UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 0-13649
Berkshire Bancorp Inc.
(Exact name of registrant as specified in its charter)
Delaware 94-2563513
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
160 Broadway, New York, New York 10038
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 791-5362
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.10 per share
(Title of Class)
Indicate by check mark if the Registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the Registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the Registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. (See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the
Exchange Act.) Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [X]
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Act. Yes [ ] No [X]
Aggregate market value of voting and non-voting common stock held by
non-affiliates of the Registrant as of June 30, 2005: $54,923,612.
Number of shares of Common Stock outstanding as of February 20, 2006: 6,890,556.
DOCUMENTS INCORPORATED BY REFERENCE:
None
Forward-Looking Statements. Statements in this Annual Report on Form 10-K that
are not based on historical fact may be "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Words such as
"believe", "may", "will", "expect", "estimate", "anticipate", "continue" or
similar terms identify forward-looking statements. A wide variety of factors
could cause the Company's actual results and experiences to differ materially
from the results expressed or implied by the Company's forward-looking
statements. Some of the risks and uncertainties that may affect operations,
performance, results of the Company's business, the interest rate sensitivity of
its assets and liabilities, and the adequacy of its loan loss allowance,
include, but are not limited to: (i) deterioration in local, regional, national
or global economic conditions which could result, among other things, in an
increase in loan delinquencies, a decrease in property values, or a change in
the housing turnover rate; (ii) changes in market interest rates or changes in
the speed at which market interest rates change; (iii) changes in laws and
regulations affecting the financial services industry; (iv) changes in
competition; (v) changes in consumer preferences; (vi) changes in banking
technology; (vii) ability to maintain key members of management; (viii) possible
disruptions in the Company's operations at its banking facilities; (ix) cost of
compliance with new corporate governance requirements; and other factors
referred to in the sections of this Annual Report entitled "Business" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Certain information customarily disclosed by financial institutions,
such as estimates of interest rate sensitivity and the adequacy of the loan loss
allowance, are inherently forward-looking statements because, by their nature,
they represent attempts to estimate what will occur in the future.
The Company cautions readers not to place undue reliance upon any
forward- looking statement contained in this Annual Report. Forward-looking
statements speak only as of the date they were made and the Company assumes no
obligation to update or revise any such statements upon any change in applicable
circumstances.
PART I
ITEM 1. Business
General. Berkshire Bancorp Inc., a Delaware corporation , is a bank
holding company registered under the Bank Holding Company Act of 1956. As used
in this Annual Report on Form 10-K, the term "Berkshire", the "Company" or "we"
and similar pronouns shall mean Berkshire Bancorp Inc. and its consolidated
subsidiaries unless the context otherwise requires. Berkshire's principal
activity is the ownership and management of its wholly-owned banking subsidiary,
The Berkshire Bank (the "Bank"), a New York State chartered commercial bank.
We file annual, quarterly and current reports, proxy statements and
other information with the Securities and Exchange Commission (the "SEC"). You
may read and copy our reports or other filings made with the SEC at the SEC's
Public Reference Room, located at 450 Fifth Street, N.W., Washington, DC 20549.
You can also access information that we file electronically on the SEC's website
at WWW.SEC.GOV.
We do not presently have a website. However, as soon as practicable
after filing with or furnishing to the SEC, we will provide at no cost, paper or
electronic copies of our Annual Reports on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K and amendments to those reports. Requests
should be directed to:
Berkshire Bancorp Inc.
Investor Relations
160 Broadway
New York, NY 10038
2
Stock Split and Stock Dividend. At the Annual Meeting of Stockholders
held on May 18, 2004, the Company's stockholders approved an amendment to the
Company's Certificate of Incorporation effecting a one-for-ten reverse stock
split of the Company's issued and outstanding Common Stock (the "Reverse
Split"). Following the effectiveness of the Reverse Split, the Company's Board
of Directors declared a thirty-for-one forward stock split in the form of a
stock dividend in Common Stock (the "Stock Dividend) which became effective
immediately. The Company paid approximately $463,000 to purchase fractional
shares from stockholders as part of the Reverse Split. The Company's Common
Stock began trading on May 19, 2004 giving effect to these transactions.
Trust Preferred Securities. As of May 18 2004, the Company established
Berkshire Capital Trust I, a Delaware statutory trust, ("BCTI"). The Company
owns all the common capital securities of BCTI. BCTI issued $15.0 million of
preferred capital securities to investors in a private transaction and invested
the proceeds, combined with the proceeds from the sale of BCTI's common capital
securities, in the Company through the purchase of $15.464 million aggregate
principal amount of Floating Rate Junior Subordinated Debentures (the
"Debentures") issued by the Company. The Debentures, the sole assets of BCTI,
mature on July 23, 2034 and bear interest at a floating rate, three month LIBOR
plus 2.70%.
On April 1, 2005, the Company established Berkshire Capital Trust II, a
Delaware statutory trust, ("BCTII"). The Company owns all the common capital
securities of BCTII. BCTII issued $7.0 million of preferred capital securities
to investors in a private transaction and invested the proceeds, combined with
the proceeds from the sale of BCTII's common capital securities, in the Company
through the purchase of $7.217 million aggregate principal amount of Floating
Rate Junior Subordinated Debentures (the "2005 Debentures") issued by the
Company. The 2005 Debentures, the sole assets of BCTII, mature on May 23, 2035
and bear interest at a floating rate, three month LIBOR plus 1.95%. See Note A
of Notes to Consolidated Financial Statements for further discussion of Trust
Preferred Securities.
Business of the Bank - General. The Bank's principal business consists
of gathering deposits from the general public and investing those deposits
primarily in loans, debt obligations issued by the U.S. Government and its
agencies, debt obligations of business corporations, and mortgage-backed
securities. The Bank currently operates from six deposit-taking offices in New
York City and four deposit-taking offices in Orange and Sullivan Counties, New
York.
Branch Locations of The Berkshire Bank
December 31, 2005
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4 East 39th Street 2 South Church Street
New York, NY Goshen, NY
5 Broadway 214 Harriman Drive
New York, NY Goshen, NY
5010 13th Avenue 80 Route 17M
Brooklyn, NY Harriman, NY
1421 Kings Highway 60 Main Street
Brooklyn, NY Bloomingburg, NY
4917 16th Avenue 1119 Avenue J
Brooklyn, NY Brooklyn, NY
In September 2005, the Bank entered into a Branch Purchase and Deposit
Assumption Agreement (the "Agreement") with the Oritani Savings Bank
("Oritani"), a New Jersey Chartered Savings Bank. Pursuant to the Agreement, the
Bank will (i) assume certain commercial checking account deposit liabilities and
(ii) purchase certain fixed assets and the real property of this Oritani bank
branch located in Ridgefield, New Jersey for a cash purchase price of $850,000.
Upon the closing of the transaction, which has received all of the required
regulatory approvals, among other things, the Bank intends to open a branch of
The Berkshire Bank at the Ridgefield, New Jersey location in May 2006.
3
In August 2005, the Bank formed Berkshire 1031 Exchange, LLC
("Berkshire 1031"), a wholly owned limited liability company. Berkshire 1031
will act as a qualified intermediary in connection with tax free exchanges under
Section 1031 of the Internal Revenue Code of 1986, as amended. A qualified
intermediary is an individual or business entity that assists owners of property
who wish to exchange their property for property of a "like-kind" in a
transaction that is tax free in whole or part for federal (and in some cases
state) income tax purposes. In accordance with detailed procedures set forth in
federal income tax regulations, Berkshire 1031 will assist the owner in the sale
of the owner's property and the purchase of replacement property so that the
transaction qualifies as a non-taxable exchange of property.
The Bank's principal loan types are residential and commercial mortgage
loans and commercial non-mortgage loans, both unsecured and secured by personal
property. The Bank's revenues come principally from interest on loans and
investment securities. The Bank's primary sources of funds are deposits and
proceeds from principal and interest payments on loans and investment
securities.
Operating Plan. The Bank's operating plan concentrates on obtaining
deposits from a variety of businesses, professionals and retail customers and
investing those funds in conservatively underwritten loans. Due to the Bank's
underwriting criteria, its deposits have significantly exceeded the level of
satisfactory loans available for investment in recent years. Hence, the Bank
has, in recent years, invested a portion of its available funds in investment
and mortgage-backed securities.
Market Area. The Bank draws its customers principally from the New York
City metropolitan area and, since the merger with Goshen Savings Bank ("Goshen
Bank") in 2001, the Villages of Goshen and Harriman, New York and their
surrounding communities, representing most of Orange County, NY. The Bank also
has a branch in Bloomingburg, New York, just over the border between Orange and
Sullivan Counties. Predominantly rural with numerous small towns, many residents
of Orange and Sullivan Counties work in New York City. Consequently, the health
of the economy in the New York City metropolitan area has, and will continue to
have a direct effect on the economic well being of residents and businesses in
these counties. Upon the completion of the transaction with Oritani, the Bank's
market area will expand into northern New Jersey. From time to time, the Bank
may make loans or accept deposits from outside these areas, but such
transactions generally represent outgrowths of existing local customer
relationships.
Competition. The Bank's principal competitors for deposits are other
commercial banks, savings banks, savings and loan associations and credit unions
in the Bank's market areas, as well as money market mutual funds, insurance
companies, securities brokerage firms and other financial institutions, many of
which are substantially larger in size than the Company. The Bank's competition
for loans comes principally from commercial banks, savings banks, savings and
loan associations, mortgage bankers, finance companies and other institutional
lenders. Many of the institutions which compete with the Bank have much greater
financial and marketing resources than the Bank. The Bank's principal methods of
competition include loan and deposit pricing, maintaining close ties with its
local communities, the quality of the personal service it provides, the types of
business services it provides, and other marketing programs.
Operations of the Bank. Reference is made to the information set forth
in Item 7 herein ("Management's Discussion and Analysis of Financial Condition
and Results of Operations") for information as to various aspects of the Bank's
operations, activities and conditions.
In March, 2001, pursuant to the terms of an Agreement and Plan of
Reorganization dated August 16, 2000 (the "GSB Agreement"), we completed the
merger with GSB Financial Corporation, a Delaware corporation, a savings and
loan holding company ("GSB Financial"), and its wholly-owned subsidiary, Goshen
Bank, a federal savings bank, chartered and existing under the laws of the
United States. GSB Financial was merged with and into Berkshire and Goshen Bank
was merged with and into The Berkshire Bank. Holders of the common stock of GSB
Financial received $20.75 in cash for each share of common stock of GSB
Financial held by them, or, in the alternative, at their election, 0.6027 shares
of Berkshire's common stock. As a result of this transaction, 978,032 shares of
GSB Financial common stock were converted into 589,460 shares of Berkshire
common
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stock, and 974,338 shares of GSB Financial common stock were purchased for
$20.75 per share, totaling approximately $20.2 million.
This transaction was accounted for under the purchase method of
accounting. Goodwill of $7.5 million was recorded in the transaction. Effective
January 1, 2002, we adopted Statement of Financial Accounting Standard No. 142,
Goodwill and Intangible Assets which eliminates the amortization of goodwill and
requires an annual impairment test. As of December 31, 2005, we have completed
the impairment testing of our intangible assets, including goodwill. We did not
identify any impairment on our outstanding goodwill.
Subsidiary Activities. The Bank is permitted under New York State law
and federal law to own subsidiaries for certain limited purposes, generally to
engage in activities which are permissible for a subsidiary of a national bank.
The Bank has two subsidiaries, Berkshire Agency, Inc., a company engaged in the
title insurance agency business, and Berkshire 1031, a company that acts as a
qualified intermediary in connection with tax free exchanges under Section 1031
of the Internal Revenue Service Code.
Regulation. Berkshire is a bank holding company under federal law and
registered as such with the Federal Reserve. The Bank is a commercial bank
chartered under the laws of New York State. It is subject to regulation at the
state level by the New York Superintendent of Banks and the New York Banking
Board, while at the federal level its primary regulator is the Federal Deposit
Insurance Corporation (the "FDIC").
Both Berkshire and the Bank are subject to extensive state and federal
regulation of their activities. The following discussion summarizes certain
banking laws and regulations that affect Berkshire and the Bank. Proposals to
change these laws and regulations are frequently proposed in Congress, in the
New York State legislature, and before state and federal bank regulatory
agencies. The likelihood and timing of any changes and the impact such changes
might have on the Company are impossible to determine with any certainty. A
change in applicable laws or regulations, or a change in the way such laws or
regulations are interpreted by regulatory agencies or courts, may have a
material impact on the business, operations and earnings of the Company, the
nature and effect of which cannot be predicted.
Bank Holding Company Regulation. The Federal Reserve is authorized to
make regular examinations of the Company and its nonbank subsidiaries. Under
federal law and Federal Reserve regulations, the activities in which the Company
and its nonbank subsidiaries may engage are limited. The Company may not acquire
direct or indirect ownership or control of more than 5% of the voting shares of
any company, including a bank, without the prior approval of the Federal
Reserve, except as specifically authorized under federal law and Federal Reserve
regulations. The Company, subject to the approval of the Federal Reserve, may
acquire more than 5% of the voting shares of non-banking corporations if those
corporations engage in activities which the Federal Reserve deems to be so
closely related to banking or managing or controlling banks as to be a proper
incident thereto. These limitations also apply to activities in which the
Company engages directly rather than through a subsidiary.
The Federal Reserve has enforcement powers over the Company and its
non- bank subsidiaries. This allows the Federal Reserve, among other things, to
stop activities that represent unsafe or unsound practices or constitute
violations of law, rules, regulations, administrative orders or written
agreements with a federal bank regulator. These powers may be exercised through
the issuance of cease-and-desist orders, the imposition of civil money penalties
or other actions.
Federal Reserve Capital Requirements. The Federal Reserve requires that
the Company, as a bank holding company, must maintain certain minimum ratios of
capital to assets. The Federal Reserve's regulations divide capital into two
categories. Primary capital includes common equity, surplus, undivided profits,
perpetual preferred stock, mandatory convertible instruments, the allowance for
loan and lease losses, contingency and other capital reserves, and minority
interests in equity accounts of consolidated subsidiaries. Secondary capital
includes limited-life preferred stock, subordinated notes and debentures and
certain unsecured long term debt.
5
The Federal Reserve requires that bank holding companies maintain a
minimum ratio of primary capital to total assets of 5.5% and a minimum level of
total capital (primary plus secondary capital) equal to 6% of total assets. In
calculating capital ratios, the allowance for loan losses, which is a component
of primary capital, is added back in determining total assets. Certain capital
components, such as debt and perpetual preferred stock, are includable as
capital only if they satisfy certain definitional tests.
The Company must also meet a risk-based capital standard. Capital, for
the risk-based capital requirement, is divided into Tier I capital and
Supplementary capital, determined as discussed below in connection with the FDIC
capital requirements imposed on the Bank. The Federal Reserve requires that the
Bank maintain a ratio of total capital (defined as Tier I plus Supplementary
capital) to risk-weighted assets of at least 8%, of which at least 4% must be
Tier I capital. Risk weighted assets are also determined in a manner comparable
to the determination of risk-weighted assets under FDIC regulations as discussed
below.
At December 31, 2005 and 2004, the Company met the definition of a
"well capitalized" bank holding company.
Inter-state Banking. Bank holding companies may generally acquire banks
in any state. Federal law also permits a bank to merge with an out-of-state bank
and convert any offices into branches of the resulting bank if both states have
not opted out of interstate branching; permits a bank to acquire branches from
an out-of-state bank if the law of the state where the branches are located
permits the interstate branch acquisition; and permits banks to establish and
operate new interstate branches whenever the host state opts-in to that
authority. Bank holding companies and banks that want to engage in such
activities must be adequately capitalized and managed.
The New York Banking Law generally authorizes interstate branching in
New York as a result of a merger, purchase of assets or similar transaction. An
out of state bank may not first enter New York by opening a new branch in New
York, but once a branch is acquired as described in the preceding sentence,
additional new branches may be opened state wide.
Regulation of the Bank. In general, the powers of the Bank are limited
to the express powers described in the New York Banking Law and powers
incidental to the exercise of those express powers. The Bank is generally
authorized to accept deposits and make loans on terms and conditions determined
to be acceptable to the Bank. Loans may be unsecured, secured by real estate, or
secured by personal property. The Bank may also invest assets in bonds, notes or
other debt securities which are not in default and certain limited classes of
equity securities including certain publicly traded equity securities in an
amount aggregating not more than 2% of assets or 20% of capital. The Bank may
also engage in a variety of other traditional activities for commercial banks,
such as the issuance of letters of credit.
The exercise of these state-authorized powers is limited by FDIC
regulations and other federal laws and regulations. In particular, FDIC
regulations limit the investment activities of state-chartered, FDIC-insured
banks such as the Bank.
Under FDIC regulations, the Bank generally may not directly or
indirectly acquire or retain any equity investment that is not permissible for a
national bank. In addition, the Bank may not directly or indirectly through a
subsidiary, engage as "principal" in any activity that is not permissible for a
national bank unless the FDIC has determined that such activities would pose no
risk to the applicable FDIC insurance fund and the Bank is in compliance with
applicable regulatory capital requirements. FDIC regulations permit real estate
investments under certain circumstances. The Bank does not engage in real estate
investing activity.
6
Loans to One Borrower. With certain exceptions, the Bank may not make
loans or other extensions of credit to a single borrower, or certain related
groups of borrowers, in an aggregate amount in excess of 15% of the Bank's net
worth, plus an additional 10% of the Bank's net worth if such amount is secured
by certain types of readily marketable collateral. In addition, the Bank is not
permitted to make a mortgage loan in excess of 15% of capital stock, surplus
fund and undivided profits.
FDIC Capital Requirements. The FDIC requires that the Bank maintain
certain minimum ratios of capital to assets. The FDIC's regulations divide
capital into two tiers. The first tier ("Tier I") includes common equity,
retained earnings, certain non-cumulative perpetual preferred stock (excluding
auction rate issues) and minority interests in equity accounts of consolidated
subsidiaries, minus goodwill and other intangible assets (except mortgage
servicing rights and purchased credit card relationships subject to certain
limitations). Supplementary ("Tier II") capital includes, among other items,
cumulative perpetual and long-term limited-life preferred stock, mandatory
convertible securities, certain hybrid capital instruments, term subordinated
debt and the allowance for loan, subject to certain limitations, less required
deductions.
The FDIC requires that the highest rated banks maintain a Tier I
leverage ratio (Tier I capital to adjusted total assets) of at least 3.0%. All
other banks subject to FDIC capital requirements must maintain a Tier I leverage
ratio of 4.0% to 5.0% or more. As of December 31, 2005 and 2004, the Bank's Tier
I leverage capital ratio was 10.1% and 8.6%, respectively.
The Bank must also meet a risk-based capital standard. The risk-based
standard requires the Bank to maintain total capital (defined as Tier I and
Supplementary capital) to risk-weighted assets of at least 8%, of which at least
4% must be Tier I capital. In determining the amount of risk-weighted assets,
all assets, plus certain off-balance sheet assets, are multiplied by a risk-
weight of 0% to 100%, based on the risks the FDIC believes are inherent in the
type of asset. As of December 31, 2005 and 2004, the Bank maintained a 22.1% and
23.3% Tier I risk-based capital ratio and a 23.0% and 24.1% total risk-based
capital ratio, respectively.
In addition to the foregoing regulatory capital requirements, the FDIC
Improvements Act of 1991 created a "prompt corrective action" framework, under
which decreases in a depository institution's capital category trigger various
supervisory actions. Pursuant to implementing regulations adopted by the FDIC,
for purposes of the prompt corrective action provisions, a state-chartered,
nonmember bank, such as the Bank, is deemed to be well capitalized if it has: a
total risk-based capital ratio of 10% or greater; a Tier I risk-based capital
ratio of 6% or greater; and a leverage ratio of 5% or greater. As of December
31, 2005 and 2004, the Bank met the definition of a "well capitalized" financial
institution.
Community Reinvestment Act. The Bank must, under federal law, meet the
credit needs of its community, including low and moderate income segments of its
community. The FDIC is required, in connection with its examination of the Bank,
to assess whether the Bank has satisfied this requirement. Failure to satisfy
this requirement could adversely affect certain applications which the Bank may
make, such as branch applications, merger applications, and applications for
permission to purchase branches. In the case of Berkshire, the Federal Reserve
will assess the record of each subsidiary bank in considering certain
applications by Berkshire. The New York Banking Law contains similar provisions
applicable to the Bank. As of the most recent Community Reinvestment Act
examinations by the FDIC and the New York State Banking Department, the Bank
received "satisfactory" ratings.
Dividends From the Bank to the Company. One source of funds for
Berkshire to pay dividends to its stockholders is dividends from the Bank to
Berkshire. Under the New York Banking Law, the Bank may pay dividends to
Berkshire, without regulatory approval, equal to its net profits for the year in
which the payment is made, plus retained net profits for the two previous years,
subject to certain limits not generally relevant. The Bank's retained net
profits for the 2004 and 2005 calendar years totaled approximately $10.86
million.
7
Under federal law, the Bank may not make any capital distribution to
Berkshire, including any dividend or repurchase of the Bank's stock, if, after
making such distribution, the Bank fails to meet the required minimum capital
ratio requirements discussed below. The FDIC may prohibit the Bank from paying
dividends if, in its opinion, the payment of dividends would constitute an
unsafe or unsound practice.
Transactions With Related Parties. The Company, its direct non-banking
subsidiaries and other companies controlled by stockholders who control the
Company are affiliates, within the meaning of the Federal Reserve Act, of the
Bank and its subsidiaries. The Bank's authority to engage in transactions with
its "affiliates" is limited by Sections 23A and 23B of the Federal Reserve Act.
Section 23A limits the aggregate amount of transactions with any individual
affiliate to 10% of the capital and surplus of the Bank and also limits the
aggregate amount of transactions with all affiliates to 20% of the Bank's
capital and surplus. Extensions of credit to affiliates must be secured by
certain specified collateral, and the purchase of low quality assets from
affiliates is generally prohibited. Section 23B provides that certain
transactions with affiliates, including loans and asset purchases, must be on
terms and under circumstances, including credit standards, that are at least as
favorable to the Bank as those prevailing at the time for comparable
transactions with non- affiliated companies. In the absence of comparable
transactions, such transactions may only occur under terms and circumstances,
including credit standards, that in good faith would be offered to or would
apply to non- affiliated companies.
The Bank may make loans to its and the Company's directors, executive
officers, and 10% stockholders, as well as to entities controlled by them,
subject to specific federal and state limits. Among other things, these loans
must (a) be made on terms that are substantially the same as, and follow credit
underwriting procedures that are not less stringent than, those prevailing for
comparable transactions with unaffiliated persons and that do not involve more
than the normal risk of repayment or present other unfavorable features and (b)
not exceed certain limitations on the amount of credit extended to such persons,
individually and in the aggregate, which limits are based, in part, on the
amount of the Bank's capital. In addition, extensions of credit in excess of
certain limits must be approved by the Bank's Board of Directors. However, the
Bank may make loans to executive officers, directors and principal stockholders
on preferential terms, provided the extension of credit is made pursuant to a
benefit or compensation program of the Bank that is widely available to
employees of the Bank or its affiliates and does not give preference to any
insider over other employees of the Bank or affiliate. The Bank has no such
benefit or compensation programs.
Enforcement. The FDIC and the Banking Department have enforcement
authority over the Bank. The Superintendent may order the Bank to appear and
explain an apparent violation of law, to discontinue unauthorized or unsafe
practices and to keep prescribed books and accounts. If any director or officer
of the Bank has violated any law, or has continued unauthorized or unsafe
practices in conducting the business of the Bank after having been notified by
the Superintendent to discontinue such practices, the New York Banking Board may
remove the individual from office after notice and an opportunity to be heard.
The Superintendent also may take over control of the Bank under specified
statutory criteria.
The FDIC's 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. As indicated above, the FDIC is required to take
prompt action to correct deficiencies in banks which do not satisfy specified
FDIC capital ratio requirements. Dividends, other capital distributions or the
payment of management fees to any controlling person are prohibited if,
following such distribution or payment, a bank would be undercapitalized. An
undercapitalized bank must file a plan to restore its capital within 45 days
after being notified that it is undercapitalized. Undercapitalized,
significantly undercapitalized and critically undercapitalized institutions are
subject to increasing prohibitions on permitted activities, and increasing
levels of regulatory supervision, based upon the severity of their capital
problems.
8
The FDIC is required to monitor closely the condition of an undercapitalized
bank. Enforcement action taken by the FDIC can escalate to the appointment of a
conservator or receiver of a critically undercapitalized bank.
Insurance of Accounts. Deposit insurance premiums payable to the FDIC
are based upon the perceived risk of the institution to the FDIC insurance fund.
The FDIC assigns an institution to one of three capital categories: (a) well
capitalized, (b) adequately capitalized or (c) undercapitalized. The FDIC also
assigns an institution to one of three supervisory categories based on an
evaluation by the institution's primary federal regulator and information that
the FDIC considers relevant to the institution's financial condition and the
risk posed to the deposit insurance funds. Deposit insurance premiums depend on
an institution's capital and supervisory categories. At present, the Bank pays
no deposit insurance premium based upon its risk-based categorization.
However, the Bank must pay a share of the cost of the bonds issued in
the late 1980s to recapitalize the now defunct Federal Savings and Loan
Insurance Corporation. The Bank must pay an annual assessment for this purpose,
which for fiscal 2005 and 2004 was equal to 0.0444% and 0.0154%, respectively,
of its insured deposits and which is recorded as a deposit insurance premium
expense for financial statement purposes. Beginning in 2006, the assessment was
revised to 0.0132% of the Bank's insured deposits.
Reserve Requirements. The Bank must maintain non-interest-earning
reserves against its transaction accounts (primarily NOW and regular checking
accounts). The Bank is generally able to satisfy reserve requirements with cash
on hand and other non-interest bearing deposits which it maintains for other
purposes, so the reserve requirements do not impose a material financial burden
on the Bank.
Governmental Policies. Our earnings are significantly affected by the
monetary and fiscal policies of governmental authorities, including the Federal
Reserve. Among the instruments of monetary policy used by the Federal Reserve to
implement these objectives are open-market operations in U.S. Government
securities and Federal funds, changes in the discount rate on member bank
borrowings and changes in reserve requirements against member bank deposits.
These instruments of monetary policy are used in varying combinations to
influence the overall level of bank loans, investments and deposits, and the
interest rates charged on loans and paid for deposits. The Federal Reserve
frequently uses these instruments of monetary policy, especially its open-market
operations and the discount rate, to influence the level of interest rates and
to affect the strength of the economy, the level of inflation or the price of
the dollar in foreign exchange markets. The monetary policies of the Federal
Reserve have had a significant effect on the operating results of banking
institutions in the past and are expected to continue to do so in the future. It
is not possible to predict the nature of future changes in monetary and fiscal
policies, or the effect which they may have on our business and earnings.
Personal Holding Company Status. For the fiscal years ended December
31, 2005, 2004 and 2003, the Company has been deemed to be a Personal Holding
Company (a "PHC"), as defined in the Internal Revenue Code. As a PHC, we may be
required to pay an additional income tax or issue a dividend to our shareholders
in an amount based upon the PHC Internal Revenue Code formulas, which is
primarily based upon net income. No such dividend was required to be paid in
fiscal 2005, 2004 and 2003. (See Dividends in Item 5).
Employees. On February 20, 2006, Berkshire had one full time employee
and the Bank employed approximately 100 full time and 6 part time employees. The
Bank's employees are not represented by a collective bargaining unit, and the
Bank considers its relationship with its employees to be good.
ITEM 1A. Risk Factors.
Our business faces significant risks. These risks include those
described below and may include additional risks and uncertainties not presently
known to us or that we currently deem immaterial. Our business, financial
condition and results of operations could be materially adversely affected by
any of these risks, and the trading price of our common stock could decline.
9
We operate in the highly competitive banking industry and there can be no
assurance that we will be able to compete successfully.
Our ability to maintain our history of strong financial performance and
return on investment to shareholders may depend in part on our ability to expand
our scope of available financial services as needed to meet the needs and
demands of our customers. Our business model focuses on using superior customer
service to provide traditional banking services to a growing customer base.
However, we operate in an increasingly competitive environment in which our
competitors now include securities dealers, brokers, mortgage bankers,
investment advisors and finance and insurance companies who seek to offer
one-stop financial services to their customers that may include services that we
have not been able or allowed to offer to our customers in the past. This
increasingly competitive environment is primarily a result of changes in
regulation, changes in technology and product delivery systems and the
accelerating pace of consolidation among financial services providers. We cannot
assure you that we will be able to continue to compete successfully in this
environment without expanding the scope of financial services we provide, or
that if we need to expand the scope of services that we provide, that we will be
able to do so successfully.
Our future success depends on our ability to compete effectively in a highly
competitive market and geographic area.
We face substantial competition in all phases of our operations from a
variety of different competitors. We encounter competition from other commercial
banks, savings and loan associations, mutual savings banks, credit unions and
other financial institutions. Our competitors, including credit unions, consumer
finance companies, factors, insurance companies and money market mutual funds,
compete with lending and deposit-gathering services offered by us. There is very
strong competition for financial services in the New York state areas in which
we currently conduct our business. This geographic area includes offices of many
of the largest financial institutions in the world. Many of those competing
institutions have much greater financial and marketing resources than we have.
Due to their size, many competitors can achieve larger economies of scale and as
a result may offer a broader range of products and services than we do. If we
are unable to offer competitive products and services, our earnings may be
negatively affected. Some of the financial services organizations with which we
compete are not subject to the same degree of regulation as is imposed on bank
holding companies like ourselves and on federally insured financial institutions
like our banking subsidiary, The Berkshire Bank. As a result, these nonbank
competitors have certain advantages over us in accessing funding and in
providing various services. The banking business in our current primary market
area is very competitive, and the level of competition we face may increase
further, which may limit our asset growth and profitability.
Economic conditions either nationally or locally in areas in which our
operations are concentrated may be less favorable than expected.
Deterioration in local, regional, national or global economic
conditions could result in, among other things, an increase in loan
delinquencies, a decrease in property values, a change in housing turnover rate
or a reduction in the level of bank deposits. Particularly, a weakening of the
real estate or employment market in our primary market areas could result in an
increase in the number of borrowers who default on their loans and a reduction
in the value of the collateral securing their loans, which in turn could have an
adverse effect on our profitability. Substantially all of our real estate loans
are collateralized by properties located in these market areas, and
substantially all of our loans are made to borrowers who live in and conduct
business in these market areas. Any material economic deterioration in these
market areas could have an adverse impact on our profitability.
Changes in interest rates could reduce our income and cash flows.
Our income and cash flow and the value of our assets and liabilities
depend to a great extent on the difference between the interest rates earned on
interest-earning assets such as loans and investment securities, and the
interest rates paid on interest-bearing liabilities such as deposits and
borrowings. These rates are highly sensitive to many factors which are beyond
our control, including general economic conditions and policies of various
governmental and regulatory agencies, in particular, the Board of Governors of
the Federal Reserve
10
System. Changes in monetary policy, including changes in interest rates, will
influence the origination of loans, the returns on our portfolio of investment
securities and the amounts paid on deposits. If the rate of interest we pay on
deposits and other borrowings increases more than the rate of interest we earn
on loans and other investments, our net interest income, and therefore our
earnings, could be adversely affected. Our earnings could also be adversely
affected if the rates on our loans and other investments fall more quickly than
those on our deposits and other borrowings.
We operate in a highly regulated environment; changes in laws and regulations
and accounting principles may adversely affect us.
We are subject to extensive state and federal regulation, supervision,
and legislation which govern almost all aspects of our operations. These laws
may change from time to time and are primarily intended for the protection of
customers, depositors, and the deposit insurance funds. The impact of any
changes to these laws may negatively impact our ability to expand our services
and to increase the value of our business. Regulatory authorities have extensive
discretion in the exercise of their supervisory and enforcement powers. They
may, among other things, impose restrictions on the operation of a banking
institution, the classification of assets by such institution and such
institution's allowance for loan losses. Regulatory and law enforcement
authorities also have wide discretion and extensive enforcement powers under
various consumer protection, civil rights and other laws, including the
Gramm-Leach-Blilely Act, the Bank Secrecy Act, the Truth-in-Lending Act, the
Equal Credit Opportunity Act, the Fair Housing Act and the Real Estate
Settlement Procedures Act. These laws also permit private individual and class
action lawsuits and provide for the recovery of attorneys fees in certain
instances. Any changes to these laws or any applicable accounting principles may
negatively impact our results of operations and financial condition. While we
cannot predict what effect any presently contemplated or future changes in the
laws or regulations or their interpretations would have, these changes could be
materially adverse to our investors and stockholders.
We are required to maintain an allowance for loan losses. These reserves are
based on management's judgment and may have to be adjusted in the future. Any
adjustment to the allowance for loan losses, whether due to regulatory changes,
economic conditions or other factors, may affect our financial condition and
earnings.
We maintain an allowance for loan losses. The allowance for loan losses
is maintained at a level believed adequate by management to absorb losses
inherent in the loan portfolio. In conjunction with an internal loan review
function that operates independently of the lending function, management
monitors the loan portfolio to identify risks on a timely basis so that an
appropriate allowance can be maintained. Based on an evaluation of the loan
portfolio, management presents a periodic review of the loan loss reserve to the
board of directors of the Bank, indicating any changes in the reserve since the
last review and any recommendations as to adjustments in the reserve. In making
its evaluation, in addition to the factors discussed below, management considers
the results of recent regulatory examinations, which typically include a review
of the allowance for loan losses as an integral part of the examination process.
In establishing the allowance, management evaluates individual large
classified loans and nonaccrual loans, and determines an aggregate reserve for
those loans based on that review. An allowance for the remainder of the loan
portfolio is also determined based on historical loss experience within the
components of the portfolio. These allocations may be modified if current
conditions indicate that loan losses may differ from historical experience,
based on economic factors and changes in portfolio mix and volume.
In addition, a portion of the allowance is established for losses
inherent in the loan portfolio which have not been identified by the more
quantitative processes described above. This determination inherently involves a
higher degree of subjectivity, and considers risk factors that may not have yet
manifested themselves in historical loss experience. Those factors include
changes in levels and trends of charge-offs, delinquencies, and nonaccrual
loans, trends in volume and terms of loans, changes in underwriting standards
and practices, portfolio mix, tenure of loan officers and management, entrance
into new geographic markets, changes in credit concentrations, and national and
local economic trends
11
and conditions. While the allowance for loan losses is maintained at a level
believed to be adequate by management for estimated losses in the loan
portfolio, determination of the allowance is inherently subjective, as it
requires estimates, all of which may be susceptible to significant change.
Changes in these estimates may impact the provisions charged to expense in
future periods. Federal and state regulatory authorities, as an integral part of
their examination process, review our loans and allowance for loan losses. We
cannot assure you that we will not increase the allowance for loan losses or the
regulators will not require us to increase this allowance. Either of these
occurrences could negatively impact Berkshire Bancorp's results of operations.
It may be difficult for a third party to acquire us and this could depress our
common stock price.
Under our amended and restated certificate of incorporation, we have
authorized 2,000,000 shares of preferred stock, which the board of directors may
issue with terms, rights, preferences and designations as the board of directors
may determine and without any vote of the shareholders, unless otherwise
required by law. Issuing the preferred stock, depending upon the rights,
preferences and designations set by the board of directors, may delay, deter, or
prevent a change in control of the Company.
In addition, we have authorized 10,000,000 shares of common stock of
which approximately 7.7 million shares have been issued and approximately 6.9
million shares are outstanding. The price of our common stock may be volatile at
times since our common stock is thinly traded and one individual owns or
controls approximately 50% of our outstanding shares. It may be difficult for a
stockholder to sell a significant number of shares at a time and at a price of
their choosing or for a third party to purchase sufficient shares on the open
market to cause a change in control of the Company, all of which could depress
the price of Berkshire Bancorp's common stock.
In addition, federal and state banking laws may restrict the ability of
the stockholders to approve a merger or business combination or obtain control
of the Company. This may tend to make it more difficult for shareholders to
replace existing management or may prevent shareholders from receiving a premium
for their shares of our common stock.
Our common stock is not insured by any governmental agency and, therefore,
investment in them involves risk.
Our securities are not deposit accounts or other obligation of any
bank, and are not insured by the FDIC, or any other governmental agency, and are
subject to investment risk, including the possible loss of principal.
ITEM 1B. Unresolved Staff Comments.
Not Applicable
12
ITEM 2. Properties.
The following are Berkshire's and the Bank's principal facilities as of
February 20, 2006:
Approximate Approximate
Floor Area Annual Lease
Location Operations (Sq. Ft.) Rent Expiration
------------ ----------------- --------- --------- ----------
New York, NY Executive Offices 1,500 $ 18,000 (1)(3)
New York, NY Main Bank Office
and Bank Branch 9,700 Owned Feb 2008
Brooklyn, NY Bank Branch 4,500 $ 200,418 March 2008
Brooklyn, NY Bank Branch 2,866 $ 59,130 March 2008
Brooklyn, NY Bank Branch 2,592 $ 108,212 December 2012
Brooklyn, NY Bank Branch 1,640 $ 72,000 June 2015
New York, NY Bank Branch 9,924 $ 353,315 June 2010 (2)(3)
Goshen, NY Bank Branch 10,680 Owned
Harriman, NY Bank Branch 1,623 Owned
Bloomingburg, NY Bank Branch 1,530 $ 20,871 August 2010
Ridgefield, NJ Bank Branch Owned
-------------
(1) Rented on a month to month basis from a company affiliated with Mr.
Moses Marx, a director of the Company.
(2) Leased from a company affiliated with Mr. Marx, a director of the
Company. (3) Management believes the annual rent paid is comparable to
the annual rent that would be paid to non-affiliated parties in a
similar commercial transaction for similar commercial space.
ITEM 3. Legal Proceedings.
In the ordinary course of operations, the Bank is a party to routine
litigation involving claims incidental to its banking business. Management
believes that no current litigation, threatened or pending, to which we or our
assets are a party, poses a substantial likelihood of potential loss or exposure
which would have a material adverse effect on the financial condition or results
of our operations.
ITEM 4. Submission of Matters to a Vote of Security Holders.
Not Applicable.
PART II
ITEM 5. Market for Registrant's Common Equity, Issuer Purchases of Equity
Securities and Related Stockholder Matters.
The Company's Common Stock trades on the Nasdaq National Market System
under the symbol BERK. The following table sets forth, for the periods
indicated, the high and low sales prices for the Company's Common Stock,
restated to reflect the reverse split and stock dividend which occurred on May
18, 2004, as reported by NASDAQ.
Fiscal Year Ended December 31, 2005 High Low
----------------------------------- ---- ----
January 1, 2005 to March 31, 2005 22.04 19.51
April 1, 2005 to June 30, 2005 20.98 17.50
July 1, 2005 to September 30, 2005 18.75 17.02
October 1, 2005 to December 31, 2005 18.30 15.83
Fiscal Year Ended December 31, 2004 High Low
----------------------------------- ---- ---
January 1, 2004 to March 31, 2004 19.67 16.33
April 1, 2004 to June 30, 2004 19.33 15.00
July 1, 2004 to September 30, 2004 17.40 15.02
October 1, 2004 to December 31, 2004 20.50 16.10
As of the close of business on February 20, 2006, there were
approximately 1,490 holders of record of the Company's Common Stock.
13
Dividends
For the fiscal years ended December 31, 2005, 2004 and 2003, the
Company has been deemed to be a PHC, as defined in the Internal Revenue Code. As
a PHC, we may be required to pay an additional income tax or issue a dividend to
our shareholders in an amount based upon applicable Internal Revenue Code
formulas, which is primarily based upon net income. No such dividend was
required to be paid in fiscal 2005, 2004 and 2003.
On March 23, 1999, the Board of Directors adopted a policy of paying
regular cash dividends in respect of the Common Stock of the Company, payable in
equal semi-annual installments. Pursuant to said policy, the Board of Directors
declared and the Company paid cash dividends, restated to reflect the reverse
split and stock dividend which occurred on May 18, 2004, as follows:
Per Share
Declaration Date Record Date Payment Date Amount
--------------------------- --------------------- --------------------- -----------------
April 8, 2003 April 23, 2003 April 30, 2003 $ .04
October 3, 2003 October 21, 2003 October 29, 2003 $ .05
April 1, 2004 April 19, 2004 April 28, 2004 $ .05
October 5, 2004 October 22, 2004 October 29, 2004 $ .06
March 21, 2005 April 22, 2005 April 29, 2005 $ .07
October 7, 2005 October 21, 2005 October 28, 2005 $ .08
The declaration, payment and amount of such dividends in the future are
within the discretion of the Board of Directors and will depend upon our
earnings, capital requirements, financial condition and other relevant factors.
Equity Compensation Plans
See Part III, Item 12 for information concerning the Company's equity
compensation plans.
14
ITEM 6. Selected Financial Data.
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Five Year Financial Highlights (a)(b)
The following is a summary of certain financial information with
respect to the Company at and for the fiscal years ended December 31, 2005,
2004, 2003, 2002 and 2001. This information is derived from and should be read
in conjunction with the Company's financial statements and notes thereto
included elsewhere in this Form 10-K.
December 31,
----------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(Dollars in thousands,except per share data)
Balance Sheet Data:
Total Assets $977,452 $972,649 $905,669 $683,738 $536,365
Loans, net 305,964 284,052 292,163 273,182 250,010
Investment securities 599,972 631,592 569,848 371,458 242,579
Goodwill, net 18,549 18,549 18,549 18,549 18,438
Deposits 680,260 619,888 604,255 473,818 338,776
Borrowings 156,245 223,352 192,136 104,372 96,034
Subordinated debt 22,681 15,464 -- -- --
Stockholders' equity 108,710 107,619 103,490 98,525 95,992
Statement of Operations Data:
Interest income 45,056 40,008 34,426 32,242 24,941
Interest expense 22,399 15,916 13,647 13,416 11,877
-------- -------- -------- -------- --------
Net interest income before
provision for loan losses 22,657 24,092 20,779 18,826 13,064
Provision for loan losses 180 180 240 387 287
-------- -------- -------- -------- --------
Net interest income 22,477 23,912 20,539 18,439 12,777
Investment securities gains 4 793 2,746 1,539 637
Other income 1,202 1,026 1,237 748 786
Other expenses 13,139 12,095 11,463 10,780 7,838
Amortization of goodwill -- -- -- -- 935
-------- -------- -------- -------- --------
Income before income taxes 10,544 13,636 13,059 9,946 5,427
Provision for income taxes 5,003 6,134 5,644 4,349 2,128
-------- -------- -------- -------- --------
Net income $ 5,541 $ 7,502 $ 7,415 $ 5,597 $ 3,299
======== ======== ======== ======== ========
Net income per share:
Basic $ .81 $ 1.12 $ 1.12 $ .81 $ .47
======== ======== ======== ======== ========
Diluted $ .80 $ 1.10 $ 1.10 $ .81 $ .47
======== ======== ======== ======== ========
Cash dividends per
common share $ .15 $ .11 $ .09 $ .07 $ .08
======== ======== ======== ======== ========
Selected Operating Ratios
Return on average assets 0.6% 0.8% 0.9% 0.9% 0.8%
Return on average equity 5.1% 7.2% 7.2% 5.9% 3.5%
Net interest margin 2.4% 2.6% 2.7% 3.3% 3.6%
Average equity/average assets 11.1% 11.0% 12.7% 15.6% 23.8%
Allowance for loan
losses/total loans 1.1% 1.0% 0.9% 0.8% 0.8%
(a) The prior years' amounts have been reclassified to conform to
the current years' presentation.
(b) The prior years' net income per share and cash dividends per
common share amounts have been retroactively restated to
reflect the one-for-ten reverse stock split and thirty-
for-one forward stock split which occurred on May 18, 2004.
15
ITEM 7. Managements' Discussion and Analysis of Financial Condition and Results
of Operations.
The following discussion and analysis is intended to provide a better
understanding of the consolidated financial condition and results of operations
of Berkshire Bancorp Inc. and subsidiaries for the fiscal years ended December
31, 2005, 2004 and 2003. All references to earnings per share, unless stated
otherwise, refer to earnings per diluted share. References to per share amounts
for the fiscal year ended December 31, 2003 have been revised to reflect the
reverse stock split and stock dividend which occurred on May 18, 2004. The
discussion should be read in conjunction with the consolidated financial
statements and related notes (Notes located in Item 8 herein). Reference is also
made to Part I, Item 1 "Business" herein.
Segments
Management has determined that the Company through its wholly owned
bank subsidiary, the Bank, operates in one business segment, community banking.
The Bank's principal business activity consists of gathering deposits from the
general public and investing those deposits in residential and commercial
mortgage loans and commercial non-mortgage loans, both unsecured and secured by
personal property. In addition, the Bank invests those deposits in debt
obligations issued by the U.S. Government, its agencies, business corporations
and mortgage-backed securities.
General
Stock Split and Stock Dividend. At the Annual Meeting of Stockholders held on
May 18, 2004, the Company's stockholders approved the Reverse Split. Following
the effectiveness of the Reverse Split, the Company's Board of Directors
declared a stock dividend which became effective immediately. The Company paid
approximately $463,000 to purchase fractional shares from stockholders as part
of the Reverse Split. The Company's Common Stock began trading on May 19, 2004
giving effect to these transactions.
Trust Preferred Securities. As of May 18 2004, the Company established BCTI. The
Company owns all the common capital securities of BCTI. BCTI issued $15.0
million of preferred capital securities to investors in a private transaction
and invested the proceeds, combined with the proceeds from the sale of BCTI's
common capital securities, in the Company through the purchase of $15.464
million aggregate principal amount of the Floating Rate Junior Subordinated
Debentures issued by the Company. The Debentures, the sole assets of BCTI,
mature on July 23, 2034 and bear interest at a floating rate, three month LIBOR
plus 2.70%.
On April 1, 2005, the Company established BCTII. The Company owns all
the common capital securities of BCTII. BCTII issued $7.0 million of preferred
capital securities to investors in a private transaction and invested the
proceeds, combined with the proceeds from the sale of BCTII's common capital
securities, in the Company through the purchase of $7.217 million aggregate
principal amount of the 2005 Debentures issued by the Company. The 2005
Debentures, the sole assets of BCTII, mature on May 23, 2035 and bear interest
at a floating rate, three month LIBOR plus 1.95%. See Note A of Notes to
Consolidated Financial Statements for a further discussion of Trust Preferred
Securities.
Branch Purchase
In September 2005, the Bank entered into an Agreement with Oritani, a
New Jersey Chartered Savings Bank. Pursuant to the Agreement, the Bank will (i)
assume certain commercial checking account deposit liabilities and (ii) purchase
certain fixed assets and the real property of this Oritani bank branch located
in Ridgefield, New Jersey for a cash purchase price of $850,000. Upon the
closing of the transaction, which is subject to the approval of regulatory
authorities, among other things, the Bank intends to open a branch of The
Berkshire Bank at the Ridgefield, New Jersey location.
16
New Subsidiary
In August 2005, the Bank formed Berkshire 1031, a wholly owned limited
liability company. Berkshire 1031 will act as a qualified intermediary in
connection with tax free exchanges under Section 1031 of the Internal Revenue
Code of 1986, as amended. A qualified intermediary is an individual or business
entity that assists owners of property who wish to exchange their property for
property of a "like-kind" in a transaction that is tax free in whole or part for
federal (and in some cases state) income tax purposes. In accordance with
detailed procedures set forth in federal income tax regulations, Berkshire 1031
will assist the owner in the sale of the owner's property and the purchase of
replacement property so that the transaction qualifies as a non-taxable exchange
of property.
Critical Accounting Policies, Judgments and Estimates
The accounting and reporting policies of the Company conform with
accounting principles generally accepted in the United States of America and
general practices within the financial services industry. The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and the
assumptions that affect the amounts reported in the financial statements and the
accompanying notes. Actual results could differ from those estimates.
The Company considers that the determination of the allowance for loan
losses involves a higher degree of judgment and complexity than any of its other
significant accounting policies. The allowance for loan losses is calculated
with the objective of maintaining a reserve level believed by management to be
sufficient to absorb estimated credit losses. Management's determination of the
adequacy of the allowance is based on periodic evaluations of the loan portfolio
and other relevant factors. However, this evaluation is inherently subjective as
it requires material estimates, including, among others, expected default
probabilities, loss given default, the amounts and timing of expected future
cash flows on impaired loans, mortgages, and general amounts for historical loss
experience. The process also considers economic conditions, uncertainties in
estimating losses and inherent risks in the loan portfolio. All of these factors
may be susceptible to significant change. To the extent actual outcomes differ
from management estimates, additional provisions for loan losses may be required
that would adversely impact earnings in future periods.
With the adoption of Statement of Financial Accounting Standards
("SFAS") No. 142 ("SFAS No. 142") on January 1, 2002, the Company discontinued
the amortization of goodwill resulting from acquisitions. Goodwill is now
subject to impairment testing at least annually to determine whether write-downs
of the recorded balances are necessary. The Company tests for impairment based
on the goodwill maintained at the Bank. A fair value is determined for each
reporting unit based on at least one of three various market valuation
methodologies. If the fair values of the reporting units exceed their book
values, no write-down of recorded goodwill is necessary. If the fair value of
the reporting unit is less, an expense may be required on the Company's books to
write down the related goodwill to the proper carrying value. As of December 31,
2005, the Company completed its annual impairment testing, which determined that
no impairment write-offs were necessary.
The Company recognizes deferred tax assets and liabilities for the
future tax effects of temporary differences, net operating loss carryforwards
and tax credits. Deferred tax assets are subject to management's judgment based
upon available evidence that future realization is more likely than not. If
management determines that the Company may be unable to realize all or part of
net deferred tax assets in the future, a direct charge to income tax expense may
be required to reduce the recorded value of the net deferred tax asset to the
expected realizable amount.
17
Discussion of Financial Condition and Results of Operations
Overview
Fiscal Year Ended December 31, 2005 Compared to Fiscal Year Ended
December 31, 2004. Net income was $5.54 million, or $.80 per diluted share, for
the fiscal year ended December 31, 2005, compared to $7.50 million, or $1.10 per
diluted share, for the fiscal year ended December 31, 2004. Net loans and total
assets increased by approximately 8% and 1%, respectively, and investment
securities decreased by approximately 5%.
Fiscal Year Ended December 31,
--------------------------------------------
2005 2004 %
Inc/(Dec)
(In millions, except per share data)
Total Assets $ 977.7 $ 972.6 1%
Loans, net 305.9 284.1 8%
Investment Securities 600.0 631.6 (5)%
Total Liabilities 868.7 865.0 0%
Deposits 680.3 619.9 10%
Borrowings 178.9 238.8 (25)%
Stockholders' Equity 109.0 107.6 1%
Total Income 46.3 41.8 11%
Interest Income 45.1 40.0 13%
Total Expense 35.5 28.0 27%
Interest Expense 22.4 15.9 41%
Net Interest Income 22.7 24.1 (6)%
Net Income 5.5 7.5 (27)%
Diluted Income Per Share .80 1.10 (27)%
Bank Branches 10 9 --
18
Fiscal Year Ended December 31, 2004 Compared to Fiscal Year Ended
December 31, 2003. Net income was $7.50 million, or $1.10 per diluted share, for
the fiscal year ended December 31, 2004, compared to $7.42 million, or $1.10 per
diluted share, for the fiscal year ended December 31, 2003. Investment
securities and total assets increased by approximately 11% and 7%, respectively,
and net loans decreased by approximately 3%.
Fiscal Year Ended December 31,
-------------------------------------------
2004 2003 %
Inc/(Dec)
(In millions, except per share data)
Total Assets $ 972.6 $ 905.7 7%
Loans, net 284.1 292.2 (3)%
Investment Securities 631.6 569.8 11%
Total Liabilities 865.0 802.2 8%
Deposits 619.9 604.3 3%
Borrowings 238.8 192.1 24%
Stockholders' Equity 107.6 103.5 4%
Total Income 41.8 38.4 9%
Interest Income 40.0 34.4 16%
Total Expense 28.0 25.4 10%
Interest Expense 15.9 13.6 17%
Net Interest Income 24.1 20.8 16%
Net Income 7.5 7.4 1%
Diluted Income Per Share 1.10 1.10 0%
Bank Branches 9 9 --
Net Interest Income
Net interest income, represents the difference between total interest
income earned on earning assets and total interest expense paid on interest-
bearing liabilities. The amount of interest income is dependent upon many
factors including: (i) the amount of interest-earning assets that the Company
can maintain based upon its funding sources; (ii) the relative amounts of
interest- earning assets versus interest-bearing liabilities; and (iii) the
difference between the yields earned on those assets and the rates paid on those
liabilities. Non-performing loans adversely affect net interest income because
they must still be funded by interest-bearing liabilities, but they do not
provide interest income. Furthermore, when we designate an asset as non-
performing, all interest which has been accrued but not actually received is
deducted from current period income, further reducing net interest income.
19
The Company's average balances, interest, and average yields are set forth on
the following table (in thousands, except percentages):
Twelve Months Ended Twelve Months Ended
December 31, 2005 December 31, 2004
------------------------------------------- -------------------------------------------
Interest Interest
Average and Average Average and Average
Balance Dividends Yield/Rate Balance Dividends Yield/Rate
INTEREST-EARNING ASSETS:
Loans (1) $ 287,178 $ 19,399 6.76% $ 290,774 $ 18,825 6.47%
Investment securities 648,829 25,355 3.91 620,511 21,120 3.40
Other (2)(5) 10,765 302 2.81 4,376 63 1.44
--------- -------- ---- --------- -------- ----
Total interest-earning assets 946,772 45,056 4.76 915,661 40,008 4.37
---- ----
Noninterest-earning assets 44,497 40,592
--------- ---------
Total Assets $ 991,269 $ 956,253
========= =========
INTEREST-BEARING LIABILITIES:
Interest bearing deposits 264,130 4,639 1.76 272,219 3,809 1.39
Time deposits 338,834 9,552 2.82 309,968 6,024 1.94
Other borrowings 225,657 8,208 3.64 223,208 6,083 2.73
--------- -------- ---- --------- -------- ----
Total interest-bearing
liabilities 828,621 22,399 2.70 805,395 15,916 1.98
-------- ---- -------- ----
Demand deposits 44,739 38,896
Noninterest-bearing liabilities 8,310 7,163
Stockholders' equity (5) 109,599 104,799
--------- ---------
Total liabilities and
stockholders' equity $ 991,269 $ 956,253
========= =========
Net interest income $ 22,657 $ 24,092
======== ========
Interest-rate spread (3) 2.06% 2.39%
==== ====
Net interest margin (4) 2.39% 2.63%
==== ====
Ratio of average interest-
earning assets to average
interest bearing liabilities 1.14 1.14
========= =========
Twelve Months Ended
December 31, 2003
------------------------------------------
-
Interest
Average and Average
Balance Dividends Yield/Rate
INTEREST-EARNING ASSETS:
Loans (1) $ 291,586 $ 19,061 6.54%
Investment securities 470,412 15,321 3.26
Other (2)(5) 3,946 44 1.12
--------- -------- ----
Total interest-earning assets 765,944 34,426 4.49
----
Noninterest-earning assets 37,844
---------
Total Assets $ 803,788
=========
INTEREST-BEARING LIABILITIES:
Interest bearing deposits 201,817 2,593 1.28
Time deposits 333,112 7,537 2.26
Other borrowings 125,609 3,517 2.80
--------- -------- ----
Total interest-bearing
liabilities 660,538 13,647 2.07
-------- ----
Demand deposits 32,592
Noninterest-bearing liabilities 8,318
Stockholders' equity (5) 102,340
---------
Total liabilities and
stockholders' equity $ 803,788
=========
Net interest income $ 20,779
========
Interest-rate spread (3) 2.42%
====
Net interest margin (4) 3.71%
====
Ratio of average interest-
earning assets to average
interest bearing liabilities 1.16
=========
----------------------
(1) Includes nonaccrual loans.
(2) Includes interest-bearing deposits, federal funds sold and securities
purchased under agreements to resell.
(3) Interest-rate spread represents the difference between the average
yield on interest-earning assets and the average cost of interest
bearing liabilities.
(4) Net interest margin is net interest income as a percentage of average
interest-earning assets.
(5) Average balances for Berkshire Bancorp Inc. (parent only) have been
calculated on a monthly basis.
20
Changes in net interest income may also be analyzed by segregating the
volume and rate components of interest income and interest expense. The
following tables set forth certain information regarding changes in interest
income and interest expense of the Company for the years indicated. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (1) changes in rate (change
in rate multiplied by prior volume), (2) changes in volume (changes in volume
multiplied by prior rate) and (3) changes in rate-volume (change in rate
multiplied by change in volume) (in thousands):
Twelve Months Ended December 31, 2005
Versus
Twelve Months Ended December 31, 2004
Increase (Decrease) Due To
-------------------------------------------------
Rate Volume Total
------------- -------------- -------------
Interest-earning assets:
Loans $ 843 $ (269) $ 574
Investment securities 3,165 1,070 4,235
Other 60 179 239
------- ------- -------
Total 4,068 980 5,048
------- ------- -------
Interest-bearing
liabilities:
Deposit accounts:
Interest bearing deposits 1,007 (177) 830
Time deposits 2,728 800 3,528
Other borrowings 2,031 94 2,125
------- ------- -------
Total 5,766 717 6,483
------- ------- -------
Net interest income $(1,698) $ 263 $(1,435)
======= ======= =======
Twelve Months Ended December 31, 2004
Versus
Twelve Months Ended December 31, 2003
Increase (Decrease) Due To
----------------------------------------------------
Rate Volume Total
---------------- -------------- -------------
Interest-earning assets:
Loans $ (204) $ (32) $ (236)
Investment securities 659 5,140 5,799
Other 13 6 19
------- ------- -------
Total 468 5,114 5,582
------- ------- -------
Interest-bearing
liabilities:
Deposit accounts:
Interest bearing deposits 222 994 1,216
Time deposits (1,066) (447) (1,513)
Other borrowings (88) 2,654 2,566
------- ------- -------
Total (932) 3,201 2,269
------- ------- -------
Net interest income $ 1,400 $ 1,913 $ 3,313
======= ======= =======
21
Interest Rate Risk
Fluctuations in market interest rates can have a material effect on the
Company's net interest income because the yields earned on loans and investments
may not adjust to market rates of interest with the same frequency, or with the
same speed, as the rates paid by the Bank on its deposits.
Most of the Bank's deposits are either interest-bearing demand deposits
or short term certificates of deposit and other interest-bearing deposits with
interest rates that fluctuate as market rates change. Management of the Bank
seeks to reduce the risk of interest rate fluctuations by concentrating on loans
and securities investments with either short terms to maturity or with
adjustable rates or other features that cause yields to adjust based upon
interest rate fluctuations. In addition, to cushion itself against the potential
adverse effects of a substantial and sustained increase in market interest
rates, the Bank has purchased off balance sheet interest rate cap contracts
which generally provide that the Bank will be entitled to receive payments from
the other party to the contract if interest rates exceed specified levels. These
contracts are entered into with major financial institutions.
We seek to maximize our net interest margin within an acceptable level
of interest rate risk. Interest rate risk can be defined as the amount of the
forecasted net interest income that may be gained or lost due to favorable or
unfavorable movements in interest rates. Interest rate risk, or sensitivity,
arises when the maturity or repricing characteristics of assets differ
significantly from the maturity or repricing characteristics of liabilities.
Allowance for Loan Losses
The Company maintains an allowance for loan losses at a level deemed
sufficient to absorb losses, which are inherent in the loan portfolio at each
balance sheet date. Management reviews the adequacy of the allowance on at least
a quarterly basis to ensure that the provision for loan losses has been charged
against earnings in an amount necessary to maintain the allowance at a level
that is appropriate based on management's assessment of estimated losses. The
Company's methodology for assessing the appropriateness of the allowance for
loan losses consists of several key elements. These elements include a specific
allowance for loan watch list classified loans, an allowance based on historical
trends, an additional allowance for special circumstances, and an unallocated
portion. The Company consistently applies the following comprehensive
methodology.
The allowance for loan watch list classified loans addresses those
loans maintained on the Company's loan watch list which are assigned a rating of
substandard, doubtful, or loss. Substandard loans are those with a well-defined
weakness or a weakness, which jeopardizes the repayment of the debt. A loan may
be classified as substandard as a result of impairment of the borrower's
financial condition and repayment capacity. Loans for which repayment plans have
not been met or collateral equity margins do not protect the Company may also be
classified as substandard. Doubtful loans have the characteristics of
substandard loans with the added characteristic that collection or liquidation
in full, on the basis of presently existing facts and conditions, is highly
improbable. Although the possibility of loss is extremely high for doubtful
loans, the classification of loss is deferred until pending factors, which might
improve the loan, have been determined. Loans rated as doubtful in whole or in
part are placed in nonaccrual status. Loans which are classified as loss are
considered uncollectible and are charged to the allowance for loan losses. There
were $330,000, $343,000 and $109,000 of classified loans at December 31, 2005,
2004 and 2003, respectively.
Loans on the loan watch list may also be impaired loans, which are
defined as nonaccrual loans or troubled debt restructurings, which are not in
compliance with their restructured terms. Each of the classified loans on the
loan watch list is individually analyzed to determine the level of the potential
loss in the loan under the current circumstances. The specific reserve
established for these criticized and impaired loans is based on careful analysis
of the loan's performance, the related collateral value, cash flow
considerations and the financial capability of any guarantor. The allowance for
loan watch list classified loans is equal to the total amount of potential
unconfirmed losses for
22
the individual classified loans on the watch list. Loan watch list loans are
managed and monitored by assigned Senior Management.
The allowance based on historical trends uses charge-off experience of
the Company to estimate potential unconfirmed losses in the balances of the loan
and lease portfolios. The historical loss experience percentage is based on the
charge-off history. Historical loss experience percentages are applied to all
non-classified loans to obtain the portion of the allowance for loan losses
which is based on historical trends. Before applying the historical loss
experience percentages, loan balances are reduced by the portion of the loan
balances which are subject to guarantee by a government agency. Loan balances
are also adjusted for unearned discount on installment loans.
The Company also maintains an unallocated allowance. The unallocated
allowance is used to cover any factors or conditions which may cause a potential
loan loss but are not specifically identifiable. It is prudent to maintain an
unallocated portion of the allowance because no matter how detailed an analysis
of potential loan losses is performed these estimates by definition lack
precision. Management must make estimates using assumptions and information,
which is often subjective and changing rapidly.
Since all identified losses are immediately charged off, no portion of
the allowance for loan losses is restricted to any individual loan or groups of
loans, and the entire allowance is available to absorb any and all loan losses.
A loan is placed in a nonaccrual status at the time when ultimate
collectibility of principal or interest, wholly or partially, is in doubt. Past
due loans are those loans which were contractually past due 90 days or more as
to interest or principal payments but are well secured and in the process of
collection. Renegotiated loans are those loans which terms have been
renegotiated to provide a reduction or deferral of principal or interest as a
result of the deteriorating financial position of the borrower.
Results of Operations Fiscal Year Ended December 31, 2005 Compared to Fiscal
Year Ended December 31, 2004.
General. References to per share amounts below, unless stated otherwise, refer
to diluted shares.
Net Income. Net income for the fiscal year ended December 31, 2005 was $5.54
million, or $.80 per share, as compared to $7.50 million, or $1.10 per share,
for the fiscal year ended December 31, 2004.
The Company's net income is largely dependent on interest rate levels,
the demand for the Company's loan and deposit products and the strategies
employed to manage the interest rate and other risks inherent in the banking
business. From June 2003 through June 30, 2004, interest rates, as measured by
the prime rate, remained constant at 4.00%. On July 1, 2004, inflation fighting
actions taken by the Federal Reserve Board with respect to short-term interest
rates (the only rates it can control) resulted in a 25 basis point increase in
the prime rate to 4.25%, the first such increase in short-term rates in more
than four years. Similar 25 basis point moves in the federal funds rate taken by
the Federal Reserve Board during 2004 and 2005, the most recent occurring on
January 31, 2006, have moved the prime rate to its present level of 7.50%, the
longest sustained period of monetary policy tightening in more than a decade.
While short-term market rates have followed the upticks of federal
funds, long-term interest rates have declined during this period, a condition
referred to as a flattening yield curve. A flat or narrowing yield curve places
a squeeze on interest margins for financial institutions, like the Company, who
depend upon a spread between long- and short-term rates for interest margin
profits and the largest percentage of income.
Net Interest Income. The Company's primary source of revenue is net interest
income, or the difference between interest income on earning assets, such as
loans and investment securities, and interest expense on interest-bearing
liabilities such as deposits and borrowings.
23
For the fiscal year ended December 31, 2005, net interest income
decreased by $1.44 million, or 5.96%, to $22.66 million from $24.09 million for
the fiscal year ended December 31, 2004. The decrease in net interest income was
the result of the 28.84% growth in the average amount of interest-bearing
liabilities to $828.62 million during fiscal 2005 from $805.40 million in fiscal
2004 and the 72 basis point increase in the average rates paid on such
liabilities to 2.70% in 2005 from 1.98% in 2004. The decrease in net interest
income was partially offset by the 3.40% increase in the average amount of
interest-earning assets to $946.77 million during 2005 from $915.66 million in
2004 and the 39 basis point increase in the average yields earned on such
earning assets to 4.76% in 2005 from 4.37% in 2004.
Also contributing to the change in net interest income was the
interest- rate spread or the difference between the average yield on
interest-earning assets and the average cost of interest-bearing liabilities.
During fiscal 2005, the Company's interest-rate spread decreased by 33 basis
points to 2.06% from 2.39% during fiscal 2004. If interest rates remain at
current levels or increase slowly over time, we expect to see only moderate
pressure on the Company's interest-rate spread and net interest income.
Investment securities in our portfolio that have been sold, matured or called by
the issuer during fiscal 2004 and 2005 have been replaced with securities
carrying somewhat higher yields and, by design, shorter maturities to provide a
hedge against a rising interest rate environment. Rates paid on deposit accounts
are likely to increase in a rising rate environment due to competition for
deposits in the market place. The cost of borrowed funds with floating rather
than fixed interest rates will increase as well.
Net Interest Margin. Net interest margin, or annualized net interest income as a
percentage of average interest-earning assets, declined to 2.39% in fiscal 2005
from 2.63% in fiscal 2004. We seek to secure and retain customer deposits with
competitive products and rates, while making strategic use of the prevailing
interest rate environment to borrow funds at what we believe to be attractive
rates. We invest such deposits and borrowed funds in a prudent mix of fixed rate
and adjustable rate loans, investment securities and short-term interest-earning
assets which provided an aggregate average yield of 4.76% and 4.37% in fiscal
2005 and 2004, respectively.
The average amount of loans decreased slightly to $287.18 million in
fiscal 2005 from $290.77 million in fiscal 2004, however, the average yield on
the loan portfolio increased by 29 basis points to 6.76% in fiscal 2005 from
6.47% in fiscal 2004. During periods of low and stable interest rates borrowers
gravitate towards fixed-rate loans to lock in a low interest rate. Adjustable
rate loans are generally preferred when interest rates are trending higher as
they did in 2004 and 2005. One-to-four family mortgage loans, approximately 45%
and 54% of our loan portfolio at December 31, 2005 and 2004, respectively, are
particularly sensitive to changes in interest rates.
The average amount of investment securities increased by $28.32 million
to $648.83 million in fiscal 2005 from $620.51 million in fiscal 2004. The
average yield on investment securities improved by 51 basis points, to 3.91% in
2005 from 3.40% in 2004 and are likely to continue to increase in a rising
interest rate environment. The average amount of other interest-earning assets,
primarily short-term investments, increased by $6.39 million to $10.77 million
in 2005 from $4.38 million in 2004 and returned an average yield of 2.81% and
1.44% in fiscal 2005 and 2004, respectively.
Interest Income. Total interest income for the fiscal year ended December 31,
2005 increased by $5.05 million, or 12.62%, to $45.06 million from $40.01
million for the fiscal year ended December 31, 2004. The increase in interest
income was primarily due to the growth in the average amount of total
interest-earning assets. Loans contributed $19.40 million of interest income in
fiscal 2005, an increase of $574,000 from the $18.83 million of interest income
contributed in fiscal 2004. Investment securities contributed $25.36 million of
interest income in fiscal 2005, an increase of $4.24 million over the $21.12
million of interest income earned on loans in fiscal 2004.
24
Fiscal 2005 Fiscal 2004
------------------------------ -----------------------------
Interest % of Interest % of
Income Total Income Total
(In thousands, except percentages)
Loans $19,399 43.06% $18,825 47.05%
Investment Securities 25,355 56.27 21,120 52.79
Other 302 0.67 63 0.16
------- ------ ------- ------
Total Interest Income $45,056 100.00% $40,008 100.00%
Loans, which are inherently risky and therefore command a higher return
than our conservative portfolio of investment securities, declined to 30.33% of
our total average interest-earning assets in fiscal 2005 from 31.76% in fiscal
2004. While we actively seek to originate new loans with qualified borrowers who
meet the Bank's underwriting standards, our strategy has been to maintain those
standards, sacrificing some current income to avoid possible large future losses
in the loan portfolio.
Fiscal 2005 Fiscal 2004
--------------------------------- -----------------------------
Average % of Average % of
Amount Total Amount Total
(In thousands, except percentages)
Loans $287,178 30.33% $290,774 31.76%
Investment Securities 648,829 68.53 620,511 67.77
Other 10,765 1.14 4,376 0.47
-------- ------ -------- ------
Total Interest-Earning Assets $946,772 100.00% $915,661 100.00%
Interest Expense. Total interest expense for the fiscal year ended December 31,
2005 increased by $6.48 million, or 40.73%, to $22.40 million from $15.92
million for the fiscal year ended December 31, 2004. The increase in interest
expense was due to the growth in the average amount of interest-bearing
liabilities and the increase in the average rate paid on such liabilities, 2.70%
and 1.98% in fiscal years 2005 and 2004, respectively. As short-term rates moved
higher during 2005, interest expense increased as we priced our deposit products
to meet the competition and the adjustable rates paid on other borrowings
increased as well. In April 2005 and May 2004, we sold $7.22 million and $15.46
million, respectively, of floating rate junior subordinated debentures which
mature in 2035 and 2034, respectively. The net proceeds of said sales were used
to augment the Bank's capital. The additional interest expense on these
debentures, which is included in other borrowings, was $1.27 million and
$463,000 during fiscal 2005 and 2004.
Fiscal 2005 Fiscal 2004
-------------------------------- -----------------------------
Interest % of Interest % of
Expense Total Expense Total
(In thousands, except percentages)
Interest-Bearing Deposits $ 4,639 20.71% $ 3,809 23.93%
Time Deposits 9,552 42.64 6,024 37.85
Other Borrowings 8,208 36.65 6,083 38.22
-------- ------ -------- ------
Total Interest Expense $ 22,399 100.00% $15,916 100.00%
Fiscal 2005 Fiscal 2004
--------------------------------- -----------------------------
Average % of Average % of
Amount Total Amount Total
(In thousands, except percentages)
Interest-Bearing Deposits $264,130 31.88% $272,219 33.80%
Time Deposits 338,834 40.89 309,968 38.49
Other Borrowings 225,657 27.23 223,208 27.71
-------- ------ -------- ------
Total Interest-Bearing Liabilities $828,621 100.00% $805,395 100.00%
25
Non-Interest Income. Non-interest income consists primarily of realized gains on
sales of marketable securities and service fee income. For the fiscal year ended
December 31, 2005, total non-interest income decreased by $613,000 to $1.21
million from $1.82 million for the fiscal year ended December 31, 2004. In 2004,
we recorded gains of $793,000 on the sales and issuer redemptions of investment
securities. In 2005, such gains amounted to $4,000. Service charges on deposit
accounts increased by $69,000 to $589,000 in fiscal 2005 from $520,000 in fiscal
2004.
Fiscal 2005 Fiscal 2004
---------------------------------- ---------------------------------
Non-Interest % of Non-Interest % of
Income Total Income Total
(In thousands, except percentages)
Service Charges on Deposits $ 589 48.84% $ 520 28.59%
Investment Securities gains 4 0.33 793 43.60
Other 613 50.83 506 27.81
------- ------ ------- ------
Total Non-Interest Income $1,206 100.00% $1,819 100.00%
Non-Interest Expense. Non-interest expense includes salaries and employee
benefits, occupancy and equipment expenses, legal and professional fees and
other operating expenses associated with the day-to-day operations of the
Company. Total non-interest expense for the year ended December 31, 2005
increased by $1.04 million, or 8.63%, to $13.14 million from $12.10 million for
the year ended December 31, 2004. The largest component of non-interest expense
are salaries and employee benefits which increased by $1.12 million, or 16.21%,
to $8.00 million in fiscal 2005 from $6.89 million in fiscal 2004. The increase
is due to the addition of personnel in our internal control and compliance
departments.
Fiscal 2005 Fiscal 2004
---------------------------------- ---------------------------------
Non-Interest % of Non-Interest % of
Expense Total Expense Total
(In thousands, except percentages)
Salaries and Employee Benefits $ 8,002 60.90% $ 6,886 56.93%
Net Occupancy Expense 1,728 13.15 1,538 12.72
Equipment Expense 397 3.02 357 2.95
FDIC Assessment 272 2.07 115 0.95
Data Processing Expense 198 1.51 157 1.30
Other 2,542 19.35 3,042 25.15
------- ------ ------- ------
Total Non-Interest Expense $13,139 100.00% $12,095 100.00%
Provision for Income Tax. During the years ended December 31, 2005 and 2004, we
recorded income tax expense of $5.00 million and $6.13 million, respectively.
The tax provisions for federal, state and local taxes recorded for 2005 and 2004
represent effective tax rates of 47.45% and 44.98%, respectively.
26
Common Stock Repurchases
On May 15, 2003, The Company's Board of Directors authorized the
purchase of up to an additional 450,000 shares of its Common Stock in the open
market, from time to time, depending upon prevailing market conditions, thereby
increasing the maximum number of shares which may be purchased by the Company
from 1,950,000 shares of Common Stock to 2,400,000 shares of Common Stock. Since
1990 through December 31, 2003, the Company has purchased a total of 1,844,646
shares of its Common Stock. During fiscal year 2004, we purchased a total of
4,263 shares and at December 31, 2005 there were 551,091 shares of Common Stock
which may yet be purchased under our stock repurchase plan. The following table
sets forth information with respect to such purchases during the periods
indicated.
Fiscal Year 2005
Number of Average Price
Shares Paid Per
Purchased Share
---------------- ------------------
January - December -- --
Fiscal Year 2004
Number of Average Price
Shares Paid Per
Purchased Share
---------------- ------------------
January 4,263 $ 16.33
February - March -- --
April - June -- --
July - September -- --
October - December -- --
Results of Operations Fiscal Year Ended December 31, 2004 Compared to Fiscal
Year Ended December 31, 2003.
General.
References to per share amounts below, unless stated otherwise, refer to diluted
shares. References to per share amounts for the fiscal years ended December 31,
2003 have been revised to reflect the reverse stock split and stock dividend
which occurred on May 18, 2004.
Net Income. Net income for the fiscal year ended December 31, 2004 was $7.50
million, or $1.10 per share, as compared to $7.42 million, or $1.10 per share,
for the fiscal year ended December 31, 2003.
The Company's net income is largely dependent on interest rate levels,
the demand for the Company's loan and deposit products and the strategies
employed to manage the interest rate and other risks inherent in the banking
business. From June 2003 through June 30, 2004, interest rates, as measured by
the prime rate, remained constant at 4.00%. On July 1, 2004, inflation fighting
actions taken by the Federal Reserve Board resulted in a 25 basis point increase
in the prime rate to 4.25%, the first such increase in more than four years.
Similar 25 basis point moves taken by the Federal Reserve Board in August,
September, November and December of 2004, and February 2005 moved the prime rate
to 5.50%.
Net Interest Income. The Company's primary source of revenue is net interest
income, or the difference between interest income on earning assets, such as
loans and investment securities, and interest expense on interest-bearing
liabilities such as deposits and borrowings.
27
For the fiscal year ended December 31, 2004, net interest income
increased by $3.31 million, or 15.94%, to $24.09 million from $20.78 million for
the fiscal year ended December 31, 2003. The increase in net interest income was
the result of a 19.55% growth in the average amount of interest-earning assets
to $915.66 million at the end of 2004 from $765.94 million at the end of 2003,
partially offset by the 21.93% growth in the average amount of interest-bearing
liabilities to $805.40 million from $660.54 million at December 31, 2004 and
2003, respectively, as well as the interest-rate spread or the difference
between the average yield on interest-earning assets and the average cost of
interest-bearing liabilities.
During fiscal 2004, the average yield on interest-earning assets fell
to 4.37% from 4.49% in fiscal 2003, a decline of 2.67%, while the average cost
of interest-bearing liabilities fell to 1.98% from 2.07%, a decline of 4.35% The
interest-rate spread decreased to 2.39% during fiscal 2004 from 2.42% during
fiscal 2003.
If interest rates remain at current levels or increase slowly over
time, we expect to see only moderate pressure on the Company's interest-rate
spread and net interest income. Investment securities in our portfolio that have
been sold, matured or called by the issuer during fiscal 2003 and 2004 have been
replaced with securities carrying somewhat lower yields and, by design, shorter
maturities to hedge against a rising interest rate environment. Rates paid on
deposit accounts are likely to increase in a rising rate environment due to
competition for deposits in the market place. The cost of borrowed funds with
floating rather than fixed interest rates will increase as well.
Net Interest Margin. Net interest margin, or annualized net interest income as a
percentage of average interest-earning assets, declined to 2.63% in fiscal 2004
from 2.71% in fiscal 2003. We seek to secure and retain customer deposits with
competitive products and rates, while making strategic use of the prevailing
interest rate environment to borrow funds at what we believe to be attractive
rates. We invest such deposits and borrowed funds in a prudent mix of fixed rate
and adjustable rate loans, investment securities and short-term interest-earning
assets which provided an aggregate average yield of 4.37% and 4.49% in fiscal
2004 and 2003, respectively.
The average amount of loans decreased slightly to $290.77 million in
fiscal 2004 from $291.59 million in fiscal 2003, as did the average yield on the
loan portfolio which declined to 6.47% in fiscal 2004 from 6.54% in fiscal 2003.
During periods of low and stable interest rates, as was the case during 2003,
borrowers gravitate towards fixed-rate loans to lock in a low interest rate,
whereas adjustable rate loans are generally preferred when interest rates are
trending higher. One-to-four family mortgage loans, approximately 54% and 57% of
our loan portfolio at December 31, 2004 and 2003, respectively, are particularly
sensitive to changes in interest rates.
The average amount of investment securities increased by $150.10
million to $620.51 million in fiscal 2004 from $470.41 million in fiscal 2003.
The average yield on investment securities improved by 14 basis points, to 3.40%
in 2004 from 3.26% in 2003 and are likely to continue to increase in a rising
interest rate environment.
Interest Income. Total interest income for the fiscal year ended December 31,
2004 increased by $5.58 million, or 16.21%, to $40.01 million from $34.43
million for the fiscal year ended December 31, 2003. The increase in interest
income was primarily due to the growth in the average amount of total
interest-earning assets. Loans contributed $18.83 million of interest income in
fiscal 2004, a decline of $236,000 from the $19.06 million of interest income
contributed in fiscal 2003. Investment securities contributed $21.12 million of
interest income in fiscal 2004, an increase of 37.85% over the $15.32 million of
interest income earned on loans in fiscal 2003.
28
Fiscal 2004 Fiscal 2003
---------------------------- ----------------------------
Interest % of Interest % of
Income Total Income Total
(In thousands, except percentages)
Loans $18,825 47.05% $19,061 55.37%
Investment Securities 21,120 52.79 15,321 44.50
Other 63 0.16 44 0.13
------- ------ ------- ------
Total Interest Income $40,008 100.00% $34,426 100.00%
Loans, which are inherently risky and therefore command a higher return
than our conservative portfolio of investment securities, declined to 31.76% of
our total average interest-earning assets in fiscal 2004 from 38.07% in fiscal
2003. While we actively seek to originate new loans with qualified borrowers who
meet the Bank's underwriting standards, our strategy has been to maintain those
standards, sacrificing some current income to avoid possible large future losses
in the loan portfolio.
Fiscal 2004 Fiscal 2003
--------------------------------- -----------------------------
Average % of Average % of
Amount Total Amount Total
(In thousands, except percentages)
Loans $290,774 31.76% $291,586 38.07%
Investment Securities 620,511 67.77 470,412 61.42
Other 4,376 0.47 3,946 0.51
-------- ------ -------- ------
Total Interest-Earning Assets $915,661 100.00% $765,944 100.00%
Interest Expense. Total interest expense for the fiscal year ended December 31,
2004 increased by $2.27 million, or 16.63%, to $15.92 million from $13.65
million for the fiscal year ended December 31, 2003. The increase in interest
expense was due primarily to the growth in the average amount of
interest-bearing liabilities, partially offset by the decline in the average
rate paid on such liabilities, 1.98% and 2.07% in fiscal years 2004 and 2003,
respectively. As rates move higher, interest expense will increase as we price
our deposit products to meet the competition and the adjustable rates paid on
other borrowings increase as well. In May 2004, we sold $15.46 million of
floating rate junior subordinated debentures which mature in 2034 and used the
net proceeds to augment the Bank's capital. The additional interest expense on
these debentures, which are included in other borrowings, was $463,000 during
fiscal 2004.
Fiscal 2004 Fiscal 2003
-------------------------------- -----------------------------
Interest % of Interest % of
Expense Total Expense Total
(In thousands, except percentages)
Interest-Bearing Deposits $ 3,809 23.93% $ 2,593 19.00%
Time Deposits 6,024 37.85 7,537 55.23
Other Borrowings 6,083 38.22 3,517 25.77
-------- ------ -------- ------
Total Interest Expense $15,916 100.00% $13,647 100.00%
Fiscal 2004 Fiscal 2003
--------------------------------- -----------------------------
Average % of Average % of
Amount Total Amount Total
(In thousands, except percentages)
Interest-Bearing Deposits $272,219 33.80% $201,817 30.55%
Time Deposits 309,968 38.49 333,112 50.43
Other Borrowings 223,208 27.71 125,609 19.02
-------- ------ -------- ------
Total Interest-Bearing Liabilities $805,395 100.00% $660,538 100.00%
29
Non-Interest Income. Non-interest income consists primarily of realized gains on
sales of marketable securities and service fee income. For the fiscal year ended
December 31, 2004, total non-interest income decrease by $2.16 million to $1.82
million from $3.98 million for the fiscal year ended December 31, 2003. In 2003,
we recorded gains of $2.75 million on the sales and issuer redemptions of
investment securities. In 2004, such gains amounted to $793,000. Service charges
on deposit accounts decreased by $120,000 to $520,000 in fiscal 2004 from
$640,000 in fiscal 2003. The decline is primarily due to marketing efforts
introducing new deposit products, which includes the waiver of such fees for a
period of time to attract new customers.
Fiscal 2004 Fiscal 2003
---------------------------------- ---------------------------------
Non-Interest % of Non-Interest % of
Income Total Income Total
(In thousands, except percentages)
Service Charges on Deposits $ 520 28.59% $ 640 16.07%
Investment Securities gains 793 43.60 2,746 68.94
Other 506 27.81 597 14.99
------- ------ ------- ------
Total Non-Interest Income $1,819 100.00% $3,983 100.00%
Non-Interest Expense. Non-interest expense includes salaries and employee
benefits, occupancy and equipment expenses, legal and professional fees and
other operating expenses associated with the day-to-day operations of the
Company. Total non-interest expense for the year ended December 31, 2004
increased by $632,000, or 5.51%, to $12.10 million from $11.46 million for the
year ended December 31, 2003. The largest component of non-interest expense are
salaries and employee benefits which increased by $1.01 million, or 17.25%, to
$6.89 million in fiscal 2004 from $5.87 million in fiscal 2003. The increase is
due to the additional staffing of our two new Brooklyn branches which opened in
April and June of 2003 and the addition of personnel in our internal control and
compliance departments.
Fiscal 2004 Fiscal 2003
---------------------------------- ---------------------------------
Non-Interest % of Non-Interest % of
Expense Total Expense Total
(In thousands, except percentages)
Salaries and Employee Benefits $ 6,886 56.93% $ 5,873 51.24%
Net Occupancy Expense 1,538 12.72 1,611 14.05
Equipment Expense 357 2.95 397 3.46
FDIC Assessment 115 0.95 80 0.70
Data Processing Expense 157 1.30 183 1.60
Other 3,042 25.15 3,319 28.95
------- ------ ------- ------
Total Non-Interest Expense $12,095 100.00% $11,463 100.00%
Provision for Income Tax. During the years ended December 31, 2004 and 2003, we
recorded income tax expense of $6.13 million and $5.64 million, respectively.
The tax provisions for federal, state and local taxes recorded for 2004 and 2003
represent effective tax rates of 44.98% and 43.22%, respectively.
30
Investment Activities
General. The investment policy of the Bank is designed primarily to
provide satisfactory yields while maintaining adequate liquidity, a balance of
high quality, diversified investments, and minimal risk. The Bank does not as a
rule invest in equity securities. The largest component of the Bank's securities
investments, representing more than 50% of total investment securities, are debt
securities issued by U.S. Government agencies including the Federal Home Loan
Mortgage Corporation (Freddie Mac), the Federal National Mortgage Association
(Fannie Mae) or the Government National Mortgage Association (Ginnie Mae). The
remainder of the Bank's debt securities investments are primarily short term
debt securities issued by the United States or its agencies. The Bank maintains
a small portfolio of less than $4 million of high-yield corporate debt
securities. Recognizing the higher credit risks of these securities, the Bank
underwrites these securities in a manner similar to its loan underwriting
procedures.
As required by the Statement of Financial Accounting Standard No. 115
("SFAS No. 115"), securities are classified into three categories: trading,
held-to-maturity and available-for-sale. Securities that are bought and held
principally for the purpose of selling them in the near term are classified as
trading securities and are reported at fair value with unrealized gains and
losses included in trading account activities in the statement of income.
Securities that the Bank has the positive intent and ability to hold to maturity
are classified as held-to-maturity and reported at amortized cost. All other
securities are classified as available-for-sale. Available-for-sale securities
are reported at fair value with unrealized gains and losses included, on an
after-tax basis, as a separate component of net worth. The Bank does not have a
trading securities portfolio and has no current plans to maintain such a
portfolio in the future. The Bank generally classifies all newly purchased debt
securities as available for sale in order to maintain the flexibility to sell
those securities if the need arises. The Bank has a limited portfolio of
securities classified as held to maturity, represented principally by securities
purchased a number of years ago.
Federal Home Loan Bank Stock. The Bank owns stock of the Federal Home
Loan Bank of New York (the "FHLBNY") which is necessary for it to be a member of
the FHLBNY. Membership requires the purchase of stock equal to 1% of the Bank's
residential mortgage loans. If the Bank borrows from the FHLBNY, the Bank must
own stock at least equal to 5% of its borrowings.
The following table sets forth the cost and fair value of
available-for- sale and held-to-maturity securities as of the dates indicated:
December 31,
-------------------------------------------------------------------------------------------
2005 2004 2003
------------------------------- ------------------------------ ----------------------------
Cost Fair Cost Fair Cost Fair
Value Value Value
--------------- --------------- -------------- -------------- -------------- -------------
(In thousands)
Available-For-Sale
U.S. Treasury Notes $ 14,985 $ 14,899 $ 24,896 $ 24,722 $ 39,941 $ 39,847
U.S. Government Agencies 448,196 439,645 471,018 467,271 419,175 416,753
Mortgage-backed securities 81,681 79,686 109,822 109,330 93,875 97,448
Corporate notes 54,590 52,304 21,089 21,627 1,570 1,662
Municipal securities 1,972 2,306 1,307 1,441 991 1,061
Marketable equity
securities and other 10,351 10,570 6,363 6,577 12,305 12,366
-------- -------- -------- -------- -------- --------
Total $611,775 $599,410 $634,495 $630,968 $567,857 $569,137
======== ======== ======== ======== ======== ========
Held-To-Maturity
U.S. Government Agencies $ 562 $ 573 $ 624 $ 633 $ 711 $ 715
-------- -------- -------- -------- -------- --------
Total $ 562 $ 573 $ 624 $ 633 $ 711 $ 715
======== ======== ======== ======== ======== ========
31
The following tables summarize the Company's available-for-sale and
held- to-maturity securities:
December 31, 2005
-------------------------------------------------------
Weighted
Average
Yield Cost Fair Value
----- ---- ----------
(Dollars in thousands)
Available-For-Sale
U.S. Treasury Notes
Due within one year 1.75% $ 14,985 $ 14,899
-------- --------
14,985 14,899
-------- --------
U.S. Government Agencies Obligations
Due within one year 2.85 61,153 60,497
Due after one year through five years 3.81 234,888 229,754
Due after five years through ten years 4.38 78,156 76,158
Due after ten years 3.57 73,999 73,236
-------- --------
448,196 439,645
-------- --------
Municipal Obligations
Due after ten years 9.41 1,972 2,306
-------- --------
1,972 2,306
-------- --------
Mortgage-backed securities
Due after five years through ten years 4.15 18,012 17,306
Due after ten years 4.22 63,669 62,380
-------- --------
81,681 79,686
-------- --------
Corporate Notes
Due within one year 4.78 18,497 18,459
Due after one year through five years 5.27 7,533 7,395
Due after five years through ten years 6.54 6,210 5,986
Due after ten years 7.58 22,350 20,464
-------- --------
54,590 52,304
-------- --------
Common Stocks 1.77 329 448
Preferred Stocks 9.60 314 414
Money market funds 4.07 5,255 5,255
Federal Home Loan Bank Stock 5.25 4,453 4,453
-------- --------
10,351 10,570
-------- --------
$611,775 $599,410
======== ========
Held-To-Maturity
U.S. Government Agencies Obligations
Due after one year through five years 1.53 93 93
Due after five years through ten years 4.75 32 32
Due after ten years 6.38 437 448
-------- --------
$ 562 $ 573
======== ========
32
Loan Portfolio
Loan Portfolio Composition. The Company's loans consist primarily of
mortgage loans secured by residential and non-residential properties as well as
commercial loans which are either unsecured or secured by personal property
collateral. Most of the Company's loans are either made to individuals or
personally guaranteed by the principals of the business to which the loan is
made. At December 31, 2005, 2004 and 2003, the Company had total loans, net of
unearned income of $309.23 million, $286.98 million and $294.76 million,
respectively, and an allowance for loan losses of $3.27 million, $2.93 million
and $2.59 million, respectively. From time to time, the Bank may originate
residential mortgage loans, sell them on the secondary market, normally
recognizing fee income in connection with the sale.
Interest rates on loans are affected by the demand for loans, the
supply of money available for lending, credit risks, the rates offered by
competitors and other conditions. These factors are in turn affected by, among
other things, economic conditions, monetary policies of the federal government,
and legislative tax policies.
In order to manage interest rate risk, the Bank focuses its efforts on
loans with interest rates that adjust based upon changes in the prime rate or
changes in United States Treasury or similar indices. Generally, credit risks on
adjustable-rate loans are somewhat greater than on fixed-rate loans primarily
because, as interest rates rise, so do borrowers' payments, increasing the
potential for default. The Bank seeks to impose appropriate loan underwriting
standards in order to protect against these and other credit related risks
associated with its lending operations.
In addition to analyzing the income and assets of its borrowers when
underwriting a loan, the Bank obtains independent appraisals on all material
real estate in which the Bank takes a mortgage. The Bank generally obtains title
insurance in order to protect against title defects on mortgaged property.
Commercial and Mortgage Loans. The Bank originates commercial mortgage
loans secured by office buildings, retail establishments, multi-family
residential real estate and other types of commercial property. Substantially
all of the properties are located in the New York City metropolitan area.
The Bank generally makes commercial mortgage loans with loan to value
ratios not to exceed 75% and with terms to maturity that do not exceed 15 years.
Loans secured by commercial properties generally involve a greater degree of
risk than one- to four-family residential mortgage loans. Because payments on
such loans are often dependent on successful operation or management of the
properties, repayment may be subject, to a greater extent, to adverse conditions
in the real estate market or the economy. The Bank seeks to minimize these risks
through its underwriting policies. The Bank evaluates the qualifications and
financial condition of the borrower, including credit history, profitability and
expertise, as well as the value and condition of the underlying property. The
factors considered by the Bank include net operating income; the debt coverage
ratio (the ratio of cash net income to debt service); and the loan to value
ratio. When evaluating the borrower, the Bank considers the financial resources
and income level of the borrower, the borrower's experience in owning or
managing similar property and the Bank's lending experience with the borrower.
The Bank's policy requires borrowers to present evidence of the ability to repay
the loan without having to resort to the sale of the mortgaged property. The
Bank also seeks to focus its commercial mortgage loans on loans to companies
with operating businesses, rather than passive real estate investors.
Commercial Loans. The Bank makes commercial loans to businesses for
inventory financing, working capital, machinery and equipment purchases,
expansion, and other business purposes. These loans generally have higher yields
than mortgages loans, with maturities of one year, after which the borrower's
financial condition and the terms of the loan are re-evaluated.
Commercial loans tend to present greater risks than mortgage loans
because the collateral, if any, tends to be rapidly depreciable, difficult to
sell at full value and is often easier to conceal. In order to limit these
risks, the
33
Bank evaluates these loans based upon the borrower's ability to repay the loan
from ongoing operations. The Bank considers the business history of the borrower
and perceived stability of the business as important factors when considering
applications for such loans. Occasionally, the borrower provides commercial or
residential real estate collateral for such loans, in which case the value of
the collateral may be a significant factor in the loan approval process.
Residential Mortgage Loans (1 to 4 family loans). The Bank makes
residential mortgage loans secured by first liens on one-to-four family owner-
occupied or rental residential real estate. At December 31, 2005 and 2004,
approximately $142.81 million and $159.68 million, respectively, or 46% and 55%,
respectively, of the Company's total loan portfolio consisted of such loans. The
Company offers both adjustable rate mortgages ("ARMS") and fixed-rate mortgage
loans. The relative proportion of fixed-rate loans versus ARMs originated by the
Bank depends principally upon current customer preference, which is generally
driven by economic and interest rate conditions and the pricing offered by the
Bank's competitors. At December 31, 2005 and 2004, approximately 4% and 7%,
respectively, of the Bank's residential one-to-four family owner-occupied first
mortgage portfolio were ARMs and approximately 96% and 93%, respectively, were
fixed-rate loans. The percentage represented by fixed-rate loans tends to
increase during periods of low interest rates. The ARMs generally carry annual
caps and life-of-loan ceilings, which limit interest rate adjustments.
The Bank's residential loan underwriting criteria are generally
comparable to those required by the Federal National Mortgage Association
("FNMA") and other major secondary market loan purchasers. Generally, ARM credit
risks are somewhat greater than fixed-rate loans primarily because, as interest
rates rise, the borrowers' payments rise, increasing the potential for default.
The Bank's teaser rate ARMs (ARMs with low initial interest rates that are not
based upon the index plus the margin for determining future rate adjustments)
were underwritten based on the payment due at the fully-indexed rate.
In addition to verifying income and assets of borrowers, the Bank
obtains independent appraisals on all residential first mortgage loans and title
insurance is required at closing. Private mortgage insurance is required on all
loans with a loan-to-value ratio in excess of 80% and the Bank requires real
estate tax escrows on such loans. Real estate tax escrows are voluntary on
residential mortgage loans with loan-to-value ratios of 80% or less.
Fixed-rate residential mortgage loans are generally originated by the
Bank for terms of 15 to 30 years. Although 30 year fixed-rate mortgage loans may
adversely affect our net interest income in periods of rising interest rates,
the Bank originates such loans to satisfy customer demand. Such loans are
generally originated at initial interest rates which exceed the fully indexed
rate on ARMs offered at the same time. Fixed-rate residential mortgage loans
originated by the Bank generally include due-on-sale clauses, which permit the
Bank to demand payment in full if the borrower sells the property without the
Bank's consent. Due-on-sale clauses are an important means of adjusting the
rates on the Bank's fixed-rate mortgage loan portfolio, and the Bank will
generally exercise its rights under these clauses if necessary to maintain
market yields.
ARMs originated in recent years have interest rates that adjust
annually based upon the movement of the one year treasury bill constant maturity
index, plus a margin of 2.00% to 2.75%. These loans generally have a maximum
interest rate adjustment of 2% per year, with a lifetime maximum interest rate
adjustment, measured from the initial interest rate, of 5.5% or 6.0%.
The Bank offers a variety of other loan products including residential
single family construction loans to persons who intend to occupy the property
upon completion of construction, home equity loans secured by junior mortgages
on one-to-four family owner-occupied residences, and short-term fixed-rate
consumer loans either unsecured or secured by monetary assets such as bank
deposits and marketable securities or personal property.
Origination of Loans. Loan originations can be attributed to
depositors, retail customers, phone inquiries, advertising, the efforts of the
Bank's loan officers, and referrals from other borrowers, real estate brokers
and builders. The Bank originates loans primarily through its own efforts,
occasionally obtaining loan opportunities as a result of referrals from loan
brokers.
34
At December 31, 2005, the Bank's total capital, net of goodwill and
loan loss reserves, was approximately $95.19 million and thus it was generally
not permitted to make loans to one borrower in excess of approximately $9.52
million, with an additional amount of approximately $14.28 million being
permitted if secured by readily marketable collateral. The Bank was also not
permitted to make any single mortgage loan in an amount in excess of
approximately $23.80 million. At December 31, 2005, the Bank was in compliance
with these standards.
Delinquency Procedures. When a borrower fails to make a required
payment on a loan, the Bank attempts to cause the deficiency to be cured by
contacting the borrower. The Bank reviews past due loans on a case by case
basis, taking the action it deems appropriate in order to collect the amount
owed. Litigation may be necessary if other procedures are not successful.
Judicial resolution of a past due loan can be delayed if the borrower files a
bankruptcy petition because collection action cannot be continued unless the
Bank first obtains relief from the automatic stay provided by the Bankruptcy
Code.
If a non-mortgage loan becomes delinquent and satisfactory arrangements
for payment cannot be made, the Bank seeks to realize upon any personal property
collateral to the extent feasible and collect any remaining amount owed from the
borrower through legal proceedings, if necessary.
It is the Bank's policy to discontinue accruing interest on a loan when
it is 90 days past due or if management believes that continued interest
accruals are unjustified. The Bank may continue interest accruals if a loan is
more than 90 days past due if the Bank determines that the nature of the
delinquency and the collateral are such that collection of the principal and
interest on the loan in full is reasonably assured. When the accrual of interest
is discontinued, all accrued but unpaid interest is charged against current
period income. Once the accrual of interest is discontinued, the Bank records
interest as and when received until the loan is restored to accruing status. If
the Bank determines that collection of the loan in full is in reasonable doubt,
then amounts received are recorded as a reduction of principal until the loan is
returned to accruing status.
35
The following table sets forth information concerning the Company's
loan portfolio by type of loan at the dates indicated:
December 31,
------------------------------------------------------------------------------------
2005 2004 2003
-------------------------- ---------------------------- ---------------------------
% of % of % of
Amount Total Amount Total Amount Total
------------- ---------- ------------- ----------- ------------ -----------
(Dollars in thousands)
Commercial and
professional loans $ 33,370 10.8% $ 16,498 5.7% $ 22,228 7.5%
Secured by real estate
1 - 4 family 139,931 45.1 155,079 53.9 169,589 57.4
Multi family 2,874 0.9 4,600 1.6 6,608 2.2
Non-residential
(commercial) 132,142 42.6 109,597 38.1 94,956 32.2
Consumer 2,018 0.6 1,989 0.7 2,239 0.7
-------- ----- ------- ----- ------- -----
Total loans 310,335 100.0% 287,763 100.0% 295,620 100.0%
===== ===== =====
Less: Allowance
for loan losses (3,266) (2,927) (2,593)
Unearned fees (1,105) (784) (864)
-------- -------- --------
Loans, net $305,964 $284,052 $292,163
======== ======== ========
December 31,
--------------------------------------------------------
2002 2001
-------------------------- -----------------------------
% of % of
Amount Total Amount Total
------------- ---------- --------------- ----------
(Dollars in thousands)
Commercial and
professional loans $ 16,704 6.0% $ 19,130 7.6%
Secured by real estate
1 - 4 family 180,730 65.4 165,195 65.5
Multi family 8,958 3.2 11,186 4.4
Non-residential
(commercial) 65,809 23.8 51,893 20.6
Consumer 4,051 1.6 4,689 1.8
140 0.1
------- ----- ------- -----
Total loans 276,252 100.0% 252,233 100.0%
===== =====
Less: Allowance
for loan losses (2,315) (2,030)
Unearned fees (755) (193)
-------- --------
Loans, net $273,182 $250,010
======== ========
36
Impaired loan balance, nonaccrual loans and loans greater than 90 days
still accruing
The following table sets forth certain information regarding nonaccrual
loans, including the ratio of such loans to total assets as of the dates
indicated, and certain other related information. The Bank had no foreclosed
real estate during these periods and loans past due more than 90 days still
accruing were $0 and $50,000 at December 31, 2005 and 2004, respectively.
December 31,
--------------------------------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
(Dollars in Thousands)
Nonaccrual loans:
Commercial and $ -- $ -- $ -- $ -- $ 9
professional loans
Consumer 3 1 -- -- --
Secured by real estate 253 342 109 59 --
------ ------ ------ ------ ------
Total nonaccrual loans 256 343 109 59 9
------ ------ ------ ------ ------
Accruing loans delinquent
90 days or more 74 50 -- -- --
------ ------ ------ ------ ------
Total nonperforming loans $ 330 $ 393 $ 109 $ 59 $ 9
====== ====== ====== ====== ======
Total nonperforming loans
to total assets .03% .04% .01% -- --
====== ====== ====== ====== ======
The following tables present information regarding the Company's total
allowance for loan losses as well as the allocation of such amounts to the
various categories of loans at the dates indicated (dollars in thousands):
December 31, 2005
-----------------------------------------------------------
Allowance
for Loan Percent of Percent of
Losses Allowance Total Loans
------------------ ------------------ -------------------
Commercial and
professional loans $ 450 13.8% 0.15%
Secured by real estate
1 - 4 family 937 28.7 0.30
Multi family 39 1.2 0.01
Non-residential 1,784 54.6 0.57
Consumer and other 27 0.8 0.01
General allowance (1) 29 0.9 0.01
------- ----- ----
Total allowance
for loan losses $ 3,266 100.0% 1.05%
======= ===== ====
---------------------
(1) The allowance for loan losses is allocated to specific loans as
necessary.
December 31, 2004
-------------------------------------------------------
Allowance
for Loan Percent of Percent of
Losses Allowance Total Loans
------------------ ------------------ ---------------
Commercial and
professional loans $ 223 7.6% 0.08%
Secured by real estate
1 - 4 family 775 26.5 0.27
Multi family 62 2.1 0.02
Non-residential 1,398 47.8 0.49
Consumer and other 27 0.9 0.01
General allowance (1) 442 15.1 0.15
------- ----- ----
Total allowance
for loan losses $ 2,927 100.0% 1.02%
======= ===== ====
---------------------
(1) The allowance for loan losses is allocated to specific loans as
necessary.
37
December 31, 2003
-------------------------------------------------------
Allowance
for Loan Percent of Percent of
Losses Allowance Total Loans
------------------ ------------------ ---------------
Commercial and
professional loans $ 300 11.6% 0.10%
Secured by real estate
1 - 4 family 424 16.3 0.14
Multi family 89 3.4 0.03
Non-residential 1,198 46.2 0.41
Consumer and other 30 1.2 0.01
General allowance (1) 552 21.3 0.19
------- ----- ----
Total allowance
for loan losses $ 2,593 100.0% 0.88%
======= ===== ====
---------------------
(1) The allowance for loan losses is allocated to specific loans as
necessary.
December 31, 2002
-------------------------------------------------------
Allowance
for Loan Percent of Percent of
Losses Allowance Total Loans
------------------ ------------------ ---------------
Commercial and
professional loans $ 225 9.7% 0.08%
Secured by real estate
1 - 4 family 452 19.5 0.16
Multi family 121 5.2 0.04
Non-residential 888 38.4 0.32
Consumer and other 55 2.4 0.02
General allowance (1) 574 24.8 0.21
------- ----- ----
Total allowance
for loan losses $ 2,315 100.0% 0.83%
======= ===== ====
---------------------
(1) The allowance for loan losses is allocated to specific loans as
necessary.
December 31, 2001
------------------------------------------------------
Allowance
for Loan Percent of Percent of
Losses Allowance Total Loans
------------------ ------------------ --------------
Commercial and
professional loans $ 188 9.3% 0.07%
Secured by real estate
1 - 4 family 804 39.6 0.32
Multi family 84 4.1 0.03
Non-residential 790 38.9 0.32
Consumer and other 24 1.2 0.06
General allowance (1) 140 6.9 0.06
------- ----- ----
Total allowance
for loan losses $ 2,030 100.0% 0.79%
======= ===== ====
---------------------
(1) The allowance for loan losses is allocated to specific loans as
necessary.
38
The following tables set forth information regarding the aggregate
maturities of the Company's loans in the specified categories and the amount of
such loans which have fixed and variable rates.
December 31, 2005
--------------------------------------------------------------
Within 1 to After
1 Year 5 Years 5 Years Total
-------- --------- --------- ------
(In thousands)
Fixed Rate
Commercial and professional $ 496 $ 13,110 $ 3,103 $ 16,709
Non-residential 9,603 35,398 25,536 70,537
--------- --------- --------- ---------
Total fixed rate $ 10,099 $ 48,508 $ 28,639 $ 87,246
--------- --------- --------- ---------
Adjustable Rate
Commercial and professional 5,345 10,571 745 16,661
Non-residential 13,164 10,852 37,589 61,605
--------- --------- --------- ---------
Total adjustable rate $ 18,509 $ 21,423 $ 38,334 $ 78,266
--------- --------- --------- ---------
Total $ 28,608 $ 69,931 $ 66,973 $ 165,512
========= ========= ========= =========
The following table sets forth information with respect to activity in
the Company's allowance for loan losses during the periods indicated (in
thousands, except percentages):
Years Ended December 31,
---------------------------------------------------------------------
2005 2004 2003 2002 2001
---- ---- ---- ---- ----
Average loans outstanding $287,178 $290,774 $291,586 $265,961 $195,296
======== ======== ======== ======== ========
Allowance at beginning
of period 2,927 2,593 2,315 2,030 1,108
Charge-offs:
Commercial and other
loans 26 24 4 199 97
Real estate loans -- -- 13 -- --
-------- -------- -------- -------- --------
Total loans charged-off 26 24 17 199 97
-------- -------- -------- -------- --------
Recoveries:
Commercial and other
loans 185 178 55 97 41
Real estate loans -- -- -- -- --
-------- -------- -------- -------- --------
Total loans recovered 185 178 55 97 41
-------- -------- -------- -------- --------
Net recoveries
(charge-offs) 159 154 38 (102) (56)
-------- -------- -------- -------- --------
Provision for loan losses
charged to operating
expenses 180 180 240 387 287
Acquisition of GSB -- -- -- -- 691
-------- -------- -------- -------- --------
Allowance at end of period $ 3,266 $ 2,927 $ 2,593 $ 2,315 $ 2,030
-------- -------- -------- -------- --------
Ratio of net recoveries
(charge-offs) to average
loans outstanding .06% .05% .01% (.03)% (.02)%
======== ======== ======== ======== ========
Allowance as a percent
of total loans 1.05% 1.02% 0.88% 0.83% 0.80%
======== ======== ======== ======== ========
Total loans at end
of period $310,335 $287,763 $295,620 $276,252 $252,233
======== ======== ======== ======== ========
39
Deposits
The Bank concentrates on obtaining deposits from a variety of
businesses, professionals and retail customers. The Bank offers a number of
different deposit programs, including statement savings accounts, NOW accounts,
money market deposits accounts, checking accounts and certificates of deposits
with terms from seven days to five years. Deposit account terms vary according
to the minimum balance required, the time period the funds must remain on
deposit and the interest rate, among other factors. The Bank prices its deposit
offerings competitively within the market it serves. These products are designed
to attract new customers, retain existing customers and create opportunities to
offer other bank products or services. While the market and pricing for deposit
funds are very competitive, the Bank believes that personalized, quality service
is also an important element in retaining core deposit customers.
The following table summarizes the composition of the average balances
of major deposit categories:
December 31,
------------------------------------------------------------------------------
2005 2004 2003
---- ---- ----
Average Average Average Average Average Average
Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ -----
(Dollars in thousands)
Demand deposits $ 44,739 -- $ 38,896 -- $ 32,592 --
NOW and money market 42,756 0.56% 47,677 0.65% 58,723 1.02%
Savings deposits 221,374 1.99 224,542 1.55 143,094 1.95
Time deposits 338,834 2.82 309,968 1.94 333,112 2.26
-------- ---- -------- ---- -------- ----
Total deposits $647,703 2.19% $621,083 1.58% $567,521 1.78%
======== ==== ======== ==== ======== ====
The aggregate amount of jumbo certificates of deposit, each with a
minimum denomination of $100,000, was approximately $203.72 million, $109.74
million and $110.08 million at December 31, 2005, 2004 and 2003, respectively.
The following table summarizes the maturity distribution of time
deposits of $100,000 or more as of December 31, 2005:
(In thousands)
3 months or less $ 62,614
Over 3 months but within 6 months 50,551
Over 6 months but within 12 months 86,382
Over 12 months 4,175
--------
Total $203,722
========
40
Short-Term Borrowings
Securities sold under agreements to repurchase generally mature within
30 days from the date of the transactions. Short-term borrowings consist of
Treasury Tax and Loan Note Options and various other borrowings which generally
have maturities of less than one year. The details of these categories are
presented below:
Years Ended December 31,
-----------------------------------------------------
2005 2004 2003
----------------- ----------------- ----------------
(Dollars in thousands)
Securities sold under repurchase
agreements and federal funds purchased
Balance at year-end $ 73,044 $127,747 $114,391
Average during the year $108,785 $129,794 $ 57,554
Maximum month-end balance $145,489 $148,753 $114,391
Weighted average rate during the year 3.47% 1.87% 1.68%
Rate at December 31 3.59% 2.27% 1.73%
Capital Resources and Liquidity
Liquidity
The management of the Company's liquidity focuses on ensuring that
sufficient funds are available to meet loan funding commitments, withdrawals
from deposit accounts, the repayment of borrowed funds, and ensuring that the
Bank and the Company comply with regulatory liquidity requirements. Liquidity
needs of The Berkshire Bank have historically been met by deposits, investments
in federal funds sold, principal and interest payments on loans, and maturities
of investment securities.
For the parent company, Berkshire Bancorp Inc., liquidity means having
cash available to fund operating expenses and to pay stockholder dividends, when
and if declared by our Board of Directors. We paid cash dividends per share of
$.15, $.11 and $.08 in fiscal 2005, 2004 and 2003, respectively. The ability to
fund our operations and to pay dividends is not dependent upon the receipt of
dividends from The Berkshire Bank. At December 31, 2005, we had cash of
approximately $11.2 million and investment securities with a fair market value
of $11.8 million.
Contingent Liabilities and Commitments
The Bank maintains financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and stand-by
letters of credit. The following table presents the Company's commitments at
December 31, 2005.
Expiration By Period
-------------------------------------------------------------------------------
Less More
Than 1-3 3-5 Than
Total 1 Year Years Years 5 Years
----- ------ ----- ----- -------
(In thousands)
Lines of Credit $ 16,808 $ 5,119 $ 8,697 $ 44 $ 2,948
Standby Letters
of Credit 1,155 1,155 -- -- --
Loan Commitments 2,531 2,531 -- -- --
-------- -------- -------- -------- --------
Total $ 20,494 $ 8,805 $ 8,697 $ 44 $ 2,948
======== ======== ======== ======== ========
41
Contractual Obligations
The following table presents the Company's contractual obligations at
December 31, 2005.
Payments Due By Periods
-------------------------------------------------------------------------------
Less More
Than 1-3 3-5 Than
Total 1 Year Years Years 5 Years
----- ------ ----- ----- -------
(In thousands)
Long-Term Debt $105,882 $ 4,290 $ 52,196 $ 26,715 $ 22,681
Operating Leases 4,156 850 1,521 985 800
Time Deposits 402,585 396,048 6,523 14 --
-------- -------- -------- -------- --------
Total Contractual
Obligations $512,623 $401,188 $ 60,240 $ 27,714 $ 23,481
======== ======== ======== ======== ========
The Company currently has two unconsolidated subsidiaries and no
special purpose entities.
Capital
The capital ratios of the Bank and Berkshire are presently in excess of
the requirements necessary to meet the "well capitalized" capital category
established by bank regulators. See Note P to the Consolidated Financial
Statements.
Interest Rate Risk
Fluctuations in market interest rates can have a material effect on the
Bank's net interest income because the yields earned on loans and investments
may not adjust to market rates of interest with the same frequency, or with the
same speed, as the rates paid by the Bank on its deposits.
Most of the Bank's deposits are either interest-bearing demand deposits
or short term certificates of deposit and other interest-bearing deposits with
interest rates that fluctuate as market rates change. Management of the Bank
seeks to reduce the risk of interest rate fluctuations by concentrating on loans
and securities investments with either short terms to maturity or with
adjustable rates or other features that cause yields to adjust based upon
interest rate fluctuations. In addition, to cushion itself against the potential
adverse effects of a substantial and sustained increase in market interest
rates, the Bank has purchased off balance sheet interest rate cap contracts
which generally provide that the Bank will be entitled to receive payments from
the other party to the contract if interest rates exceed specified levels. These
contracts are entered into with major financial institutions.
The Company seeks to maximize its net interest margin within an
acceptable level of interest rate risk. Interest rate risk can be defined as the
amount of the forecasted net interest income that may be gained or lost due to
favorable or unfavorable movements in interest rates. Interest rate risk, or
sensitivity, arises when the maturity or repricing characteristics of assets
differ significantly from the maturity or repricing characteristics of
liabilities.
42
In the banking industry, a traditional measure of interest rate sensitivity is
known as "gap" analysis, which measures the cumulative differences between the
amounts of assets and liabilities maturing or repricing at various time
intervals. The following table sets forth the Company's interest rate repricing
gaps for selected maturity periods:
Berkshire Bancorp Inc.
Interest Rate Sensitivity Gap at December 31, 2005
(in thousands, except for percentages)
-------------------------------------------------------------------------------------------
3 Months 3 Through 1 Through Over
or Less 12 Months 3 Years 3 Years Total Fair Value
-------------- --------------- -------------- -------------- -------------- -------------
Federal funds sold 13,600 13,600 13,600
(Rate) 4.27%
Interest bearing deposits in banks 4,457 -- -- -- 4,457 4,457
(Rate) 3.60% 3.60%
Loans (1)(2)
Adjustable rate loans 49,923 11,248 11,698 26,134 99,003 103,943
(Rate) 8.05% 6.07% 7.44% 6.61% 7.37%
Fixed rate loans 87 10,354 19,661 181,230 211,332 209,122
(Rate) 6.27% 7.52% 6.70% 6.27% 6.37%
--------- --------- --------- --------- ----------
Total loans 50,010 21,602 31,359 207,364 310,335 313,065
Investments (3)(4) 108,447 166,837 94,744 229,944 599,972 599,983
(Rate) 3.65% 3.34% 4.10% 4.11% 4.11%
--------- --------- --------- --------- ----------
Total rate-sensitive assets 176,514 188,439 126,103 437,308 928,364
--------- ---------- --------- --------- ----------
Deposit accounts (5)
Savings and NOW 204,776 -- -- -- 204,776 204,776
(Rate) 2.08% 2.08%
Money market 22,630 -- -- -- 22,630 22,630
(Rate) 0.82% 0.82%
Time Deposits 116,331 279,717 6,523 14 402,585 400,407
(Rate) 2.91% 3.63% 2.80% 1.74% 3.41%
--------- --------- --------- --------- ----------
Total deposit accounts 343,737 279,717 6,523 14 629,991
Repurchase Agreements 40,044 30,000 3,000 -- 73,044 72,505
(Rate) 4.00% 2.86% 3.52% -- 3.51%
Other borrowings -- 4,290 52,196 49,396 105,882 105,753
(Rate) % 3.09% 3.56% 5.81% 4.59%
--------- --------- --------- --------- ----------
Total rate-sensitive liabilities 383,781 314,007 61,719 49,410 808,917
--------- --------- --------- --------- ----------
Interest rate caps 20,000 (20,000) 20
Gap (repricing differences) (227,267) (125,568) 84,384 387,898 119,447
========= ========= ========= ========= ==========
Cumulative Gap (227,267) (352,835) (268,451) 119,447
========= ========= ========= =========
Cumulative Gap to Total Rate
Sensitive Assets (24.48)% (38.01)% (28.92)% 12.87%
========= ========= ========= =========
---------------------
(1) Adjustable-rate loans are included in the period in which the interest
rates are next scheduled to adjust rather than in the period in which
the loans mature. Fixed-rate loans are scheduled according to their
maturity dates.
(2) Includes nonaccrual loans.
(3) Investments are scheduled according to their respective repricing
(variable rate loans) and maturity (fixed rate securities) dates.
(4) Investments are stated at book value.
(5) NOW accounts and savings accounts are regarded as readily accessible
withdrawal accounts. The balances in such accounts have been allocated
among maturity/repricing periods based upon The Berkshire Bank's
historical experience. All other time accounts are scheduled according
to their respective maturity dates.
43
Impact of Inflation and Changing Prices
The Company's financial statements measure financial position and
operating results in terms of historical dollars without considering the changes
in the relative purchasing power of money over time due to inflation. The impact
of inflation is reflected in the increasing cost of the Company's operations.
The assets and liabilities of the Company are largely monetary. As a result,
interest rates have a greater impact on the Company's performance than do the
effects of general levels of inflation. In addition, interest rates do not
necessarily move in the direction, or to the same extent as the price of goods
and services. However, in general, high inflation rates are accompanied by
higher interest rates, and vice versa.
New Accounting Pronouncements
Accounting For Stock Based Compensation
In December 2004, the Financial Accounting Standards Board (the "FASB")
issued Statement No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123(R)")
which requires the measurement and recognition of compensation expense for all
stock-based compensation payments and supersedes the Company's current
accounting under Accounting Principals Board Opinion No. 25, "Accounting for
Stock Issued to Employees" (APB 25). SFAS 123(R) is effective for all annual
periods beginning after June 15, 2005 or our fiscal year 2006. In March 2005,
the Securities and Exchange Commission (the "SEC") issued Staff Accounting
Bulletin No. 107 ("SAB 107") relating to the adoption of SFAS 123(R).
The Company will adopt SFAS 123(R) in the first quarter of fiscal year
2006, the adoption of which is not expected to have an impact on its operating
results and financial condition. The pro forma information presented in Note B9,
Stock Based Compensation, presents the estimated compensation charges under
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation."
At December 31, 2005, the Company has one stock-based employee
compensation plan. The Company accounted for that plan under the recognition and
measurement principles of APB 25 and related interpretations. Stock-based
employee compensation costs were not reflected in net income, as all options
granted under the plan had an exercise price equal to the market value of the
underlying common stock on the date of the grant. The Company did not grant
stock options during 2005, 2004 and 2003 and we have no plans to grant
significant stock options, if any, in 2006. Therefore, we do not expect the
implementation of FAS 123(R) to affect our financial position or results of
operations in the near future.
Accounting for Loans or Certain Debt Securities Acquired in a Transfer
In October 2003, the American Institute of Certified Public Accountants
(the "AICPA") issued SOP 03-3, Accounting for Loans or Certain Debt Securities
Acquired in a Transfer. SOP 03-3 applies to a loan with the evidence of
deterioration of credit quality since origination acquired by completion of a
transfer for which it is probable at acquisition, that the Company will be
unable to collect all contractually required payments receivable. SOP 03-3
requires that the Company recognize the excess of all cash flows expected at
acquisition over the investor's initial investment in the loan as interest
income on a level-yield basis over the life of the loan as the accretable yield.
The loan's contractual required payments receivable in excess of the amount of
its cash flows excepted at acquisition (nonaccretable difference) should not be
recognized as an adjustment to yield, a loss accrual or a valuation allowance
for credit risk. SOP 03-3 was effective for loans acquired in fiscal years
beginning after December 31, 2004. The adoption of SOP 03-3 has not had a
material effect on our consolidated financial statements.
44
The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments
In November 2003, the Emerging Issues Task Force (the "EITF") of the
FASB issued EITF Abstract 03-1, "The Meaning of Other-Than-Temporary Impairment
and its Application to Certain Investments" (EITF Issue No. 03-1). In March
2004, the EITF reached a consensus on EITF Issue No. 03-1 and in September 2004,
the FASB issued a proposed Board-directed FASB Staff Position (an "FSP"), FSP
EITF 03-1-a, "Implementation Guidance for the Application of Paragraph 16 of
EITF Issue No. 03-1" (FSP EITF 03-1-a). The guidance in FSP EITF 03-1-a is
applicable for investments in (a) debt and equity securities that are within the
scope of SFAS Nos. 115 and 124, and (b) equity securities that are not subject
to the scope of FAS 115 and 124 and not accounted for under the equity method of
accounting, "cost-method investments."
The final FSP, retitled FSP FAS 115-1 and FAS 124-1 "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments,"
nullifies certain requirements of EITF No. 03-1 and supersedes EITF Topic No.
D-44, "Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a
Security Whose Cost Exceeds Fair Value." FSP FAS 115-1 and FAS 124-1
specifically (a) nullifies the requirements of paragraphs 10-18 of EITF No.
03-1, (b) carries forward the requirements of paragraphs 8 and 9 with respect to
cost- method-investments and the disclosure requirements included in paragraphs
21 and 22 of EITF No. 03-1 and related examples, and (c) references existing
other-than- temporary impairment guidance. FSP FAS 115-1 and FAS 124-1
establishes a three-step approach for determining when an investment is
considered impaired, whether that impairment is other than temporary, and the
measurement of an impairment loss.
Application of the guidance in FSP FAS 115-1 and FAS 124-1, applicable
to reporting periods beginning after December 15, 2005, is not expected to have
a material adverse effect on our consolidated financial statements.
Internal Control Over Financial Reporting
The current objective of the Company's Internal Control Program is to
allow the Bank and management to comply with Part 363 of the FDIC's regulations
("FDICIA") and to allow the Company to comply with Section 302 of the
Sarbanes-Oxley Act of 2002 (the "Act"). In November 2005, the FDIC amended Part
363 of its regulations by raising the asset-size threshold from $500 million to
$1 billion for internal control assessments by management and external auditors.
The final rule is effective December 28, 2005.
Section 302 of the Act requires the CEOs and CFOs of the Company to
(i) certify that the annual and quarterly reports filed with the Securities and
Exchange Commission are accurate and (ii) acknowledge that they are responsible
for establishing, maintaining and periodically evaluating the effectiveness of
the disclosure controls and procedures. Section 404 of the Act requires
management to (i) report on internal control over financial reporting, (ii)
assess the effectiveness of such internal controls, and (iii) obtain an external
auditor's report on management's assessment of its internal control. The Company
is not an accelerated filer as defined in Rule 12b-2 of the Securities Exchange
Act of 1934. Therefore, the Company is not required to comply with Section 404
until the year ending December 31, 2007.
The Committee of Sponsoring Organizations (COSO) methodology may be
used to document and test the internal controls pertaining to the accuracy of
Company issued financial statements and related disclosures. COSO requires a
review of the control environment (including anti-fraud and audit committee
effectiveness), risk assessment, control activities, information and
communication, and ongoing monitoring.
ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk.
See Item 7. Managements' Discussion and Analysis of Financial Condition
and Results of Operations - Interest Rate Risk
ITEM 8. Financial Statements and Supplementary Data.
45
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
of Berkshire Bancorp Inc.
We have audited the accompanying consolidated balance sheets of Berkshire
Bancorp Inc. and subsidiaries as of December 31, 2005 and 2004, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 2005. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, 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 financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Berkshire Bancorp
Inc. and subsidiaries as of December 31, 2005 and 2004, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended December 31, 2005, in conformity with accounting
principles generally accepted in the United States of America.
/s/ GRANT THORNTON LLP
New York, New York
February 24, 2006
46
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
December 31, December 31,
2005 2004
--------------------------------------
ASSETS
Cash and due from banks $ 9,825 $ 9,511
Interest bearing deposits 4,457 372
Federal funds sold 13,600 7,500
--------- ---------
Total cash and cash equivalents 27,882 17,383
Investment Securities:
Available-for-sale 599,410 630,968
Held-to-maturity, fair value of $573
in 2005 and $633 in 2004 562 624
--------- ---------
Total investment securities 599,972 631,592
Loans, net of unearned income 309,230 286,979
Less: allowance for loan losses (3,266) (2,927)
--------- ---------
Net loans 305,964 284,052
Accrued interest receivable 6,784 6,014
Premises and equipment, net 8,602 8,677
Goodwill, net 18,549 18,549
Other assets 9,699 6,382
--------- ---------
Total assets $ 977,452 $ 972,649
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 50,269 $ 42,191
Interest bearing 629,991 577,697
--------- ---------
Total deposits 680,260 619,888
Securities sold under agreements to repurchase 73,044 127,747
Long term borrowings 83,201 95,605
Subordinated debt 22,681 15,464
Accrued interest payable 5,731 2,516
Other liabilities 3,825 3,810
--------- ---------
Total liabilities 868,742 865,030
--------- ---------
Stockholders' equity
Preferred stock - $.10 Par value: -- --
2,000,000 shares authorized - none issued
Common stock - $.10 par value
Authorized -- 10,000,000 shares
Issued -- 7,698,285 shares
Outstanding --
December 31, 2005, 6,890,556 shares
December 31, 2004, 6,748,675 shares 770 770
Additional paid-in capital 90,594 89,543
Retained earnings 33,504 28,983
Accumulated other comprehensive loss, net (8,415) (2,602)
Treasury Stock
December 31, 2005, 807,729 shares
December 31, 2004, 949,610 shares (7,743) (9,075)
--------- ---------
Total stockholders' equity 108,710 107,619
--------- ---------
Total liabilities and stockholders' equity $ 977,452 $ 972,649
========= =========
The accompanying notes are an integral part of these statements
47
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Data)
For The Years Ended December 31,
-----------------------------------------------
2005 2004 2003
-------- -------- ------
INTEREST INCOME
Federal funds sold and interest bearing deposits $ 302 $ 63 $ 44
Investments securities 25,355 21,120 15,321
Loans, including related fees 19,399 18,825 19,061
-------- -------- --------
Total interest income 45,056 40,008 34,426
-------- -------- --------
INTEREST EXPENSE
Deposits 14,191 9,833 10,130
Short-term borrowings 3,167 2,422 794
Long-term borrowings 5,041 3,661 2,723
-------- -------- --------
Total interest expense 22,399 15,916 13,647
-------- -------- --------
Net interest income 22,657 24,092 20,779
PROVISION FOR LOAN LOSSES 180 180 240
-------- -------- --------
Net interest income after
provision for loan losses 22,477 23,912 20,539
-------- -------- --------
NON-INTEREST INCOME
Service charges on deposit accounts 589 520 640
Investment securities gains 4 793 2,746
Other income 613 506 597
-------- -------- --------
Total non-interest income 1,206 1,819 3,983
-------- -------- --------
NON-INTEREST EXPENSE
Salaries and employee benefits 8,002 6,886 5,873
Net occupancy expense 1,728 1,538 1,611
Equipment expense 397 357 397
FDIC assessment 272 115 80
Data processing expense 198 157 183
Other 2,542 3,042 3,319
-------- -------- --------
Total non-interest expense 13,139 12,095 11,463
-------- -------- --------
Income before provision for taxes 10,544 13,636 13,059
Provision for income taxes 5,003 6,134 5,644
-------- -------- --------
Net income $ 5,541 $ 7,502 $ 7,415
======== ======== ========
Net income per share:
Basic $ .81 $ 1.12 $ 1.12
======== ======== ========
Diluted $ .80 $ 1.10 $ 1.10
======== ======== ========
Number of shares used to compute net income per share:
Basic 6,805 6,672 6,636
======== ======== ========
Diluted 6,939 6,848 6,747
======== ======== ========
Dividends per share $ .15 $ .11 $ .09
The accompanying notes are an integral part of these statements
48
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For The Years Ended December 31, 2005, 2004 and 2003
(In Thousands)
Accumulated
Common Stock Additional other Total
Par paid-in comprehensive Retained Treasury Comprehensive stockholders'
Shares value capital (loss) net earnings stock income equity
------ ----- ------- ---------- -------- ----- ------ ------
Balance at January 1, 2003 2,566 $256 $89,890 $1,480 $ 16,145 $(9,246) $ 98,525
Net income 7,415 7,415 7,415
Acquisition of treasury shares (1,350) (1,350)
Exercise of stock options (24) 229 205
Other comprehensive (loss) net
of reclassification adjustment
and taxes (705) (705) (705)
-------
Comprehensive income $ 6,710
=======
Cash dividends (600) (600)
------ ---- ------- ------ -------- -------- --------
Balance at December 31, 2003 2,566 256 89,866 775 22,960 (10,367) 103,490
Net income 7,502 7,502 7,502
Exercise of stock options (90) 1,361 1,271
Acquisition of treasury shares (69) (69)
Effect of reverse one-for-ten
stock split (2,309) (230) (233) (463)
Effect of thirty-for-one
stock dividend 7,441 744 (744)
Other comprehensive (loss) net
of reclassification adjustment
and taxes (3,377) (3,377) (3,377)
-------
Comprehensive income $ 4,125
=======
Cash dividends (735) (735)
------ ---- ------- ------- -------- -------- --------
Balance at December 31, 2004 7,698 770 89,543 (2,602) 28,983 (9,075) 107,619
Net income 5,541 5,541 5,541
Exercise of stock options 354 1,332 1,686
Deferred tax benefit from exercise
of stock options 697 697
Other comprehensive (loss) net
of reclassification adjustment
and taxes (5,813) (5,813) (5,813)
-------
Comprehensive loss $ (272)
=======
Cash dividends (1,020) (1,020)
----- ---- ------- ------- -------- -------- --------
Balance at December 31, 2005 7,698 $770 $90,594 $(8,415) $ 33,504 $ (7,743) $108,710
==== ======= ======= ======== ======== ========
The accompanying notes are an integral part of these statements
49
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For The Years Ended December 31,
--------------------------------------------------
2005 2004 2003
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 5,541 $ 7,502 $ 7,415
Adjustments to reconcile net income
to net cash provided by operating
activities:
Realized gains on investment securities (4) (793) (4,151)
Net (accretion) amortization of premiums
of investment securities (3) 2,282 1,405
Depreciation and amortization 650 590 605
Provision for loan losses 180 180 240
CHANGES IN ASSETS AND LIABILITIES:
(Increase) in accrued interest receivable (770) (716) (1,192)
(Increase) in other assets (3,030) (3,873) (860)
Increase (decrease) in accrued interest
payable and other liabilities 3,640 538 (1,054)
----------- ----------- -----------
Net cash provided by operating activities 6,204 5,710 2,408
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment securities available for sale
Purchases (378,781) (1,740,889) (1,837,653)
Sales, maturities and calls 404,533 1,674,188 1,641,186
Investment securities held to maturity
Purchases -- 91 --
Maturities 62 -- 118
Net (increase) decrease in loans (22,092) 7,931 (19,221)
Acquisition of premises and equipment (575) (602) (294)
----------- ----------- -----------
Net cash provided by (used in)
investing activities 3,147 (59,281) (215,864)
----------- ----------- -----------
50
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
(in thousands)
For The Years Ended December 31,
--------------------------------------------------
2005 2004 2003
---- ---- ----
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in non interest
bearing deposits 8,078 3,769 7,102
Net increase in interest bearing deposits 52,294 11,864 123,335
(Decrease) increase in securities sold
under agreements to repurchase (54,703) 13,356 67,718
Proceeds from long term debt 20,000 37,164 20,046
Repayment of long term debt (32,404) (19,304) --
Proceeds from issuance of
subordinated debentures, net 7,217 14,791 --
Acquisition of treasury stock -- (69) (1,350)
Proceeds from exercise of common
stock options 1,686 1,271 205
Cash paid for fractional shares -- (463) --
Dividends paid (1,020) (735) (600)
----------- ----------- -----------
Net cash provided by financing activities 1,148 61,644 216,456
----------- ----------- -----------
Net increase in cash and
cash equivalents 10,499 8,073 3,000
Cash and cash equivalents at
beginning of year $ 17,383 $ 9,310 $ 6,310
----------- ----------- -----------
Cash and cash equivalents at
end of year $ 27,882 $ 17,383 $ 9,310
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash used to pay interest $ 19,184 $ 15,608 $ 14,787
Cash used to pay income taxes,
net of refunds $ 6,716 $ 5,960 $ 2,015
The accompanying notes are an integral part of these statements
51
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2005 and 2004
Note A - ORGANIZATION AND CAPITALIZATION
Organization
Berkshire Bancorp Inc. ("Berkshire" or the "Company" or "we" and
similar pronouns), a Delaware corporation, is a bank holding company registered
under the Bank Holding Company Act of 1956. Berkshire's principal activity is
the ownership and management of its wholly owned subsidiary, The Berkshire Bank
(the "Bank"), a New York State chartered commercial bank.
The Bank was established in 1989 to provide highly personalized
services to high net worth individuals and to small and mid-sized commercial
businesses primarily from the New York City metropolitan area. In March 2001,
the Company expanded its customer base and market area with the acquisition of
GSB Financial Corporation. The Bank's main office and branch is in mid-town
Manhattan. The Bank has one other branch in lower Manhattan, four branches in
Brooklyn, New York, and four branches in Orange and Sullivan Counties in New
York State.
The Bank competes with other banking and financial institutions in its
markets. Commercial banks, savings banks, savings and loan associations,
mortgage bankers and brokers, and credit unions actively compete for deposits
and loans. Such institutions, as well as consumer finance, mutual funds,
insurance companies, and brokerage and investment banking firms may be
considered to be competitors of the Bank with respect to one or more of the
services provided by the Bank.
The Company and the Bank are subject to the regulations of certain
state and federal agencies and, accordingly, are periodically examined by those
regulatory authorities. As a consequence of such regulation of banking
activities, the Bank's business may be affected by state and federal
legislation.
Stock Split and Stock Dividend
At the Annual Meeting of Stockholders held on May 18, 2004, the
Company's stockholders approved an amendment to the Company's Certificate of
Incorporation effecting a one-for-ten reverse stock split of the Company's
issued and outstanding Common Stock (the "Reverse Split"). Following the
effectiveness of the Reverse Split, the Company's Board of Directors declared a
thirty-for-one forward stock split in the form of a stock dividend in Common
Stock (the "Stock Dividend) which became effective immediately. The Company paid
approximately $463,000 to purchase fractional shares from stockholders as part
of the Reverse Split. The Company's Common Stock began trading on May 19, 2004
giving effect to these transactions.
Trust Preferred Securities
As of May 18 2004, the Company established Berkshire Capital Trust I, a
Delaware statutory trust, ("BCTI"). The Company owns all the common capital
securities of BCTI. BCTI issued $15.0 million of preferred capital securities to
investors in a private transaction and invested the proceeds, combined with the
proceeds from the sale of BCTI's common capital securities, in the Company
through the purchase of $15.464 million aggregate principal amount of Floating
Rate Junior Subordinated Debentures (the "Debentures") issued by the Company.
The Debentures, the sole assets of BCTI, mature on July 23, 2034 and bear
interest at a floating rate, three month LIBOR plus 2.70%.
On April 1, 2005, the Company established Berkshire Capital Trust II, a
Delaware statutory trust, ("BCTII"). The Company owns all the common capital
securities of BCTII. BCTII issued $7.0 million of preferred capital securities
to investors in a private transaction and invested the proceeds, combined with
the proceeds from the sale of BCTII's common capital securities, in the Company
through the purchase of $7.217 million aggregate principal amount of Floating
Rate Junior Subordinated Debentures (the "2005 Debentures") issued by the
Company. The 2005 Debentures, the sole assets of BCTII, mature on May 23, 2035
and bear interest at a floating rate, three month LIBOR plus 1.95%.
52
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note A - (continued)
Based on current interpretations of the banking regulators, the 2004
Debentures and 2005 Debentures (collectively, the "Debentures") qualify under
the risk-based capital guidelines of the Federal Reserve as Tier 1 capital,
subject to certain limitations. The Debentures are callable by the Company,
subject to any required regulatory approvals, at par, in whole or in part, at
any time after five years from the date of issuance. The Company's obligations
under the Debentures and related documents, taken together, constitute a full,
irrevocable and unconditional guarantee on a subordinated basis by the Company
of the obligations of BCTI and BCTII under the preferred capital securities sold
by BCTI and BCTII to investors. FIN46(R) precludes consideration of the call
option embedded in the preferred capital securities when determining if the
Company has the right to a majority of BCTI and BCTII expected residual returns.
Accordingly, BCTI and BCTII are not included in the consolidated balance sheet
of the Company.
The Federal Reserve has issued guidance on the regulatory capital
treatment for the trust-preferred securities issued by BCTI and BCTII. This rule
would retain the current maximum percentage of total capital permitted for Trust
Preferred Securities at 25%, but would enact other changes to the rules
governing Trust Preferred Securities that affect their use as part of the
collection of entities known as "restricted core capital elements." The rule
would take effect March 31, 2009; however, a five year transition period
starting March 31, 2004 and leading up to that date would allow bank holding
companies to continue to count Trust Preferred Securities as Tier 1 Capital
after applying FIN-46(R). Management has evaluated the effects of this rule and
does not anticipate a material impact on its capital ratios when the proposed
rule is finalized.
Note B - SUMMARY OF ACCOUNTING POLICIES
1. Basis of Financial Statement Presentation
The consolidated financial statements have been prepared in accordance
with accounting principals generally accepted in the United States of America
and predominant practice within the banking industry, and include the accounts
of Berkshire Bancorp Inc. and its wholly owned subsidiaries, Greater American
Finance Group, Inc. ("GAFG"), East 39, LLC and the Bank, (collectively, the
"Company"). All significant intercompany accounts and transactions have been
eliminated.
In preparing the 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, the disclosure of contingent assets and liabilities at
the date of the balance sheets, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The principal estimates that are susceptible to significant change in
the near term relates to the allowance for loan losses, goodwill, and deferred
tax assets and liabilities. The evaluation of the adequacy of the allowance for
loan losses includes an analysis of the individual loans and overall risk
characteristics and size of the different loan portfolios, and takes into
consideration current economic and market conditions, the capability of specific
borrowers to pay specific loan obligations, as well as current loan collateral
values. However, actual losses on specific loans, which also are encompassed in
the analysis, may vary from estimated losses.
Substantially all outstanding goodwill resulted from the acquisition of
The Berkshire Bank and Goshen Savings Bank, depository institutions
concentrating in the New York City and Orange and Sullivan County communities,
respectively. As the result of the market penetration in these New York areas,
the Company had formulated its own strategy to create such a market role.
Accordingly, implicit in the purchase of these franchises was the acquisition of
that role. However, if such benefits, including new business, are not derived or
the Company changes its business plan, an impairment may be recognized.
53
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note B - (continued)
The Company recognizes deferred tax assets and liabilities for the
future tax effects of temporary differences, net operating loss carryforwards
and tax credits. Deferred tax assets are subject to management's judgment based
upon available evidence that future realization is more likely than not. If
management determines that the Company may be unable to realize all or part of
net deferred tax assets in the future, a direct charge to income tax expense may
be required to reduce the recorded value of the net deferred tax asset to the
expected realizable amount.
The Company is required to provide disclosures under Statement of
Financial Accounting Standards ("SFAS") 131, "Disclosures About Segments of an
Enterprise and Related Information." Operating segments are components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and assess performance. The Company has one operating segment
and, accordingly, one reportable segment, "Community Banking." All of the
Company's activities are interrelated, and each activity is dependent and
assessed based on how each of the activities of the Company supports the others.
For example, commercial lending is dependent upon the ability of the Bank to
fund itself with retail deposits and other borrowings and to manage interest
rate and credit risk. This situation is also similar for consumer and
residential mortgage lending. Accordingly, all significant operating decisions
are based upon analysis of the Company as one operating segment or unit.
2. Investment Securities
The Company accounts for its investment securities in accordance with
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities". Investments in securities are classified in one of three
categories: held to maturity, trading or available for sale. Investments for
which management has both the ability and intent to hold to maturity, are
carried at cost, adjusted for the amortization of premiums and accretion of
discounts computed by the interest method. Investments which management believes
may be sold prior to maturity due to changes in interest rates, prepayment risk
and equity, liquidity requirements or other factors, are classified as available
for sale. Available- for-sale securities are carried at fair value, with the
unrealized gains and losses, net of tax, reported as a separate component of
stockholders' equity and excluded from the determination of net income. Gains or
losses on disposition are based on the net proceeds and cost of the securities
sold, adjusted for amortization of premiums and accretion of discounts, using
the specific identification method.
The Meaning of Other-Than-Temporary Impairment and Its Application to
Certain Investments
In November 2003, the Emerging Issues Task Force (the "EITF") of the
FASB issued EITF Abstract 03-1, "The Meaning of Other-Than-Temporary Impairment
and its Application to Certain Investments" (EITF Issue No. 03-1). In March
2004, the EITF reached a consensus on EITF Issue No. 03-1 and in September 2004,
the FASB issued a proposed Board-directed FASB Staff Position (an "FSP"), FSP
EITF 03-1-a, "Implementation Guidance for the Application of Paragraph 16 of
EITF Issue No. 03-1" (FSP EITF 03-1-a). The guidance in FSP EITF 03-1-a is
applicable for investments in (a) debt and equity securities that are within the
scope of SFAS Nos. 115 and 124, and (b) equity securities that are not subject
to the scope of FAS 115 and 124 and not accounted for under the equity method of
accounting, "cost-method investments."
The final FSP, retitled FSP FAS 115-1 and FAS 124-1 "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments,"
nullifies certain requirements of EITF No. 03-1 and supersedes EITF Topic No.
D-44, "Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a
Security Whose Cost Exceeds Fair Value." FSP FAS 115-1 and FAS 124-1
specifically (a) nullifies the requirements of paragraphs 10-18 of EITF No.
03-1,
54
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note B - (continued)
(b) carries forward the requirements of paragraphs 8 and 9 with respect to cost-
method-investments and the disclosure requirements included in paragraphs 21 and
22 of EITF No. 03-1 and related examples, and (c) references existing
other-than- temporary impairment guidance. FSP FAS 115-1 and FAS 124-1
establishes a three-step approach for determining when an investment is
considered impaired, whether that impairment is other than temporary, and the
measurement of an impairment loss.
Application of the guidance in FSP FAS 115-1 and FAS 124-1, applicable
to reporting periods beginning after December 15, 2005, is not expected to have
a material adverse effect on our consolidated financial statements.
3. Loans and Allowance for Loan Losses
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are stated at the amount of
unpaid principal and are net of unearned discount, unearned loan fees and an
allowance for credit losses. The allowance for loan losses is established
through a provision for loan losses charged to expense. Loan principal
considered to be uncollectible by management is charged against the allowance
for credit losses. The allowance is an amount that management believes will be
adequate to absorb losses on existing loans that may become uncollectible based
upon an evaluation of known and inherent risks in the loan portfolio. The
evaluation takes into consideration such factors as changes in the nature and
size of the loan portfolio, overall portfolio quality, specific problem or
impaired loans, and current economic conditions which may affect the borrowers'
ability to pay. The evaluation details historical losses by loan category, the
resulting loss rates for which are projected at current loan total amounts.
The Company accounts for its impaired loans in accordance with 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 - Income Recognition and
Disclosures." This standard requires that a creditor measure impairment based on
the present value of expected future cash flows discounted at the loan's
effective interest rate, except that as a practical expedient, a creditor may
measure impairment based on a loan's observable market price, or the fair value
of the collateral if the loan is collateral-dependent. Regardless of the
measurement method, a creditor must measure impairment based on the fair value
of the collateral when the creditor determines that foreclosure is probable.
Interest income is accrued as earned on a simple interest basis.
Accrual of interest is discontinued on a loan when management believes, after
considering economic and business conditions and collection efforts, that the
borrower's financial condition is such that collection of interest is doubtful.
When a loan is placed on such non-accrual status, all accumulated accrued
interest receivable applicable to periods prior to the current year is charged
off to the allowance for loan losses. Interest which had accrued in the current
year is reversed out of current period income. Loans 90 days or more past due
and still accruing interest must have both principal and accruing interest
adequately secured and must be in the process of collection.
The Company follows the provisions of SFAS No. 140 "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,"
SFAS No. 140 is based on consistent application of a financial-components
approach that recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has been
surrendered and derecognizes liabilities when extinguished. SFAS No. 140
provides consistent guidelines for distinguishing transfers of financial assets
from transfers that are secured borrowings. The Company adopted SFAS 140 on
April 1, 2001 and the adoption did not have a material impact upon the Company's
consolidated financial statements.
55
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note B - (continued)
In October 2003, the AICPA issued SOP 03-3 Accounting for Loans or
Certain Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan with
the evidence of deterioration of credit quality since origination acquired by
completion of a transfer for which it is probable at acquisition, that the
Company will be unable to collect all contractually required payments
receivable. SOP 03-3 requires that the Company recognize the excess of all cash
flows expected at acquisition over the investor's initial investment in the loan
as interest income on a level-yield basis over the life of the loan as the
accretable yield. The loan's contractual required payments receivable in excess
of the amount of its cash flows excepted at acquisition (nonaccretable
difference) should not be recognized as an adjustment to yield, a loss accrual
or a valuation allowance for credit risk. SOP 03-3 is effective for loans
acquired in fiscal years beginning after December 31, 2004. Early adoption is
permitted. The adoption of SOP 03-3 did not have a significant impact on the
financial condition or results of operations of the Company.
Loan Commitments Accounted for as Derivative Instruments
The SEC staff recently released Staff Accounting Bulletin (SAB) 105,
"Loan Commitments Accounted for as Derivative Instruments." SAB 105 provides
guidance about the measurement of loan commitments recognized at fair value
under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities. SAB 105 also requires companies to disclose their accounting policy
for those loan commitments including methods and assumptions used to estimate
fair value and associated hedging strategies. SAB 105 is effective for all loan
commitments accounted for as derivatives that are entered into after March 31,
2004. The adoption of SAB 105 did not have a material effect on our consolidated
financial statements.
The Company adopted SFAS No. 149 ("SFAS No. 149"), Amendment of SFAS
No. 133 on Derivative Instruments and Hedging Activities, on July 1, 2003. SFAS
No. 149 clarifies and amends SFAS No. 133 for implementation issues raised by
constituents or includes the conclusions reached by the FASB on certain FASB
Staff Implementation Issues. Statement No. 149 also amends SFAS No. 133 to
require a lender to account for loan commitments related to mortgage loans that
will be held for sale as derivatives. SFAS No. 149 is effective for contracts
entered into or modified after September 30, 2003. The Company periodically
enters into commitments with its customers, which it intends to sell in the
future. The adoption of SFAS No. 149 did not have a material impact on the
Company's financial position or results of operations.
The Bank has entered into interest rate cap agreements in order to
hedge its exposure to interest rate fluctuations. The Company adopted the
provisions of SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities", as amended, as of January 1, 2001. The statement requires the
Company to recognize all derivative instruments at fair value as either assets
or liabilities. Financial derivatives are reported at fair value in other assets
or other liabilities. For derivatives not designated as hedges, the gain or loss
is recognized in current earnings. Amounts reclassed into earnings, when the
hedged transaction culminates, are included in interest income.
4. Bank Premises and Equipment
Bank premises and equipment, including leasehold improvements, are
stated at cost less accumulated depreciation. Depreciation expense is computed
on the straight-line method over the estimated useful lives of the assets.
Leasehold improvements are amortized over the shorter of the estimated useful
lives of the improvements or the terms of the related leases.
56
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note B - (continued)
On January 1, 2002 the Company adopted SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 retains the
existing requirements to recognize and measure the impairment of long-lived
assets to be held and used or to be disposed of by sale. However, SFAS No. 144
makes changes to the scope and certain measurement requirements of existing
accounting guidance. The adoption of this statement did not have a significant
impact on the financial condition or results of operations of the Company.
5. Other Real Estate Owned
Other real estate owned, representing property acquired through
foreclosure, is recorded at the lower of cost or estimated fair market value,
less costs of disposal. When property is acquired, the excess, if any, of the
loan balance over fair market value is charged to the allowance for loan losses.
Periodically thereafter, the asset is reviewed for subsequent declines in the
estimated fair market value. Subsequent declines, if any, and holding costs, as
well as gains and losses on subsequent sale, are included in the consolidated
statements of operations.
6. Goodwill
Goodwill resulting from the acquisition of The Berkshire Bank in 1999
and GSB Financial Corporation in 2001 is accounted for under SFAS No. 142,
Goodwill and Intangible Assets. SFAS No. 142 includes requirements to test
goodwill and indefinite lived intangible assets for impairment rather than
amortize them. The Company performs such tests annually and did not identify any
impairment on its outstanding goodwill and its identifiable intangible assets
from its most recent testing, performed at December 31, 2005.
7. Income Taxes
The Company accounts for income taxes under the liability method of
accounting for income taxes. Deferred tax assets and liabilities are determined
based on the difference between the financial statement and tax bases of assets
and liabilities as measured by the enacted tax rates that will be in effect when
these differences reverse. Deferred tax expense is the result of changes in
deferred tax assets and liabilities. The principal types of differences between
assets and liabilities for financial statement and tax return purposes are
allowance for loan losses, deferred loan fees, deferred compensation and
securities available for sale.
8. Net Income Per Share
The Company follows the provisions of SFAS No. 128, "Earnings Per
Share." Basic earnings per share excludes dilution and is computed by dividing
income available to common shareholders by the weighted-average common shares
outstanding during the period. Diluted earnings per share takes into account the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised and converted into common stock. All weighted
average share and per share information in 2003 have been retroactively restated
to reflect the stock split and stock dividend discussed in Note A.
9. Stock Based Compensation
At December 31, 2005, the Company has one stock-based employee
compensation plan, which is more fully described in Note K. The Company accounts
for that plan in accordance with SFAS Statement No. 123, "Accounting for
Stock-Based Compensation," which allows the Company to measure compensation
expense under Accounting Principals Board ("APB") Opinion No. 25, "Accounting
for Stock Issued to Employees," and related interpretations.
57
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note B - (continued)
Stock-based employee compensation costs were not reflected in net
income, as all options granted under the plan had an exercise price equal to the
market value of the underlying common stock on the date of the grant. The
following table illustrates the effect on net income and earnings per share if
the Company had applied the fair value recognition provisions of SFAS No. 123 to
stock-based employee compensation.
For The Years Ended December 31,
--------------------------------------------
2005 2004 2003
------ ------ -----
(In thousands, except per share amounts)
Net income As Reported: $ 5,541 $ 7,502 $ 7,415
Less: Stock based compensation
costs determined under fair
value methods for all awards -- -- 32
------- ------- -------
Pro Forma: $ 5,541 $ 7,502 $ 7,383
======= ======= =======
Basic earnings per share As Reported: $ .81 $ 1.12 $ 1.12
Pro Forma: .81 1.12 1.11
Diluted earnings per share As Reported: .80 1.10 1.10
Pro Forma: .80 1.10 1.09
The fair value of each option was estimated on the date of grant using
the Black-Scholes options-pricing model using weighted-average assumptions for
expected volatility, risk-free interest and expected life of the option. The
Company did not grant stock options in 2005, 2004 and 2003.
In December 2004, the FASB issued Statement No. 123 (revised 2004),
"Share- Based Payment" ("SFAS 123(R)") which requires the measurement and
recognition of compensation expense for all stock-based compensation payments
and supersedes the Company's current accounting under APB 25. SFAS 123(R) is
effective for all annual periods beginning after June 15, 2005 or our fiscal
year 2006. In March 2005, the Securities and Exchange Commission (the "SEC")
issued Staff Accounting Bulletin No. 107 ("SAB 107") relating to the adoption of
SFAS 123(R). The Company will adopt SFAS 123(R) in the first quarter of fiscal
year 2006, the adoption of which is not expected to have an adverse affect on
our financial position or results of operations.
10. Cash Equivalents
The Company considers all highly liquid debt investments purchased with
an original maturity of three months or less, and amounts due from brokers to be
cash equivalents.
11. Restrictions on Cash and Due From Banks
The Bank is required to maintain reserves against customer demand
deposits by keeping cash on hand or balances with the Federal Reserve Bank in a
non-interest bearing account. The amounts of those reserve and cash balances was
approximately $2,589,000 and $2,763,000 at December 31, 2005 and 2004,
respectively.
58
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note B - (continued)
12. Comprehensive Income
The Company follows the provisions of SFAS No. 130, "Reporting
Comprehensive Income" which includes net income as well as certain other items,
which results in a change to equity during the period. (In thousands.)
Year Ended December 31, 2005
-----------------------------------------------------
Tax
Before tax (expense) Net of tax
amount benefit Amount
------------------ ---------------- ----------------
Unrealized gains (losses) on investment securities:
Unrealized holding gains (losses)
arising during period $ (8,834) $ 3,313 $ (5,521)
Less reclassification adjustment for
gains realized in net income 4 (1) 3
-------- ------- --------
Unrealized (loss) on investment securities (8,838) 3,314 (5,524)
Change in minimum pension liability (289) -- (289)
-------- ------- --------
Other comprehensive income (loss), net $ (9,127) $ 3,314 $ (5,813)
======== ======= ========
Year Ended December 31, 2004
-----------------------------------------------------
Tax
Before tax (expense) Net of tax
amount benefit Amount
------------------ ---------------- ----------------
Unrealized gains (losses)
on investment securities:
Unrealized holding gains
arising during period $ (4,014) $ 1,711 $ (2,303)
Less reclassification adjustment for
gains realized in net income 793 (317) 476
-------- ------- --------
Unrealized (loss) on investment securities (4,807) 2,028 (2,779)
Change in minimum pension liability (598) -- (598)
-------- ------- --------
Other comprehensive income (loss), net $ (5,405) $ 2,028 $ (3,377)
======== ======= ========
Year Ended December 31, 2003
---------------------------------------------------
Tax
Before tax (expense) Net of tax
amount benefit Amount
--------------- ---------------- ----------------
Unrealized gains (losses)
on investment securities:
Unrealized holding gains
arising during period $ 1,231 $ (491) $ 740
Less reclassification adjustment for
gains realized in net income 2,746 (1,097) 1,649
-------- -------- ---------
Unrealized (loss) on investment securities (1,515) 606 (909)
Change in minimum pension liability 340 (136) 204
-------- -------- ---------
Other comprehensive income (loss), net $ (1,175) $ 470 $ (705)
======== ======== =========
13. Reclassifications
Certain amounts in the December 31, 2004 and 2003 financial statements
have been reclassified to conform to the current period's presentation.
59
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note C - INVESTMENT SECURITIES
The following is a summary of held to maturity investment securities:
December 31, 2005
------------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
--------------- ------------------- ----------------- ---------------
(In thousands)
Investment securities
U.S. Government Agencies $ 562 $ 11 $ -- $ 573
------- ------- ----- --------
Totals $ 562 $ 11 $ -- $ 573
======= ======= ======= ========
December 31, 2004
------------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
--------------- ------------------- ----------------- ---------------
(In thousands)
Investment securities
U.S. Government Agencies $ 624 $ 10 $ (1) $ 633
------- ------- ------- --------
Totals $ 624 $ 10 $ (1) $ 633
======= ======= ======= ========
The following is a summary of available-for-sale investment securities:
December 31, 2005
-------------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
----------------- ----------------- ----------------- -----------------
(In thousands)
Investment securities
U.S. Treasury and Notes $ 14,985 $ -- $ (86) $ 14,899
U.S. Government Agencies 448,196 -- (8,551) 439,645
Mortgage-backed securities 81,681 112 (2,107) 79,686
Corporate notes 54,590 352 (2,638) 52,304
Municipal securities 1,972 334 -- 2,306
Marketable equity
securities and other 10,351 284 (65) 10,570
-------- ------- -------- --------
Totals $611,775 $ 1,082 $(13,447) $599,410
======== ======= ======== ========
60
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note C - (continued)
December 31, 2004
-------------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
----------------- ----------------- ----------------- -----------------
(In thousands)
Investment securities
U.S. Treasury and Notes $ 24,896 $ -- $ (174) $ 24,722
U.S. Government Agencies 471,018 97 (3,844) 467,271
Mortgage-backed securities 109,822 504 (996) 109,330
Corporate notes 21,089 692 (154) 21,627
Municipal securities 1,307 134 -- 1,441
Marketable equity
securities and other 6,363 279 (65) 6,577
-------- ------- ------- --------
Totals $634,495 $ 1,706 $(5,233) $630,968
======== ======= ======= ========
The Company has investments in certain debt and equity securities that
have unrealized losses or may be otherwise impaired, but an other-than-temporary
impairment has not been recognized in the financial statements. The following
table indicates the length of time individual securities have been in a
continuous unrealized loss position at December 31, 2005 (in thousands):
Less than 12 months 12 months or longer Total
-------------------------------- ------------------------------- -------------------------------
Fair Value Unrealized Fair Value Unrealized Fair Value Unrealized
Losses Losses Losses
Description of Securities
U.S. Treasury and Notes $ -- $ -- $ 14,898 $ 86 $ 14,898 $ 86
U.S. Government Agencies 67,642 525 372,096 8,026 439,738 8,551
Mortgage-backed securities 45,623 1,197 30,790 910 76,413 2,107
Corporate notes 22,168 2,319 4,775 319 26,943 2,638
Municipal securities -- -- -- -- -- --
-------- ------- -------- ------- -------- --------
Subtotal, debt securities 135,433 4,041 422,559 9,341 557,992 13,382
Marketable equity -- -- 78 65 78 65
-------- ------- -------- ------- -------- --------
securities and other
Total temporarily
impaired securities $135,433 $ 4,041 $422,637 $ 9,406 $558,070 $ 13,447
======== ======= ======== ======= ======== ========
The Company had a total of 114 debt securities with a fair market value
of $557.99 million which were temporarily impaired at December 31, 2005. The
total unrealized loss on these securities was $13.38 million, of which $10.74
million is attributable to increases in interest rates which have decreased the
market value of these securities. The remaining unrealized loss of $2.64 million
is on 2 corporate notes which are currently reorganizing in U.S. bankruptcy
court. We have the ability to hold these securities to maturity, all but 14 of
which are US Government and US Government Agency securities, therefore, the
unrealized losses associated with these securities are not considered to be
other than temporary.
The Company also had 4 equity securities with an aggregated fair market
value of $78,000 which were temporarily impaired at December 31, 2005. The total
unrealized loss on these securities was $65,000. Based upon our review of the
available information, such unrealized losses are not considered to be other
than temporary.
61
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE C - (continued)
The amortized cost and fair value of investment securities available
for sale and held to maturity, by contractual maturity, at December 31, 2005 are
shown below. 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.
December 31, 2005
---------------------------------------------------------------------------------
Available for Sale Held to Maturity
-------------------------------------------- -----------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
-------------------- ---------------------- ----------------- ----------------
(In thousands)
Due in one year or less $ 94,635 $ 93,885 $ -- $ --
Due after one through
five years 242,421 237,149 93 93
Due after five through
ten years 102,378 99,450 32 32
Due after ten years 160,018 156,080 437 448
Marketable equity
securities and other 12,323 12,876 -- --
-------- -------- -------- --------
Totals $611,775 $599,410 $ 562 $ 573
======== ======== ======== ========
Gross gains realized on the sales of investment securities for the
years ended December 31, 2005, 2004 and 2003 were $10,000, $965,000 and $2.91
million, respectively. Gross losses were $6,000, $172,000 and $163,000 for the
years ended December 31, 2005, 2004 and 2003, respectively.
As of December 31, 2005 and 2004, securities sold under agreements to
repurchase with a book value of approximately $73.04 million and $127.75
million, respectively, were outstanding. The book value of the securities
pledged for these repurchase agreements was $77.15 million and $141.04 million,
respectively. As of December 31, 2005 and 2004, the Company did not have any
investment securities of any one issuer where the carrying value exceeded 10% of
shareholders' equity.
62
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE D - LOANS
Major classifications of loans are as follows:
December 31, December 31,
2005 2004
------------------- -------------------
(In thousands)
Commercial and professional loans $ 33,370 $ 16,498
Secured by real estate
1 - 4 family 139,931 155,079
Multi family 2,874 4,600
Non-residential 132,142 109,597
Consumer 2,018 1,989
-------- --------
310,335 287,763
Deferred loan fees (1,105) (784)
Allowance for loan losses (3,266) (2,927)
-------- --------
$305,964 $284,052
======== ========
Changes in the allowance for loan losses are as follows:
For The Years Ended December 31,
------------------------------------------------------------
2005 2004 2003
------------------- ------------------- -------------------
(In thousands)
Balance at beginning $ 2,927 $ 2,593 $ 2,315
of year
Provision charged to 180 180 240
operations
Loans charged off (26) (24) (17)
Recoveries 185 178 55
------- ------- -------
Balance at end of year $ 3,266 $ 2,927 $ 2,593
======= ======= =======
The Company had $256,000, $343,000 and $109,000 non accrual loans as of
December 31, 2005, 2004 and 2003, respectively, and $74,000 and $50,000 of loans
delinquent more than ninety days and still accruing interest at December 31,
2005 and 2004, respectively. The Company did not have any impaired loans or
loans past due more than 90 days and still accruing interest as of December 31,
2003.
The Company, from time to time, enters into lending transactions in the
ordinary course of business with directors, executive officers, principal
stockholders and affiliates of such persons on the same terms as those
prevailing for comparable transactions with other borrowers. At December 31,
2005, loans to these related parties amounted to $12.3 million, were current as
to principal and interest payments, and do not involve more than normal risk of
collectibility. An analysis of activity in loans to related parties for the year
ended December 31, 2005, resulted in new loans of $0 and repayments of
approximately $400,000.
63
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE E - PREMISES AND EQUIPMENT
Major classifications of premises and equipment are summarized as
follows:
Estimated December 31, December 31,
useful lives 2005 2004
----------------------- --------------------- ---------------------
(In thousands)
Land Indefinite $ 3,817 $ 3,817
Buildings 39 years 4,059 4,059
Furniture and equipment 3 to 10 years 2,890 2,573
Leasehold improvements 2 to 10 years 1,239 968
12,005 11,417
Accumulated depreciation
and amortization (3,403) (2,740)
------- -------
Total $ 8,602 $ 8,677
======= =======
Depreciation and amortization expense was approximately $650,000,
$590,000 and $605,000 for the years ended December 31, 2005, 2004 and 2003,
respectively.
NOTE F - DEPOSITS
The aggregate amount of jumbo certificates of deposits greater than
$100,000 were approximately $203.72 million and $109.74 million as of December
31, 2005 and 2004, respectively.
The scheduled maturities of all certificates of deposit are as follows:
December 31, 2005
-----------------
(In thousands)
2006 $ 396,048
2007 4,456
2008 2,067
2009 12
2010 2
---------
$ 402,585
=========
NOTE G - BORROWINGS
Short-Term Borrowings Securities sold under agreements to repurchase
generally mature within 30 days from the date of the transactions. Short-term
borrowings consist of various borrowings which generally have maturities of less
than one year. The details of these categories are presented below:
Year Ended December 31,
-----------------------------------------------------
2005 2004 2003
----------------- ---------------- ----------------
(Dollars in Thousands)
Securities sold under repurchase
agreements and federal funds purchased
Balance at year-end $ 73,044 $127,747 $114,391
Average during the year $108,785 $129,794 $ 57,554
Maximum month-end balance $145,489 $148,753 $114,391
Weighted average rate during the year 3.47% 1.87% 1.68%
Rate at December 31 3.59% 2.27% 1.73%
64
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note G - (continued)
Long-Term Borrowings At December 31, 2005, advances from the Federal
Home Loan Bank ("FHLB") totaling $83.2 million will mature within one to five
years and are reported as long-term borrowings. The advances are collateralized
by FHLB stock and certain first mortgage loans. The advances had a weighted
average rate of 4.01%. Unused lines of credit at the FHLB were $394.0 million at
December 31, 2005.
Outstanding long-term borrowings mature as follows (in thousands):
Year Amount
------ ---------
2006 $ 4,290
2007 22,256
2008 29,940
2009 12,715
2010 14,000
---------
Total $ 83,201
=========
NOTE H - EARNINGS PER SHARE
The Company's calculation of earnings per share in accordance with SFAS
No. 128 is as follows:
Year Ended December 31, 2005
(In thousands, except per share data)
-----------------------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
------------------- --------------------- ----------------
Basic earnings per share
Net income available to
common stockholders $ 5,541 6,805 $ .81
Effect of dilutive securities
Options -- 134 (.01)
------- ------- ------
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $ 5,541 6,939 $ .80
======= ======= ======
Year Ended December 31, 2004
(In thousands, except per share data)
-----------------------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
------------------- --------------------- ----------------
Basic earnings per share
Net income available to
common stockholders $ 7,502 6,672 $ 1.12
Effect of dilutive securities
Options -- 176 (.02)
------- ------- ------
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $ 7,502 6,848 $ 1.10
======= ======= ======
65
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE H - (continued)
Year Ended December 31, 2003
(In thousands, except per share data)
-----------------------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
------------------- --------------------- ----------------
Basic earnings per share
Net income available to
common stockholders $ 7,415 6,636 $ 1.12
Effect of dilutive securities
Options -- 111 (.02)
------- ------- ------
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $ 7,415 6,747 $ 1.10
======= ======= ======
NOTE I - INCOME TAXES
The components of income tax expense are as follows:
Years Ended December 31,
-------------------------------------------------------
2005 2004 2003
---- ---- ----
Current $ 4,985,000 $ 6,515,000 $ 5,848,000
Deferred Taxes (Benefit) 18,000 (381,000) (204,000)
----------- ----------- -----------
$ 5,003,000 $ 6,134,000 $ 5,644,000
=========== =========== ===========
A reconciliation of the provision for income taxes for the years ended
December 31, 2005, 2004 and 2003 and the amount computed by applying the
statutory Federal income tax rate to income from continuing operations follows:
Years Ended December 31,
-----------------------------------------------
2005 2004 2003
---- ---- ----
Effective Tax Reconciliation
Tax at statutory rate $ 3,585,000 $ 4,636,000 $ 4,439,000
State and City, net of federal
income tax benefit 1,344,000 1,423,000 1,211,000
Tax exempt income -- -- (76,000)
Other 74,000 75,000 70,000
----------- ----------- -----------
Actual provision for
income taxes $ 5,003,000 $ 6,134,000 $ 5,644,000
=========== =========== ===========
66
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note I - (continued)
The tax effect of the principal temporary differences at December 31,
2005 and 2004 are as follows:
December 31,
-----------------------------------
2005 2004
---- ----
Net deferred tax assets
Loan loss provision $1,504,000 1,359,000
Depreciation 39,000 92,000
Other 124,000 234,000
Unrealized loss on
investment securities 4,841,000 1,528,000
---------- -----------
Net deferred tax asset
included in other assets $6,508,000 $ 3,213,000
========== ===========
NOTE J - STOCK PLANS
In March 1999, the stockholder's of the Company approved the 1999 Stock
Incentive Plan (the "1999 Stock Incentive Plan"). The 1999 Stock Incentive Plan
permits the granting of awards in the form of nonqualified stock options,
incentive stock options, restricted stock, deferred stock, and other stock-based
incentives. Up to 600,000 shares of common stock of the Company may be issued
pursuant to the 1999 Stock Incentive Plan. Officers, directors and other key
employees of the Company or any subsidiary are eligible to receive awards under
the 1999 Stock Incentive Plan. Options outstanding under the 1999 Stock
Incentive Plan were 223,203 and 365,084 as of December 31, 2005 and 2004,
respectively, including 49,703 options and 50,834 options, respectively, as a
result of the GSB acquisition. The Company did not grant options in 2005, 2004
and 2003.
A summary of activity with respect to the Stock Option Plan follows:
December 31,
------------------------------------------------------------------------------
2005 2004 2003
------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Outstanding at
beginning of year 365,084 $ 10.65 508,419 $ 10.12 532,503 $ 10.10
Granted -- $ -- -- $ -- -- $ --
Cancelled (3,000) $ 12.67 (1,500) $ 10.00 -- $ --
Exercised (138,881) $ 12.20 (141,835) $ 8.95 (24,084) $ 8.61
------- ------- -------
Outstanding at
end of year 223,203 $ 9.70 365,084 $ 10.65 508,419 $ 10.12
======= ======= =======
Exercisable at
end of year 223,203 $ 9.70 365,084 $ 10.65 497,394 $ 10.16
======= ======= =======
Weighted average
fair value of
options granted
during the year $ -- $ -- $ --
========== ========== ==========
67
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note J - (continued)
The following table summarizes information about options outstanding
and exercisable at December 31, 2005:
Options Outstanding and Exercisable
-------------------------------------------------------------------------------
Number Weighted
outstanding average Weighted
at remaining average
Range of December 31, contractual exercise
exercise prices 2005 life (years) price
--------------- ------ ------------ ------
$ 5.98 - 8.78 49,703 3.58 $ 8.55
10.00 - 10.58 173,500 2.29 10.02
--------
223,203
========
NOTE K - EMPLOYEE BENEFIT PLANS
1. Retirement Income Plan
The Company's Retirement Income Plan (the "Plan") covers substantially
all full-time employees. Benefits are based upon a combination of employee
compensation and years of service. The Company pays the entire cost of the Plan
and funds such costs as they accrue. The Company's funding policy is to make
annual contributions within minimum and maximum levels required by applicable
regulations. The Company's customary contributions are designed to fund normal
cost on a current basis and to fund over 30 years the estimated prior service
cost of benefit improvements (15 years of annual gains and losses). The
projected unit cost method was used to determine the annual cost.
The following table summarizes the major categories of Plan assets as
of the dates indicated:
December 31,
----------------------------------------------------------------------
2005 2004
---------------------------------- ----------------------------------
Fair Value % of Total Fair Value % of Total
---------------- ---------------- ---------------- ----------------
(In thousands, except percentages
Mutual Funds
International Equity Fund $ 128 7.45% $ 120 6.64%
Large Cap Equity Growth Fund 396 23.04 793 43.94
International Investment
Grade Bond Fund 507 29.49 550 30.47
Small Cap Equity Growth Fund 114 6.63 118 6.54
Large Cap Equity Value Fund 397 23.09 -- --
Corporate Common Stocks(1) 165 9.60 216 11.97
Cash and cash equivalents 12 0.70 8 0.44
------- ------ ------- ------
Total Plan Assets $ 1,719 100.00% $ 1,805 100.00%
---------------------
(1) Includes 4,500 shares of the Company's Common Stock with a market value
of $75,465 and $92,250 at December 31, 2005 and 2004, respectively.
68
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note K - (continued)
The assets of the Plan are primarily invested in well diversified
common stock and fixed income funds designed to minimize risk while maximizing
expected portfolio returns. To achieve the long term rate of return, Plan assets
are invested in a mixture of instruments, including but not limited to,
corporate common stock, investment grade bond funds, small and large cap equity
funds and international equity funds. The allocation of assets is determined by
the Investment Manager, and typically include 50% to 70% equities, with the
remainder invested in fixed income and a minimal amount of cash. Presently, this
diversified portfolio is expected to return approximately 8.50% in the long run.
The expected rate of return on Plan assets was determined based upon a
review of historical returns, both for our Plan and for medium to large-sized
defined benefit pension funds with similar asset allocations. This review
generated separate expected future long-term returns for each asset class listed
in the above table. These expected future returns were then blended based upon
our Plan's target asset allocation.
Assumptions
Weighted-average assumptions used to determine benefit obligations were
as follows at the dates indicated:
December 31,
-------------------------------
2005 2004
--------------- ---------------
Discount rate 5.50% 5.75%
Rate of compensation increase 5.00% 5.00%
Weighted-average assumptions used to determine net periodic benefit
cost for the years ended December 31, 2005 and 2004 were as follows:
December 31,
-------------------------------
2005 2004
--------------- ---------------
Discount rate 5.75% 6.60%
Rate of compensation increase 5.00% 5.00%
Expected return on plan assets 8.50% 8.50%
Measurement date 1/1/2005 1/1/2004
69
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note K - (continued)
The following table sets forth the Plan's benefit obligations, fair
value of the Plan assets and the funded status of the Plan for the years ended
December 31, 2005 and 2004:
December 31,
---------------------------------------------
2005 2004
----------------------- ---------------------
Change in benefit obligation
Benefit obligation at beginning of year $ 2,316,075 $1,814,032
Service cost 304,144 243,916
Interest cost 134,275 121,005
Actualarial loss 158,125 281,272
Benefits paid (177,442) (144,150)
----------- ----------
Benefits obligation at end of year $ 2,735,177 $2,316,075
=========== ==========
Change in plan assets
Fair value of plan assets at beginning of year $ 1,804,866 $1,815,905
Actual return on plan assets (20,484) 133,111
Employer contribution 112,350 --
Benefits paid (177,442) (144,150)
----------- ----------
Fair value of plan assets at end of year $ 1,719,290 $1,804,866
=========== ==========
Reconciliation of funded status
Funded status $(1,015,887) $ (511,209)
Unrecognized prior service cost 120,874 139,244
Unrecognized actuarial loss 887,262 597,925
----------- ----------
Net amount recognized at year end $ (7,751) $ 225,960
=========== ==========
Amounts recognized in the statement of financial
position consist of:
Prepaid benefit cost $ 0 $ 0
Accrued benefit liability (1,015,887) (511,209)
Intangible asset 120,874 139,244
Accumulated other comprehensive loss 887,262 597,925
---------- ----------
Net amount recognized at year end $ (7,775) $ 225,960
========== ==========
Additional year-end information for pension plans
with accumulated benefit obligations in excess of
plan assets
Projected benefit obligation $2,375,177 $2,316,075
Accumulated benefit obligation 2,735,177 2,316,075
Fair value of plan assets 1,719,290 1,804,866
Minimum liability 1,015,887 511,209
Additional liability 1,008,136 737,169
70
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note K - (continued)
A summary of the components of net periodic pension cost and total pension
expense for the years ended December 31, 2005, 2004 and 2003 is as follows:
December 31,
----------------------------------------------------------------
2005 2004 2003
------------------------------------------ ---------------------
Service cost-benefits earned
during the period $ 304,144 $ 243,916 $ 195,162
Interest cost on projected
benefit obligation 134,275 121,005 107,211
Expected return on plan assets (150,819) (150,145) (123,482)
Net amortization and deferral 58,461 37,428 43,208
--------- --------- ---------
Net pension cost of defined
benefit plan $ 346,061 $ 252,204 $ 222,099
========= ========= =========
The following table sets forth the funded status and amounts recognized
in the Company's balance sheet for its defined benefit plan at December 31, 2005
and 2004:
December 31,
-----------------------------------------------------
2005 2004
---------------------------- ------------------------
Actuarial present value of vested
accumulated benefit obligations $ 2,735,177 $ 2,316,075
Actuarial present value of
accumulated benefit obligations 2,735,177 2,316,075
----------- -----------
Projected benefit obligations $(2,735,177) $(2,316,075)
Fair value of plan assets 1,719,290 1,804,866
----------- -----------
Excess of projected benefit
obligation over fair value
of plan assets (1,015,887) (511,209)
Unrecognized prior service cost 120,874 139,244
Unrecognized net loss 887,262 597,925
----------- -----------
Prepaid pension cost, included
in other assets $ (7,751) $ 225,960
=========== ===========
Estimated Future Benefit Payments
We estimate future benefit payments to be as follows:
Benefit
Years Payments
----- --------
2006 $ 140,754
2007 174,725
2008 161,623
2009 265,952
2010 180,886
Years 2011-2015 1,474,829
71
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE K - (continued)
Company Contributions
The Company contributed approximately $112,000 to its Retirement Plan
in the fiscal year ended December 31, 2005. During the fiscal year ending
December 31, 2006, the Company expects to contribute approximately $332,700 to
its Retirement Plan.
2. Former Goshen Bank Pension Plan
The Bank, as successor to Goshen Bank, had a non-contributory defined
benefit pension plan covering substantially all of its employees. In the fourth
quarter of 2000, the Goshen Bank froze its defined benefit pension plan and
provided that there would be no further accruals under the plan. On October 24,
2002, the Board of Directors of the Bank approved the termination of this plan.
In 2003, we paid out approximately $600,000 to complete the termination of this
plan and purchase annuity contracts. Upon the notice of termination, all
participant benefits vest 100%.
2. Postretirement Welfare Plan
The Bank, as successor to Goshen Bank provides certain health care and
life insurance benefits for retired employees and their spouses. The
postretirement health care and life insurance benefits plan was terminated for
persons retiring after December 31, 1998. Eligible employees retired on or
before that date will have benefits paid through the plan under the agreed upon
terms existing at the employee's retirement date.
December 31,
-------------------------------
2005 2004
--------- ---------
(In thousands)
Change in benefit obligation
Benefit obligation at beginning of year $ 719 $ 715
Service cost -- --
Interest cost 43 43
Actual loss 22 10
Benefits paid (49) (49)
-------- --------
Benefits obligation at end of year 735 719
-------- --------
Change in plan assets
Fair value of plan assets
at beginning of year -- --
Actual return on plan assets -- --
Employer contribution 49 49
Benefits paid (49) (49)
-------- --------
Fair value of plan assets
at end of year -- --
-------- --------
Funded status (735) (719)
Unrecognized net actuarial loss 47 25
-------- --------
Accrued benefit cost (included in
other liabilities) $ 688 $ 694
======== ========
72
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE K - (continued)
Net benefit cost included the following components:
Year Ended December 31,
------------------------------
2005 2004
--------- ---------
(In thousands)
Service cost $ -- $ --
Interest cost on projected
benefit obligation 43 43
Actual return on plan assets -- --
-------- --------
Net periodic benefit cost $ 43 $ 43
======== ========
The assumed discount rate used in determining the actuarial present
value of the projected benefit obligation was 5.875% and 6.125% in 2005 and
2004, respectively.
3. 401(k) Plans
The Bank has a 401(k) plan in which employees can contribute up to 15%
of their salary. The Bank also matches 50% of the employee contribution up to a
maximum of 3% of the employee's salary. The matching expense was $107,000,
$89,000 and $76,000 for the years ended December 31, 2005, 2004 and 2003,
respectively.
4. Deferred Compensation Arrangements
GSB Financial and Goshen Bank established deferred compensation
arrangements for certain directors and executives. These deferred compensation
arrangements were terminated as a result of the acquisition. At December 31,
2005 and 2004, the balance accumulated under these arrangements was
approximately $241,000 and $241,000, respectively, and will be paid out when the
individual (i) ceases to be a director and/or executive of the Company; (ii)
attains the age of 75; or (iii) specifies a particular date.
NOTE L - COMMITMENTS AND CONTINGENCIES
1. Leases and Other Commitments
The Company leases certain of its operating facilities under
non-cancelable operating leases expiring in 2008 through 2015. The leases
require payment by the Company of the real estate taxes and insurance on the
leased properties. Approximate future minimum annual rental payments are as
follows:
Year Ending (In thousands)
December 31,
---------------------
2006 $ 850
2007 869
2008 653
2009 581
2010 403
Thereafter 800
-------
$ 4,156
=======
Rental expense was approximately $1,208,000, $964,000 and $699,000 for
the fiscal years ended December 31, 2005, 2004 and 2003, respectively. Included
in rental expense was approximately $359,000, $298,000 and $270,000 for the
fiscal years ended December 31, 2005, 2004 and 2003, respectively, which was
paid to a company affiliated with a director of the Company.
73
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE M - FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107 requires disclosure of the estimated fair value of an
entity's assets and liabilities considered to be financial instruments. For the
Company, as for most financial institutions, the majority of its assets and
liabilities are considered financial instruments as defined in SFAS No. 107.
However, many such instruments lack an available trading market, as
characterized by a willing buyer and seller engaging in an exchange transaction.
Also, it is the Company's general practice and intent to hold its financial
instruments to maturity and not to engage in trading or sales activities, except
for certain loans. Therefore, the Company had to use significant estimations and
present value calculations to prepare this disclosure.
Changes in the assumptions or methodologies used to estimate fair
values may materially affect the estimated amounts. Also, management is
concerned that there may not be reasonable comparability between institutions
due to the wide range of permitted assumptions and methodologies in the absence
of active markets. This lack of uniformity gives rise to a high degree of
subjectivity in estimating financial instrument fair values.
Estimated fair values have been determined by the Company using the
best available data and an estimation methodology suitable for each category of
financial instruments. The estimation methodologies used, the estimated fair
values, and recorded book balances at December 31, 2005 and 2004 are outlined
below.
For cash and cash equivalents, the recorded book values of $27.88
million and $17.38 million at December 31, 2005 and 2004, respectively,
approximate fair values. The estimated fair values of investment securities are
based on quoted market prices, if available. Estimated fair values are based on
quoted market prices of comparable instruments if quoted market prices are not
available.
December 31,
-----------------------------------------------------------------------
2005 2004
-------------------------------- ------------------------------------
Carrying Estimated Carrying Estimated
amount fair value amount fair value
-------------- --------------- ----------------- ----------------
(In thousands)
Investment securities $599,972 $599,983 $631,592 $631,601
Loans, net of unearned income 309,230 313,065 286,979 291,460
Time Deposits 402,585 400,407 274,309 273,397
Repurchase Agreements 73,044 72,505 127,747 127,442
Long-term Debt 105,882 105,753 111,069 112,598
The net loan portfolio at December 31, 2005 and 2004 has been valued
using a present value discounted cash flow where market prices were not
available. The discount rate used in these calculations is the estimated current
market rate adjusted for credit risk. The carrying value of accrued interest
approximates fair value.
The estimated fair values of demand deposits (i.e. interest (checking)
and non-interest bearing demand accounts, savings and certain types of money
market accounts) are, by definition, equal to the amount payable on demand at
the reporting date (i.e. their carrying amounts). The carrying amount of accrued
interest payable approximates its fair value.
The fair value of commitments to extend credit is estimated based upon
the amount of unamortized deferred loan commitment fees. The fair value of
letters of credit is based upon the amount of unearned fees plus the estimated
cost to terminate letters of credit. Fair values of unrecognized financial
instruments, including commitments to extend credit, and the fair value of
letters of credit are considered immaterial.
74
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE M - (continued)
The fair value of interest rate caps are based upon the estimated
amount the Company would receive or pay to terminate the contracts or
agreements, taking into account current interest rates and, when appropriate,
the current creditworthiness of the counterparties. The aggregate fair value for
the interest rate caps were approximately $20,000 and $132,000 at December 31,
2005 and 2004, respectively.
NOTE N - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS
OF CREDIT RISK
The Bank is party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of their customers.
These financial instruments include commitments to extend credit and standby
letters of credit. Such financial instruments are recorded in the financial
statements when they become payable. Those instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
recognized in the consolidated balance sheets. The contract or notional amounts
of those instruments reflect the extent of involvement the Banks have in
particular classes of financial instruments.
The Bank's exposure to credit loss in the event of non-performance by
the other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual or notional amount
of those instruments. The Bank uses the same credit policies in making
commitments and conditional obligations as they do for on-balance-sheet
instruments.
Unless noted otherwise, the Bank does not require collateral or other
security to support financial instruments with credit risk. The approximate
contract amounts are as follows:
December 31,
-----------------------------------------
2005 2004
-------------------- -------------------
(In thousands)
Unused lines of credit $ 16,808 $ 15,859
Commitments to extend credit 2,531 --
Standby letters of credit and financial
guarantees written 1,155 750
-------- --------
$ 20,494 $ 16,609
======== ========
Interest rate caps-notional amount $ 20,000 $ 25,000
======== ========
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. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Bank upon extension of credit, is based on management's
credit evaluation.
Standby letters of credit are conditional commitments issued by the
Bank to guarantee the performance of a customer to a third party. Those
guarantees are primarily issued to support public and private borrowing
arrangements, including commercial paper, bond financing and similar
transactions. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Bank holds residential or commercial real estate, accounts receivable,
inventory and equipment as collateral supporting those commitments for which
collateral is deemed necessary. The extent of collateral held for those
commitments at December 31, 2005 varies up to 100%.
75
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE N - (continued)
The Company defines the initial fair value of these letters of credit
as the fee received from the customer. The maximum potential undiscounted amount
of future payments of these letters of credit as of December 31, 2005 are
$1,155,000 and they expire through 2006. Amounts due under these letters of
credit would be reduced by any proceeds the Company would be able to obtain in
liquidating the collateral for the loans, which varies depending on the
customer.
The Bank grants loans primarily to customers in New York and its
immediately adjacent suburban communities. Although the Bank has a diversified
loan portfolio, a large portion of their loans are secured by commercial or
residential real property. The Bank does not generally engage in non-recourse
lending and typically will require the principals of any commercial borrower to
obligate themselves personally on the loan. Although the Bank has diversified
loan portfolios, a substantial portion of their debtors' ability to honor their
contracts is dependent upon the economic sector. Commercial and standby letters
of credit were granted primarily to commercial borrowers.
The Bank has entered into interest rate cap agreements in order to
hedge its exposure to interest rate fluctuations. The Company adopted the
provisions of SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities", as amended, as of January 1, 2001. The statement requires the
Company to recognize all derivative instruments at fair value as either assets
or liabilities. Financial derivatives are reported at fair value in other assets
or other liabilities. For derivatives not designated as hedges, the gain or loss
is recognized in current earnings. Amounts reclassed into earnings, when the
hedged transaction culminates, are included in interest income.
NOTE O - REGULATORY MATTERS
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 possible additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Bank's consolidated financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Company must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities and certain off-balance-sheet items
as calculated under regulatory accounting practices. The Bank's capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
Quantitative measures established by regulations to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set forth in
the table below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets, and of Tier 1 capital to average assets. Management
believes that, as of December 31, 2005, the Bank meets all capital adequacy
requirements to which it is subject.
As of December 31, 2005, the Bank met all regulatory requirements for
classification as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the Bank must maintain
minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set
forth in the following table. There are no conditions or events since that date
that management believes have changed the institution's category.
76
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note O - (continued)
The following table sets forth the actual and required regulatory
capital amounts and ratios of, the Company and the Bank as of December 31, 2005
and 2004 (dollars in thousands):
To be well
capitalized under
For capital prompt corrective
Actual adequacy purposes action provisions
------ ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
December 31, 2005
Total Capital (to Risk-Weighted Assets)
Company 124,523 28.6% 34,820 >=8.0% -- N/A
Bank 95,193 23.0% 33,116 >=8.0% 34,416 >=10.0%
Tier I Capital (to Risk-Weighted Assets)
Company 121,257 27.9% 17,410 >=4.0% -- N/A
Bank 91,927 22.2% 16,558 >=4.0% 20,649 >=6.0%
Tier I Capital (to Average Assets)
Company 121,257 12.2% 39,651 >=4.0% -- N/A
Bank 91,927 10.1% 36,495 >=4.0% 46,550 >=5.0%
To be well
capitalized under
For capital prompt corrective
Actual adequacy purposes action provisions
------ ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
December 31, 2004
Total Capital (to Risk-Weighted Assets)
Company 110,063 30.1% 29,234 >=8.0% -- N/A
Bank 82,970 24.1% 27,533 >=8.0% 34,416 >=10.0%
Tier I Capital (to Risk-Weighted Assets)
Company 107,136 29.3% 14,617 >=4.0% -- N/A
Bank 80,042 23.3% 13,766 >=4.0% 20,649 >=6.0%
Tier I Capital (to Average Assets)
Company 107,136 11.2% 38,250 >=4.0% -- N/A
Bank 80,042 8.6% 37,240 >=4.0% 46,550 >=5.0%
77
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE P - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY
The condensed financial information for Berkshire Bancorp Inc. (parent
company only) is as follows:
CONDENSED BALANCE SHEETS
(In Thousands)
December 31,
---------------------------------------
2005 2004
------------------ ------------------
ASSETS
Cash $ 11,196 $ 7,415
Equity investment in subsidiaries 109,026 101,004
Investment in securities available for sale 11,760 9,022
Loans -- 6,059
Accrued interest receivable 481 284
Other assets 1,547 892
--------- ---------
Total assets $ 134,010 $ 124,676
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Subordinated debt $ 22,681 $ 15,464
Other liabilities 2,619 1,593
--------- ---------
Total liabilities 25,300 17,057
--------- ---------
Stockholders' equity
Common stock 770 770
Additional paid-in capital 90,594 89,543
Retained earnings 33,504 28,983
Accumulated other comprehensive
income, net (8,415) (2,602)
Common stock in treasury, at cost (7,743) (9,075)
--------- ---------
Total stockholders' equity 108,710 107,619
--------- ---------
$ 134,010 $ 124,676
========= =========
78
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE P - (continued)
CONDENSED STATEMENTS OF INCOME
(In Thousands)
For The Years Ended December 31,
----------------------------------------
2005 2004 2003
-------- -------- ------
INCOME
Interest income from the Bank $ 53 $ 71 $ 106
Interest income 1,622 1,090 795
Gain on sales of 10 734 1,131
investment securities
Other income (loss) 217 96 407
-------- -------- --------
Total income 1,902 1,991 2,439
EXPENSES
Salaries and employee benefits 605 489 442
Interest expense 1,268 463 --
Other expenses 580 1,058 759
-------- -------- --------
Total expenses 2,453 2,010 1,201
-------- -------- --------
Income (loss) before income taxes
and equity in undistributed net
income of the Bank (551) (19) 1,238
Equity in undistributed
net income of the Bank 6,229 7,668 6,710
-------- -------- --------
Income before taxes 5,678 7,649 7,948
Provision for income taxes 137 147 533
-------- -------- --------
Net income $ 5,541 $ 7,502 $ 7,415
======== ======== ========
79
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE P - (continued)
CONDENSED STATEMENTS OF CASH FLOWS
(In Thousands)
For The Years Ended December 31,
--------------------------------------------
2005 2004 2003
---- ---- ----
Operating activities:
Net income $ 5,541 $ 7,502 $ 7,415
Adjustments to reconcile net
income to net cash provided by
(used in) operating activities:
Gain on sales of investment securities (10) (734) (1,131)
Equity in undistributed net income of the Bank (6,229) (7,668) (6,843)
Dividends received from the Bank 1,291 500 --
Increase in other liabilities 1,025 798 294
(Increase) decrease in other assets (154) 69 151
-------- -------- --------
Net cash provided by (used in) operating activities 1,464 467 (114)
-------- -------- --------
Investing activities:
Investment securities available for sale
Purchases (4,548) (9,150) (5,172)
Sales 140 3,874 9,451
Net decrease in loans 6,059 185 2,176
Contribution to the Bank (7,217) (14,791) --
-------- -------- --------
Net cash provided by (used in) investing activities (5,566) (19,882) 6,455
-------- -------- --------
Financing activities:
Proceeds from exercise of common stock options 1,686 1,271 205
Acquisition of treasury stock -- (69) (1,350)
Cash paid for fractional shares -- (463) --
Issuance of subordinated debentures 7,217 14,791 --
Dividends paid (1,020) (735) (600)
-------- -------- --------
Net cash provided by (used in) financing activities 7,883 14,795 (1,745)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 3,781 (4,620) 4,596
Cash and cash equivalents at beginning of year 7,415 12,035 7,439
-------- -------- --------
Cash and cash equivalents at end of year $ 11,196 $ 7,415 $ 12,035
======== ======== ========
Supplemental disclosures of cash flow information:
Cash used to pay interest $ 1,132 $ 273 $ --
Cash used to pay income taxes $ 362 $ 419 $ 375
Transfer of premises and equipment to
subsidiary for note receivable $ -- $ -- $ 5,056
80
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE Q - QUARTERLY FINANCIAL DATA (UNAUDITED)
The following represents summarized quarterly financial data of the
Company which, in the opinion of management, reflects all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of the Company's results of operations. (In thousands, except per
share data).
Three Months Ended
---------------------------------------------------------------------
March 31 June 30 September 30 December 31
---------- ---------- ------------ -----------
2005
----
Interest income $ 10,967 $ 11,378 $ 11,250 $ 11,461
Interest expense (4,814) (5,585) (5,879) (6,121)
-------- -------- -------- --------
Net interest income 6,153 5,793 5,371 5,340
Provision for loan losses (45) (45) (45) (45)
Gains (losses) on sales of securities 6 3 -- (5)
Non-interest income 263 282 300 357
Non-interest expenses (3,193) (3,378) (3,221) (3,347)
-------- -------- -------- --------
Income before taxes 3,184 2,655 2,405 2,300
Provision for taxes (1,486) (1,304) (1,108) (1,105)
-------- -------- -------- --------
Net income $ 1,698 $ 1,351 $ 1,297 $ 1,195
======== ======== ======== ========
Per share data
Net income per common share
Basic $ .25 $ .20 $ .19 $ .17
======== ======== ======== ========
Diluted $ .25 $ .20 $ .19 $ .16
======== ======== ======== ========
Three Months Ended
--------------------------------------------------------------------
March 31 June 30 September 30 December 31
---------- ---------- ------------ -----------
2004
----
Interest income $ 9,638 $ 9,626 $ 10,276 $ 10,468
Interest expense (3,720) (3,796) (4,103) (4,297)
-------- -------- -------- --------
Net interest income 5,918 5,830 6,173 6,171
Provision for loan losses (45) (45) (45) (45)
Gains on sales of securities 93 49 173 478
Non-interest income 325 202 282 217
Non-interest expenses (2,962) (3,172) (3,126) (2,835)
-------- -------- -------- --------
Income before taxes 3,329 2,864 3,457 3,986
Provision for taxes (1,378) (1,383) (1,489) (1,884)
-------- -------- -------- --------
Net income $ 1,951 $ 1,481 $ 1,968 $ 2,102
======== ======== ======== ========
Per share data
Net income per common share
Basic $ .29 $ .22 $ .30 $ .31
======== ======== ======== ========
Diluted $ .28 $ .22 $ .30 $ .30
======== ======== ======== ========
81
ITEM 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.
Not Applicable.
ITEM 9A. Controls and Procedures
Evaluation of the Company's Disclosure Controls and Internal Control. As of the
end of the period covered by this Annual Report on Form 10-K, the Company
evaluated the effectiveness of the design and operation of its "disclosure
controls and procedures" as defined in Rule 13a-15(e) of the Securities Exchange
Act of 1934 ("Disclosure Controls"). This evaluation ("Controls Evaluation") was
done under the supervision and with the participation of the Company's
management, including the Chief Executive Officer ("CEO") who is also the Chief
Financial Officer ("CFO").
Limitations on the Effectiveness of Controls. The Company's management,
including the CEO/CFO, does not expect that its Disclosure Controls and/or its
"internal control over financial reporting" as defined in Rule 13a-15(f) of the
Securities Exchange Act of 1934 ("Internal Control") will prevent all error and
all fraud. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Further, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the Company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based in
part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, control may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
Conclusions. Based upon the Controls Evaluation, the CEO/CFO has concluded that
the Disclosure Controls are effective in reaching a reasonable level of
assurance that information required to be disclosed by the Company is recorded,
processed, summarized and reported within the time period specified in the
Securities and Exchange Commission's rules and forms. In accordance with SEC
requirements, the CEO/CFO notes that during the fiscal quarter ended December
31, 2005, no changes in Internal Control have occurred that have materially
affected or are reasonably likely to materially affect Internal Control.
ITEM 9B. Other Information
Not Applicable
82
PART III
ITEM 10. Directors and Executive Officers of the Registrant.
The following are the current directors and executive officers of the Company:
Name Age Position(s)
---- --- --------------------------------------------------
Steven Rosenberg 57 President, Chief Executive Officer,
Chief Financial Officer and Director
William L. Cohen 64 Director
Thomas V. Guarino 52 Director
Moses Marx 70 Director
Randolph B. Stockwell 59 Director
Moses Krausz 65 President of The Berkshire Bank
David Lukens 56 Executive Vice President, Chief Financial Officer
of The Berkshire Bank
Mr. Rosenberg has served as President and Chief Executive Officer of
the Company since March 1999 and as Vice President and Chief Financial Officer
of the Company from April 1990 to March 1999. He continues to serve as Chief
Financial Officer. Mr. Rosenberg was elected a director in May 1995. From
September 1987 through April 1990, he served as President and Director of Scomel
Industries, Inc., a company engaged in international marketing and consulting.
Mr. Rosenberg is a director of The Cooper Companies, Inc. (a developer and
manufacturer of healthcare products).
Mr. Cohen was elected a director in July 1993. He has served as the
Chief Executive Officer of Andover Properties, LLC, a real estate development
company specializing in self storage facilities since November 2003, and has
been a private investor for over six years. Mr. Cohen served as President, Chief
Executive Officer and Chairman of the Board of The Andover Apparel Group, Inc.,
an apparel manufacturing company, from 1980 to 2000.
Mr. Guarino was elected a director in March 2001. He served as a
director of Goshen Savings Bank from 1996, and chairman of the Board of
Directors of GSB Financial Corporation from April 1998, until the respective
mergers of those companies into The Berkshire Bank and the Company in March
2001. Mr. Guarino is the President and Senior Portfolio Manager of the Hudson
Valley Investment Advisors, Inc., an investment management and advisory company,
a position he has held since 1995. Prior to that, he had been, since 1988, a
Vice President of Fleet Investment Advisors, Inc. and was Vice President in
charge of investments of Norstar Bank of the Hudson Valley from 1981 to 1988.
Mr. Marx was elected a director in May 1995. Mr. Marx has been the
General Partner in United Equities Company since 1954 and General Partner in
United Equities Commodities Company since 1972. He is also President of Momar
Corp. All of these are investment companies. Mr. Marx is a director of The
Cooper Companies, Inc.
Mr. Stockwell was elected a director in July 1988. He has been a
private investor for over ten years. Since April 1999, Mr. Stockwell has served
as President of Yachting Systems of America, LLC, a small start-up company. In
addition, he served in various capacities with the Community Bank, a commercial
bank, from September 1972 to January 1987.
Mr. Krausz has held the position of President of The Berkshire Bank
since March 1992 and Chief Executive Officer since November 1993. Prior to
joining The Berkshire Bank, Mr. Krausz was Managing Director of SFS Management
Co., L.P., a mortgage banker, from 1987 to 1992 and was President of UMB Bank
and Trust Company, a New York State chartered bank, from 1978 to 1987.
Mr. Lukens has held the position of Senior Vice President and Chief
Financial Officer of The Berkshire Bank since December 1999 and Executive Vice
President since December 2003. Prior to joining the Bank, Mr. Lukens was Senior
Vice President and Chief Financial officer of First Washington State Bank, a New
Jersey commercial bank, from 1994 to 1999 and was Vice President and Controller
at the Philadelphia, PA branch of Bank Leumi Le-Israel B.M., an international
commercial bank, from 1978 to 1994.
There are no family relationships (whether by blood, marriage or
adoption) among any of the Company's current directors or executive officers.
83
Audit Committee Members, Financial Expert and Independence
The Board of Directors of the Company has established an Audit
Committee comprised of three independent directors, Messrs. William L. Cohen,
Thomas V. Guarino and Randolph B. Stockwell. All of the members of the Audit
Committee meet the independence requirements under current NASDAQ corporate
governance standards for companies whose securities are quoted on NASDAQ. Based
upon their education and relevant experience, the Board of Directors has
determined that Messrs. Guarino and Stockwell each qualify as financial experts
as defined by the Sarbanes-Oxley Act of 2002 and the rules of the Securities and
Exchange Commission.
Corporate Code of Ethics
We have adopted a Corporate Code of Ethics that applies to the
directors, officers and employees, including the senior management: the chief
executive officer, chief financial officer, controller and persons performing
similar functions, of Berkshire Bancorp Inc. and its subsidiaries. Copies of our
Corporate Code of Ethics are available without charge upon written request to
the Company, Attention President, at its principal executive office.
ITEM 11. Executive Compensation
The following table shows the compensation paid in or with respect to
each of the last three fiscal years to the individual who served as the
Company's Chief Executive Officer for the fiscal year ended December 31, 2005,
and to each of the other executive officers of the Bank who were paid more than
$100,000 during the fiscal year ended December 31, 2005.
Summary Compensation Table
Annual Compensation
-----------------------------
Name and Principal Position
--------------------------- All Other
Year Salary Bonus Compensation
---- ------ ----- ------------
Steven Rosenberg 2005 $191,000 $ 25,000 $ --
President, Chief Executive 2004 $182,000 $ 10,000 $ --
Officer and Chief Financial 2003 $175,500 $ -- $ --
Officer
Moses Krausz 2005 $402,029 $250,000 $ 9,197(1)
President and Chief Executive 2004 $382,865 $200,000 $ 11,405(1)
Officer of The Berkshire Bank 2003 $358,864 $175,000 $ 10,405(1)
David Lukens 2005 $165,000 $ 25,000 $ 7,480(2)
Executive Vice President and 2004 $155,000 $ 25,000 $ 7,350(2)
Chief Financial Officer of 2003 $138,500 $ 25,000 $ 5,968(2)
The Berkshire Bank
---------------------
(1) Consists of contributions by the Company to a 401(k) account of $6,300,
$8,000 and $7,000, respectively, in 2005, 2004 and 2003, and income
associated with life insurance coverage in excess of $50,000.
(2) Consists of contributions by the Company to a 401(k) account of $5,700,
$5,205 and $4,905, respectively, in 2005, 2004 and 2003, and income
associated with life insurance coverage in excess of $50,000. Does not
include the annual retirement credits of 5% of gross wages under the
Company's Retirement Income Plan.
84
Option Grants in Last Fiscal Year
There were no stock option grants during the fiscal year ended December 31,
2005.
Aggregated Option Exercises and Fiscal Year-End Option Values
The following table sets forth information concerning options exercised
during the fiscal year ended December 31, 2005, and the number of options owned
and the value of any in-the-money unexercised options as of December 31, 2005 by
each of the individuals named in the Summary Compensation Table.
Number of
Unexercised
Shares Options at
Acquired Fiscal Year-End Value of Unexercised
on Value (#) In-the-Money Options at
Exercise Realized Exercisable Fiscal Year-End ($)
Name (#) ($) /Unexercisable Exercisable/Unexercisable
---- ----- ----- -------------- -------------------------
Steven Rosenberg -0- -0- 30,000 / 0 211,500 / 0
Moses Krausz 90,000 478,625 60,000 / 0 423,000 / 0
David Lukens 10,000 74,370 20,000 / 0 138,100 / 0
---------------------
Year-end values for unexercised in-the-money options represent the positive
spread between the exercise price of such options and the fiscal year end market
value of the common stock. An Option is "in-the-money" if the fiscal year end
fair market value of the Common Stock exceeds the option exercise price.
Compensation of Directors
Each director who is not also an employee of the Company (a
"Non-Employee Director") receives a stipend of $18,000 per annum and $1,500 for
each day during which he participates in a meeting of the Board or a Committee
of the Board. Each Non-Employee Director also receives a fee of $1,000 for
telephonic meetings of the Board or a Board Committee. In addition, see "1999
Stock Incentive Plan" below.
1999 Stock Incentive Plan
The 1999 Stock Incentive Plan permits the granting of awards in the
form of nonqualified stock options, incentive stock options, restricted stock,
deferred stock, and other stock-based incentives. Up to 600,000 shares of common
stock of the Company may be issued pursuant to the 1999 Stock Incentive Plan
(subject to appropriate adjustment in the event of changes in the corporate
structure of the Company). Officers, directors and other key employees of the
Company or any subsidiary are eligible to receive awards under the 1999 Stock
Incentive Plan. The option exercise price of all options which are granted under
the 1999 Stock Incentive Plan must be at least equal to 100% of the fair market
value of a share of common stock of the Company on the date of grant. At
December 31, 2005, options to acquire 557,757 shares of common stock have been
granted under this plan, 223,203 options are outstanding and exercisable, and
42,243 options are available for future grants.
Retirement Income Plan
The Company has a Retirement Income Plan (the "Retirement Plan"), a
noncontributory plan covering substantially all full-time, non-union United
States employees of the Company. Benefits were based upon a combination of
employee compensation and years of service. The Company paid the entire cost of
the plan for its employees and funded such costs as they accrued. The Company's
funding policy was to make annual contributions within minimum and maximum
levels required by applicable regulations. The Company's customary contributions
were designed to fund normal cost on a current basis and fund over 30 years the
estimated prior service cost of benefit improvements (15 years of annual gains
and losses). The projected unit cost method was used to determine the annual
cost. Plan assets consist principally of equity and fixed income mutual funds.
85
Benefit accruals were frozen as of September 15, 1988, resulting in a
plan curtailment. As a result of such curtailment, the Company did not accrue
benefits for future services; however, the Company did continue to contribute as
necessary for any unfunded liabilities. In 2000, the Company reinstated the
Retirement Plan to cover substantially all full-time, non-union United States
employees of the Company.
A participant in the Plan accumulates a balance in his or her
retirement account by receiving: (i) an annual retirement credit of 5% of gross
wages paid during the year, but not in excess of the applicable annual maximum
compensation permitted to be taken into account under Internal Revenue Service
guidelines for each year of service; and (ii) an annual interest credit based
upon the 30-year U. S. Treasury securities rate. The Company pays the entire
cost of the Plan for its employees and funds such costs as they accrue.
The estimated annual benefits payable under the Plan upon retirement
(at the normal retirement age of 65) for Messrs. Rosenberg and Lukens are
approximately $160,000 and $16,000, respectively. In accordance with the laws
currently governing the Plan, the estimated annual benefit payable to Mr.
Rosenberg is not expected to increase. Mr. Krausz is not a participant in the
Plan. (see Note K of Notes to Consolidated Financial Statements).
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management and Equity Compensation Plans.
The following table sets forth certain information as of February 20,
2006 with respect to the beneficial ownership of the Company's Common Stock by
(i) each person who is known by the Company to own beneficially more than 5% of
the Company's Common Stock, (ii) each of the Company's directors and persons
named in the Summary Compensation Table, and (iii) all executive officers and
directors as a group.
Number of Percent
Shares of Class
--------------- -------------
William Cohen 7,500 (1) *
Thomas V. Guarino 99,370 (2) 1.4%
Moses Krausz 148,691 (3) 2.1%
David Lukens 20,600 (4) *
Moses Marx 3,559,693 (5) 51.6%
160 Broadway
New York, NY 10038
Steven Rosenberg 62,580 (6) *
Randolph B. Stockwell 24,000 (7) *
All executive officers and directors
as a group (7 persons) 3,922,434 (8) 55.6%
--------------------------------------------------------
* Less than 1%
(1) Includes 3,000 shares issuable upon the exercise of options which have
been granted to Mr. Cohen under the Company's 1999 Stock Incentive
Plan.
(2) Includes 43,650 shares issuable upon the exercise of options which have
been granted to Mr. Guarino under the Company's 1999 Stock Incentive
Plan. Includes 7,920 shares held in trust for minor children and 900
shares held by Mr. Guarino's wife.
(3) Includes 60,000 shares issuable upon the exercise of options which have
been granted to Mr. Krausz under the Company's 1999 Stock Incentive
Plan and 2,100 shares owned by Mr. Krausz's spouse.
(4) Includes 20,000 shares issuable upon the exercise of options which have
been granted to Mr. Lukens under the Company's 1999 Stock Incentive
Plan.
86
ITEM 12. (continued)
(5) Includes 3,000 shares issuable upon the exercise of options which have
been granted to Mr. Marx under the Company's 1999 Stock Incentive Plan,
285,000 shares owned by Momar Corporation and 641,163 shares owned by
Terumah Foundation. Does not include 37,302.32 shares representing
23.0% of the shares owned by Eva and Esther, L.P., of which Mr. Marx
has a 23.0% limited partnership interest. Mr. Marx's daughters and
their husbands are the general partners of Eva and Esther, L.P.
(6) Includes 30,000 shares issuable upon the exercise of options which have
been granted to Mr. Rosenberg under the Company's 1999 Stock Incentive
Plan.
(7) Includes 3,000 shares issuable upon the exercise of options which have
been granted to Mr. Stockwell under the Company's 1999 Stock Incentive
Plan.
(8) Includes 162,650 shares of Common Stock which are issuable upon the
exercise of outstanding options.
Equity Compensation Plans
The following table details information regarding the Company's
existing equity compensation plans as of December 31, 2005.
(c)
Number of securities
(a) (b) remaining available for
Number of securities to Weighted-average future issuance under
be issued upon exercise exercise price of equity compensation plans
of outstanding options, outstanding options, (excluding securities
Plan Category warrants and rights warrants and rights reflected in column (a)
------------- ------------------- ------------------- -----------------------
Equity compensation 223,203 $ 9.70 42,243
plans approved by
security holders
Equity compensation -- -- --
plans not approved by
security holders
Total 223,203 $ 9.70 42,243
ITEM 13. Certain Relationships and Related Transactions.
In January 2000, the Bank entered into a lease agreement with Bowling
Green Associates, LP, the principal owner of which is Mr. Marx, for commercial
space to open a bank branch. The Company obtained an appraisal of the market
rental value of the space from an independent appraisal firm and management
believes that the terms of the lease, including the annual rent paid, $353,000
and $298,000 in fiscal 2005 and 2004, is comparable to the terms and annual rent
that would be paid to non-affiliated parties in a similar commercial transaction
for similar commercial space.
See Item 1. Business - Transactions With Related Parties and Item 2.
Properties for additional information.
87
ITEM 14. Principal Accountant Fees and Services
The Company's principal accountant is Grant Thornton LLP ("Grant
Thornton"). The total fees paid to Grant Thornton for the last two fiscal years
are as follows:
Fiscal Year Ended Fiscal Year Ended
December 31, 2005 December 31, 2004
----------------------- ------------------------
Audit Fees $168,581 $208,167
Audit Related Fees: Professional services 26,959 16,250
rendered for employee benefit plan audits,
accounting assistance in connection with
acquisitions and consultations related to
financial accounting and reporting standards
Tax Fees: Tax consulting, preparation of 57,160 55,070
returns
All Other Fees: Professional services -- 3,400
rendered for corporate support
The Audit Committee has established its pre-approval policies and
procedures, pursuant to which the Audit Committee approved the foregoing audit
and permissible non-audit services provided by Grant Thornton LLP in 2005 and
2004. Consistent with the Audit Committee's responsibility for engaging our
independent auditors, all audit and permitted non-audit services require
pre-approval by the Audit Committee. The full Audit Committee approves proposed
services and fee estimates for these services. The Audit Committee chairperson
has been designated by the Audit Committee to approve any services arising
during the year that were not pre-approved by the Audit Committee and services
that were pre-approved. Service approved by the Audit Committee chairperson are
communicated to the full Audit Committee at its next regular quarterly meeting
and the Audit Committee reviews services and fees for the fiscal year at each
such meeting. Pursuant to these procedures, the Audit Committee approved the
foregoing audit and permissible non-audit services provided by Grant Thornton
LLP.
PART IV
ITEM 15. Exhibits, Financial Statement Schedules.
(a) Documents filed as part of this Report:
(1) Financial Statements
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2005 and 2004
Consolidated Statements of Income for the Years Ended December 31,
2005, 2004 and 2003
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 2005, 2004 and 2003
Consolidated Statements of Cash Flows for the Years Ended December 31,
2005, 2004 and 2003
Notes to Consolidated Financial Statements
88
ITEM 15. (continued)
Schedule
Number Description
------ -----------
None
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are not applicable and, therefore, have been omitted.
(3) Exhibits
Exhibit
Number Description
------ -----------
2.1 Agreement and Plan of Reorganization, dated as of August 16, 2000, by
and between Berkshire Bancorp Inc., Greater American Finance Group,
Inc., The Berkshire Bank, GSB Financial Corporation and Goshen Savings
Bank (incorporated by reference to the Companies Registration Statement
on Form S-4 dated October 13, 2000.
3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 to the Company's Current
Report on Form 8-K dated March 30, 1999, and the Company's Quarterly
Report on Form 10-Q for the Quarterly Period Ended June 30, 2004).
3.2 Amended and Restated By-laws of the Company (incorporated by reference
to Exhibit 3.2 to the Company's Current Report on Form 8-K dated March
30, 1999).
10.1 1999 Stock Incentive Plan of the Company (incorporated by reference to
Exhibit 10.8 to the Company's Current Report on Form 8-K dated March
30, 1999).+
10.2 Employment Agreement, dated May 1, 1999, between The Berkshire Bank and
Moses Krausz (incorporated by reference to Exhibit 10.3 to the
Company's Annual Report on Form 10-K for the Fiscal Year Ended December
31, 2000).+
10.3 Employment Agreement, dated January 1, 2001, between The Berkshire Bank
and David Lukens (incorporated by reference to Exhibit 10.4 to the
Company's Annual Report on Form 10-K for the Fiscal Year Ended December
31, 2000).+
10.4 Lease Agreement, dated October 26, 1999, between Braun Management, Inc.
as agent for Bowling Green Associates, L.P., and The Berkshire Bank
(incorporated by reference to Exhibit 10.5 to the Company's Quarterly
Report on Form 10-Q for the Quarterly Period Ended March 31, 2001).
10.5 Amendment No. 1 to Employment Agreement, dated August 1, 2001, by and
between The Berkshire Bank and Moses Krausz (incorporated by reference
to Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for the
Quarterly Period Ended September 30, 2001).+
10.6 Amendment No. 1 to Employment Agreement, dated June 3, 2002, by and
between The Berkshire Bank and David Lukens (incorporated by reference
to Exhibit 10.7 to the Company's Quarterly Report on Form 10-Q for the
Quarterly Period Ended June 30, 2002).+
10.7 Amendment No. 2 to Employment Agreement, dated August 1, 2001, by and
between The Berkshire Bank and Moses Krausz (incorporated by reference
to Exhibit 10.8 to the Company's Quarterly Report on Form 10-Q for the
Quarterly Period Ended June 30, 2002).+
21. Subsidiaries of the Company.
23. Consent of Independent Registered Public Accounting Firm
31. Certification of Principal Executive and Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32. Certification of Principal Executive and Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
---------------------
+ Denotes a management compensation plan or arrangement.
89
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 BANCORP INC.
By: /s/ Steven Rosenberg
------------------------------------
Steven Rosenberg
President, (Chief Executive Officer)
Date: February 27, 2006
------------------------------------
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.
Signature Title Date
--------- ----- ----
President, (Chief
Executive Officer,
Principal Financial
Officer and Principal
Accounting Officer);
/s/ Steven Rosenberg Director February 27, 2006
-------------------------
Steven Rosenberg
/s/ William Cohen Director February 27, 2006
-------------------------
William Cohen
/s/ Thomas V. Guarino Director February 27, 2006
-------------------------
Thomas V. Guarino
/s/ Moses Marx Director February 27, 2006
-------------------------
Moses Marx
/s/ Randolph B. Stockwell Director February 27, 2006
--------------------------
Randolph B. Stockwell
90
STATEMENT OF DIFFERENCES
The greater-than-or-equal-to sign shall be expressed as.................... >=