not including nonrecurring gains or losses.
The Company's operating segments are strategic business units that offer different products and services. They are managed separately because each segment appeals to different markets and, accordingly, requires different technology and marketing strategies.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
SEGMENT REPORTING (concluded)
The Company derives a majority of its revenues from interest income and licensing fees and the chief operating decision maker relies primarily on net interest revenue and licensing fees to assess the performance of the segments and make decisions about resources to be allocated to the segment. Therefore, the segments are reported using net interest income and licensing fees for the years ended December 31. The Company does not allocate income taxes to the segments.
The Company does not have a single external customer from which it derives 10 percent or more of its revenues and operates in one geographical area.
22. QUARTERLY DATA (UNAUDITED) - --------------------------------------------------------------------------------
Quarterly results of operations for the years ended December 31, 2003 and 2002 are as follows:
Note: (1) The decrease in the fourth quarter 2003 other income was due to the loss on the sale of sub-prime automobile loans.
(2) The increase in the fourth quarter 2002 operating expenses was primarily due to severance expenses, funding of the retirement plan benefit for directors and the write-down in value of repossessed automobiles.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - --------------------------------------------------------------------------------
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES - --------------------------------------------------------------------------------
The Company's management, including the Company's principal executive officer and principal financial officer, have evaluated the effectiveness of the Company's "disclosure controls and procedures," as such term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the "Exchange Act"). Based upon their evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, the Company's disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the "SEC") (1) is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and (2) is accumulated and communicated to the Company's management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. In addition, based on that evaluation, no change in the Company's internal control over financial reporting occurred during the quarter ended December 31, 2003 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - --------------------------------------------------------------------------------
For information concerning the directors of the Company, the information contained under the sections captioned "Proposal 1 -- Election of Directors" in Berkshire Hills' Proxy Statement for the 2004 Annual Meeting of Stockholders is incorporated by reference. For information concerning officers of the Company, reference is made to Part I, Item 1A, "Business--Executive Officers of the Registrant" in this report. Reference is made to the cover page of this report and to the section captioned "Section 16(a) Beneficial Ownership Reporting Compliance" in the Proxy Statement for information regarding compliance with Section 16(a) of the Exchange Act. For information concerning the audit committee financial expert, reference is made to the section captioned "Corporate Governance - Committees of the Board of Directors - Audit Committee" in the Proxy Statement.
For information concerning the Company's code of ethics, the information contained under the section captioned "Corporate Governance - Code of Business Conduct" in the Proxy Statement is incorporated by reference. A copy of the Company's code of ethics is available to stockholders on the Company's website at "www.berkshirebank.com."
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION - --------------------------------------------------------------------------------
The information contained under the sections captioned "Executive Compensation" and "Directors Compensation" in the Proxy Statement is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS - --------------------------------------------------------------------------------
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference to the section captioned "Stock Ownership" in the Proxy Statement.
(b) Security Ownership of Management
Information required by this item is incorporated herein by reference to the section captioned "Stock Ownership" in the Proxy Statement.
(c) Management of Berkshire Hills knows of no arrangements, including any pledge by any person of securities of Berkshire Hills, the operation of which may at a subsequent date result in a change in control of the registrant.
(d) Equity Compensation Plan Information
The following table sets forth information, as of December 31, 2003, about Company common stock that may be issued upon exercise of options under the Berkshire Hills Bancorp, Inc. 2001 Stock-Based Incentive Plan and the Berkshire Hills Bancorp, Inc. 2003 Equity Compensation Plan. Each of the plans was approved by the Company's stockholders.
ITEM 13.
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.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES - --------------------------------------------------------------------------------
The information required by this item is incorporated herein by reference to the section captioned "Proposal 2 - Ratification of Independent Auditors" in the Proxy Statement.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. - --------------------------------------------------------------------------------
(a) [1] Financial Statements
o Independent Auditors' Report
o Consolidated Balance Sheets as of December 31, 2003 and
o Consolidated Statements of Income for the Years Ended December 31, 2003, 2002 and 2001
o Consolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 2003, 2002 and
o Consolidated Statements of Cash Flows for the Years Ended December 31, 2003, 2002 and 2001
o Notes to Consolidated Financial Statements
[2] Financial Statement Schedules
All financial statement schedules are omitted because they are not required or applicable. The required information is shown in the consolidated financial statements or the notes thereto.
[3] Exhibits
3.1 Certificate of Incorporation of Berkshire Hills Bancorp, Inc.(1)
3.2 Bylaws of Berkshire Hills Bancorp, Inc.
4.0 Draft Stock Certificate of Berkshire Hills Bancorp, Inc.(1)
10.1 Employment Agreement between Berkshire Bank and Michael P. Daly (2)
10.2 Employment Agreement between Berkshire Hills Bancorp, Inc. and Michael P. Daly (2)
10.3 Severance Agreement, dated October 16, 2002, by and among James A. Cunningham, Jr., Berkshire Hills Bancorp, Inc. and Berkshire Bank (3)
10.4 Severance Agreement, dated November 13, 2002, by and among Charles F. Plungis, Jr., Berkshire Hills Bancorp, Inc. and Berkshire Bank (4)
10.5 Severance Agreement, dated November 13, 2002, by and among Susan M. Santora, Berkshire Hills Bancorp, Inc. and Berkshire Bank (4)
10.6 Change in Control Agreement between Berkshire Bank and Gayle P. Fawcett
10.7 Change in Control Agreement between Berkshire Hills Bancorp, Inc. and Gayle P. Fawcett
10.8 Change in Control Agreement between Berkshire Bank and Wayne F. Patenaude
10.9 Change in Control Agreement between Berkshire Hills Bancorp, Inc. and Wayne F. Patenaude
10.10 Supplemental Executive Retirement Agreement between Berkshire Bank and Michael P. Daly
10.11 Berkshire Hills Bancorp, Inc. 2003 Equity Compensation Plan(5)
10.12 Letter Agreement, dated June 26, 2003, by and among Berkshire Hills Bancorp, Inc., Berkshire Bank and Robert A. Wells(2)
10.13 Form of Berkshire Bank Employee Severance Compensation Plan(1)
10.14 Form of Berkshire Bank Supplemental Executive Retirement Plan(1)
10.15 Berkshire Hills Bancorp, Inc. 2001 Stock-Based Incentive Plan(6)
10.16 Retirement Agreement, dated December 4, 2003, by and among Berkshire Hills Bancorp, Inc., Berkshire Bank and Robert A. Wells
11.0 Statement re: Computation of Per Share Earnings
21.0 Subsidiary Information is incorporated herein by reference to Part I, Item 1, "Business - Subsidiary Activities"
23.0 Consent of Wolf & Company, P.C.
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32.1 Section 1350 Certification of Chief Executive Officer
32.2 Section 1350 Certification of Chief Financial Officer
- -----------------------------------------------
(1) Incorporated herein by reference into this document from the Exhibits to Form S-1, Registration Statement and amendments thereto, initially filed on March 10, 2000, Registration No. 333-32146.
(2) Incorporated herein by reference into this document from the Exhibits to the Form 10-Q as filed on August 13, 2003.
(3) Incorporated herein by reference into this document from the Exhibits to the Form 10-K as filed on March 29, 2001.
(4) Incorporated herein by reference into this document from the Exhibits to the Form 10-Q as filed on November 14, 2003.
(5) Incorporated herein by reference into this document from the Appendix to the Proxy Statement as filed on March 27, 2003.
(6) Incorporated herein by reference into this document from the Appendix to the Proxy Statement as filed on December 7, 2000.
(b) Reports on Form 8-K
On October 15, 2003, the Company filed a Form 8-K in which it announced under Item 5 that it expected to issue its third quarter earnings release on October 22, 2003. The Company announced that it would conduct a conference call at 10:00 a.m. on October 23, 2003 to discuss third quarter results. Instructions on how to access the call and an investor presentation that supplemented the call were contained in the press release. The press release announcing this conference call was attached by exhibit.
On October 23, 2003, the Company furnished a Form 8-K in which it announced under Item 12 its financial results for the quarter ended September 30, 2003. The press release announcing financial results for the quarter ended September 30, 2003 was attached by exhibit.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Berkshire Hills Bancorp, Inc.
Date: February 26, 2004 By: /s/ Michael P. Daly ------------------------------------- Michael P. Daly President, Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.