UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2006
------------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _________________
Commission file number: 0-13649
-------
BERKSHIRE BANCORP INC.
----------------------
(Exact name of registrant as specified in its charter)
Delaware 94-2563513
------------------------------- ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
160 Broadway, New York, New York 10038
---------------------------------------- ------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 791-5362
---------------
N/A
-------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the Registrant is 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 Exchange Act. Yes [ ] No [X]
As of November 1, 2006, there were 6,898,556 outstanding shares of the issuers
Common Stock, $.10 par value.
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
FORWARD-LOOKING STATEMENTS
Forward-Looking Statements. Statements in this Quarterly Report on Form 10-Q
that are not based on historical fact may be "forward-looking statements" within
the meaning of the Private Securities Litigation Reform Act of 1995. Words such
as "believe", "may", "will", "expect", "estimate", "anticipate", "continue" or
similar terms identify forward-looking statements. A wide variety of factors
could cause the Company's actual results and experiences to differ materially
from the results expressed or implied by the Company's forward-looking
statements. Some of the risks and uncertainties that may affect operations,
performance, results of the Company's business, the interest rate sensitivity of
its assets and liabilities, and the adequacy of its loan loss allowance,
include, but are not limited to: (i) deterioration in local, regional, national
or global economic conditions which could result, among other things, in an
increase in loan delinquencies, a decrease in property values, or a change in
the housing turnover rate; (ii) changes in market interest rates or changes in
the speed at which market interest rates change; (iii) changes in laws and
regulations affecting the financial services industry; (iv) changes in
competition; (v) changes in consumer preferences, (vi) changes in banking
technology; (vii) ability to maintain key members of management, (viii) possible
disruptions in the Company's operations at its banking facilities, (ix) cost of
compliance with new corporate governance requirements, and other factors
referred to in the sections of this Quarterly Report entitled "Business" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Certain information customarily disclosed by financial institutions,
such as estimates of interest rate sensitivity and the adequacy of the loan loss
allowance, are inherently forward-looking statements because, by their nature,
they represent attempts to estimate what will occur in the future.
The Company cautions readers not to place undue reliance upon any
forward-looking statement contained in this Quarterly Report. Forward-looking
statements speak only as of the date they were made and the Company assumes no
obligation to update or revise any such statements upon any change in applicable
circumstances.
2
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of
September 30, 2006 (unaudited) and
December 31, 2005 4
Consolidated Statements of Income
For The Three and Nine Months Ended
September 30, 2006 and 2005 (unaudited) 5
Consolidated Statements of Stockholders'
Equity For The Nine Months Ended
September 30, 2006 and 2005 (unaudited) 6
Consolidated Statements of Cash Flows
For The Nine Months Ended
September 30, 2006 (unaudited) 7
Notes to Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis
of Financial Condition and Results
of Operations 19
Item 3. Quantitative and Qualitative Disclosure
About Market Risk 31
Item 4. Controls and Procedures 39
PART II OTHER INFORMATION
Item 6. Exhibits 40
Signature 41
Index of Exhibits 42
3
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
(unaudited)
September 30, December 31,
2006 2005
----------------------------------------
ASSETS
Cash and due from banks $ 9,366 $ 9,825
Interest bearing deposits 4,312 4,457
Federal funds sold -- 13,600
--------- ---------
Total cash and cash equivalents 13,678 27,882
Investment Securities:
Available-for-sale 508,540 599,410
Held-to-maturity, fair value of $441
in 2006 and $573 in 2005 440 562
--------- ---------
Total investment securities 508,980 599,972
Loans, net of unearned income 353,167 309,230
Less: allowance for loan losses (3,373) (3,266)
--------- ---------
Net loans 349,794 305,964
Accrued interest receivable 6,143 6,784
Premises and equipment, net 9,520 8,602
Goodwill, net 18,549 18,549
Other assets 8,102 9,699
--------- ---------
Total assets $ 914,766 $ 977,452
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 48,553 $ 50,269
Interest bearing 609,149 629,991
--------- ---------
Total deposits 657,702 680,260
Securities sold under agreements to repurchase 50,357 73,044
Long term borrowings 58,748 83,201
Subordinated debt 22,681 22,681
Accrued interest payable 7,382 5,731
Other liabilities 4,314 3,825
--------- ---------
Total liabilities 801,184 868,742
--------- ---------
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 --
September 30, 2006, 6,898,556 shares
December 31, 2005, 6,890,556 shares 770 770
Additional paid-in capital 90,600 90,594
Retained earnings 36,228 33,504
Accumulated other comprehensive loss, net (6,350) (8,415)
Treasury Stock
September 30, 2006, 799,729 shares (7,666) (7,743)
December 31, 2005, 807,729 shares --------- ---------
113,582 108,710
Total stockholders' equity --------- ---------
$ 914,766 $ 977,452
========= =========
The accompanying notes are an integral part of these statements
4
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Data)
(unaudited)
For The For The
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -----------------------
2006 2005 2006 2005
-------- -------- -------- --------
INTEREST INCOME
Loans $ 6,059 $ 4,738 $ 17,148 $ 14,279
Investment securities 5,989 6,452 18,393 19,104
Federal funds sold and
interest bearing deposits 93 60 251 212
-------- -------- -------- --------
Total interest income 12,141 11,250 35,792 33,595
-------- -------- -------- --------
INTEREST EXPENSE
Deposits 5,831 3,730 16,031 9,845
Short-term borrowings 583 849 1,577 2,622
Long-term borrowings 1,095 1,300 3,453 3,811
-------- -------- -------- --------
Total interest expense 7,509 5,879 21,061 16,278
-------- -------- -------- --------
Net interest income 4,632 5,371 14,731 17,317
PROVISION FOR LOAN LOSSES 45 45 135 135
-------- -------- -------- --------
Net interest income after
provision for loan losses 4,587 5,326 14,596 17,182
-------- -------- -------- --------
NON-INTEREST INCOME
Service charges on deposits 148 158 434 436
Investment securities gains -- -- 743 5
Other income 211 142 540 413
-------- -------- -------- --------
Total non-interest income 359 300 1,717 854
-------- -------- -------- --------
NON-INTEREST EXPENSE
Salaries and employee benefits 2,149 1,996 6,326 5,972
Net occupancy expense 489 433 1,455 1,291
Equipment expense 112 99 316 293
FDIC assessment 22 70 65 206
Data processing expense 90 51 271 144
Other 538 572 1,757 1,886
-------- -------- -------- --------
Total non-interest expense 3,400 3,221 10,190 9,792
-------- -------- -------- --------
Income before provision for taxes 1,546 2,405 6,123 8,244
Provision for income taxes 689 1,108 2,850 3,898
-------- -------- -------- --------
Net income $ 857 $ 1,297 $ 3,273 $ 4,346
======== ======== ======== ========
Net income per share:
Basic $ .12 $ .19 $ .47 $ .64
======== ======== ======== ========
Diluted $ .12 $ .19 $ .47 $ .63
======== ======== ======== ========
Number of shares used to compute net income per share:
Basic 6,899 6,817 6,895 6,778
======== ======== ======== ========
Diluted 6,984 6,926 6,983 6,925
======== ======== ======== ========
The accompanying notes are an integral part of these statements.
5
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For The Nine Months Ended September 30, 2006 and 2005
(In Thousands)
(unaudited)
Accumulated
Stock Additional other Total
Common Par paid-in comprehensive Retained Treasury Comprehensive stockholders'
Shares value capital (loss), net earnings stock income (loss) equity
------ ----- --------- ------------ -------- -------- -------------- -----------
Balance at January 1, 2006 7,698 $770 $90,594 $ (8,415) $ 33,504 $ (7,743) $108,710
Net income 3,273 3,273 3,273
Exercise of stock options 6 77 83
Other comprehensive income net
of reclassification adjustment
and taxes 2,065 2,065 2,065
-------
Comprehensive income (loss) $ 5,338
=======
Cash dividends (549) (549)
------ ---- ------- -------- -------- -------- --------
Balance at September 30, 2006 7,698 $770 $90,600 $ (6,350) $ 36,228 $ (7,666) $113,582
(Unaudited) ====== ==== ======= ======== ======== ======== ========
Balance at January 1, 2005 7,698 $770 $89,543 $ (2,602) $ 28,983 $ (9,075) $107,619
Net income 4,346 4,346 4,346
Exercise of stock options 741 1,178 1,919
Other comprehensive (loss) net
of reclassification adjustment
and taxes (3,540) (3,540) (3,540)
-------
Comprehensive income $ 806
=======
Cash dividends (471) (471)
------ ---- ------- -------- -------- -------- --------
Balance at September 30, 2005 7,698 $770 $90,284 $ (6,142) $ 32,858 $( 7,897) $109,873
(Unaudited) ====== ==== ======= ======= ======== ======== ========
The accompanying notes are an integral part of this statement.
6
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For The Nine Months Ended
September 30,
-------------------------------
2006 2005
---- ----
Cash flows from operating activities:
Net income $ 3,273 $ 4,346
Adjustments to reconcile net income to net
cash provided by operating activities:
Realized gains on investment securities (743) (5)
Net (accretion) of premiums of investment securities (482) (10)
Depreciation and amortization 543 481
Provision for loan losses 135 135
Decrease (increase) in accrued interest receivable 641 (129)
Decrease (increase) in other assets 1,597 (2,258)
Increase in accrued interest payable
and other liabilities 2,140 2,888
-------- --------
Net cash provided by operating activities 7,104 5,448
-------- --------
Cash flows from investing activities:
Investment securities available for sale
Purchases (306,995) (337,510)
Sales, maturities and calls 401,155 353,208
Investment securities held to maturity
Maturities 122 46
Net (increase) decrease in loans (43,965) 5,554
Acquisition of premises and equipment (1,461) (502)
-------- --------
Net cash provided by investing activities 48,856 20,796
-------- --------
7
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For The Nine Months Ended
September 30,
--------------------------
2006 2005
---- ----
Cash flows from financing activities:
Net (decrease) increase in non interest bearing deposits (1,716) 1,878
Net (decrease) increase in interest bearing deposits (20,842) 30,147
(Decrease) in securities sold under agreements
to repurchase (22,687) (62,457)
Proceeds from long term debt -- 20,000
Repayment of long term debt (24,453) (23,886)
Proceeds from issuance of subordinated debentures -- 7,217
Proceeds from exercise of common stock options 83 1,509
Dividends paid (549) (471)
-------- --------
Net cash (used in) financing activities (70,164) (26,063)
-------- --------
Net (decrease) increase in cash and cash equivalents (14,204) 181
Cash and cash equivalents - beginning of period 27,882 17,383
-------- --------
Cash and cash equivalents - end of period $ 13,678 $ 17,564
======== ========
Supplemental disclosure of cash flow information:
Cash used to pay interest $ 19,410 $13,983
Cash used to pay taxes, net of refunds $ 3,871 $ 5,558
The accompanying notes are an integral part of these statements.
8
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 30, 2006 and 2005
NOTE 1. General
Berkshire Bancorp Inc., a Delaware corporation, is a bank holding
company registered under the Bank Holding Company Act of 1956. References herein
to "Berkshire", the "Company" or "we" and similar pronouns, shall be deemed to
refer to 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 subsidiary, The Berkshire Bank (the "Bank"), a
New York State chartered commercial bank.
The accompanying financial statements of Berkshire Bancorp Inc. and
subsidiaries includes the accounts of the parent company, Berkshire Bancorp
Inc., and its wholly-owned subsidiaries: The Berkshire Bank, Greater American
Finance Group, Inc. and East 39, LLC.
We have prepared the accompanying financial statements pursuant to the
rules and regulations of the Securities and Exchange Commission (the "SEC") for
interim financial reporting. These consolidated financial statements are
unaudited and, in our opinion, include all adjustments, consisting of normal
recurring adjustments and accruals necessary for a fair presentation of our
consolidated balance sheets, operating results, and cash flows for the periods
presented. Operating results for the periods presented are not necessarily
indicative of the results that may be expected for 2006 due to a variety of
factors. Certain information and footnote disclosures normally included in
financial statements prepared in accordance with accounting principles generally
accepted in the United States ("GAAP") have been omitted in accordance with the
rules and regulations of the SEC. These consolidated financial statements should
be read in conjunction with the audited consolidated financial statements and
accompanying notes included in our 2005 Annual Report on Form 10-K.
NOTE 2. Trust Preferred Securities.
As of May 18 2004, the Company established Berkshire Capital Trust I, a
Delaware statutory trust, ("BCTI"). The Company owns all the common capital
securities of BCTI. BCTI issued $15.0 million of preferred capital securities to
investors in a private transaction and invested the proceeds, combined with the
proceeds from the sale of BCTI's common capital securities, in the Company
through the purchase of $15.464 million aggregate principal amount of Floating
Rate Junior Subordinated Debentures (the "2004 Debentures") issued by the
Company. The 2004 Debentures, the sole assets of BCTI, mature on July 23, 2034
and bear interest at a floating rate, three month LIBOR plus 2.70%.
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%.
9
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note 2. - (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 3. Earnings Per Share
Basic earnings per share is calculated by dividing income available to
common stockholders by the weighted average common shares outstanding, excluding
stock options from the calculation. In calculating diluted earnings per share,
the dilutive effect of stock options is calculated using the average market
price for the Company's common stock during the period. The following table
presents the calculation of earnings per share for the periods indicated:
For The Three Months Ended
----------------------------------------------------------------------------------
September 30, 2006 September 30, 2005
---------------------------------------- ---------------------------------------
Per Per
Income Shares share Income Shares share
(numerator) (denominator) amount (numerator) (denominator) amount
----------- ------------- ------ ----------- ------------ ------
(In thousands, except per share data)
Basic earnings per share
Net income available to
common stockholders $ 857 6,899 $.12 $1,297 6,817 $.19
Effect of dilutive securities
options -- 85 -- -- 109 --
------ ------- ------ ------ ------ ------
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $ 857 6,984 $.12 $1,297 6,926 $.19
======= ======= ====== ======= ====== ======
10
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE 3. - (continued)
For The Nine Months Ended
----------------------------------------------------------------------------------
September 30, 2006 September 30, 2005
---------------------------------------- ---------------------------------------
Per Per
Income Shares share Income Shares share
(numerator) (denominator) amount (numerator) (denominator) amount
----------- ------------- ------ ----------- ------------ ------
(In thousands, except per share data)
Basic earnings per share
Net income available to
common stockholders $3,273 6,895 $.47 $4,346 6,778 $.64
Effect of dilutive securities
options -- 88 -- -- 147 (.01)
------ ------- ------ ------ ------ ------
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $3,273 6,983 $.47 $4,346 6,925 $.63
======= ======= ====== ======= ====== ======
NOTE 4. Investment Securities
The following tables summarize held to maturity and available-for-sale
investment securities as of September 30, 2006 and December 31, 2005:
September 30, 2006
-----------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
--------------- --------------- ----------------- ---------------
(In thousands)
Held To Maturity
Investment Securities
U.S. Government Agencies $ 440 $ 2 $ 1 $ 441
----- --- --- -----
Totals $ 440 $ 2 $ 1 $ 441
===== === === =====
December 31, 2005
-----------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
--------------- ---------------- ---------------- ---------------
(In thousands)
Held To Maturity
Investment Securities
U.S. Government Agencies $ 562 $ 11 $ -- $ 573
----- ---- ---- -----
Totals $ 562 $ 11 $ -- $ 573
===== ==== ==== =====
11
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE 4. - (continued)
September 30, 2006
-----------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
--------------- --------------- --------------- ------------
(In thousands)
Available-For-Sale Investment
Securities
U.S. Treasury and Notes $ -- $ -- $ -- $ --
U.S. Government Agencies 344,074 8 (6,889) 337,193
Mortgage-backed securities 71,570 54 (2,181) 69,443
Corporate notes 32,496 155 (1,265) 31,386
Municipal Securities 1,973 1,035 -- 3,008
Marketable equity
securities and other 67,370 202 (62) 67,510
-------- ------- -------- --------
Totals $517,483 $ 1,454 $(10,397) $508,540
======== ======= ======== ========
December 31, 2005
----------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
--------------- --------------- --------------- ------------
(In thousands)
Available-For-Sale 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
======== ======= ======== ========
Financial Accounting Standards Board ("FASB") Staff Position No. FAS
115-1 and FAS 124-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments" (the "FSP"), was issued on November 3, 2005
and addresses the determination of when an investment is considered impaired;
whether the impairment is other than temporary; and how to measure an impairment
loss. The FSP also addresses accounting considerations subsequent to the
recognition of an other-than-temporary impairment on a debt security, and
requires certain disclosures about unrealized losses that have not been
recognized as other-than-temporary impairments. The FSP replaces the impairment
guidance in EITF Issue No. 03-1 with references to existing authoritative
literature concerning other-than-temporary determinations (principally Statement
of Financial Accounting Standards ("SFAS") No. 115 and SEC Staff Accounting
Bulletin 59). Under the FSP, impairment losses must be recognized in earnings
equal to the entire difference between the security's cost and its fair value at
the financial statement date, without considering partial recoveries subsequent
to that date.
12
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE 4. - (continued)
The FSP also requires that an investor recognize an
other-than-temporary impairment loss when a decision to sell a security has been
made and the investor does not expect the fair value of the security to fully
recover prior to the expected time of sale. Application of the guidance in FSP
FAS 115-1 and FAS 124-1 is applicable to reporting periods beginning after
December 15, 2005. The company adopted FSP 115-1 and FAS 124-1 in the first
quarter of fiscal year 2006, the adoption of which did not have an impact on its
operating results and financial condition.
Our available-for-sale portfolio is carried at estimated fair value,
with any unrealized gains or losses, net of taxes, reported as accumulated other
comprehensive income or loss in stockholders' equity. Our held-to-maturity
portfolio, consisting of debt securities for which we have a positive intent and
ability to hold to maturity, is carried at amortized cost. We conduct a periodic
review and evaluation of the securities portfolio to determine if the value of
any security has declined below its cost or amortized cost, and whether such
decline is other-than-temporary.
The company has investments in debt and equity securities that have
unrealized losses, but an other-than-temporary impairment has not been
recognized in its financial statements. Based upon management's review of the
available information including the changes in interest rates during the period,
current market conditions, applicable industry and company information specific
to each investment, the creditworthiness of the issuer, and the Company's
ability to hold the investment to maturity, such unrealized losses are not
considered to be other-than-temporary.
NOTE 5. Loan Portfolio
The following table sets forth information concerning the Company's
loan portfolio by type of loan at the dates indicated:
September 30, 2006 December 31, 2005
------------------------ -----------------------
% of % of
Amount Total Amount Total
------ ----- ------ -----
(Dollars in thousands)
Commercial and professional loans $ 54,080 15.3% $ 33,370 10.8%
Secured by real estate
1-4 family 142,513 40.2 139,931 45.1
Multi family 3,940 1.1 2,874 0.9
Non-residential (commercial) 150,971 42.6 132,142 42.6
Consumer 2,840 0.8 2,018 0.6
-------- ----- -------- -----
Total loans 354,344 100.0% 310,335 100.0%
===== =====
Deferred loan fees (1,177) (1,105)
Allowance for loan losses (3,373) (3,266)
-------- --------
Loans, net $349,794 $305,964
======== ========
13
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE 6. Deposits
The following table summarizes the composition of the average balances
of major deposit categories:
September 30, 2006 December 31, 2005
------------------ -----------------
Average Average Average Average
Amount Yield Amount Yield
------ ------ ------ -----
(Dollars in thousands)
Demand deposits $ 47,535 -- $ 44,739 --
NOW and money market 37,137 0.61% 42,756 0.56%
Savings deposits 171,408 2.80 221,374 1.99
Time deposits 408,203 4.00 338,834 2.82
-------- ---- -------- ----
Total deposits $664,283 3.22% $647,703 2.19%
======== ==== ======== ====
NOTE 7. Comprehensive Income
The following table presents the components of comprehensive income,
based on the provisions of SFAS No. 130.:
For The Nine Months Ended
----------------------------------------------------------------------------------------------------
September 30, 2006 September 30, 2005
---------------------------------------------- ---------------------------------------------------
Tax Tax
Before tax (expense) Net of tax Before tax (expense) Net of tax
amount benefit Amount amount benefit amount
-------------- -------------- ------------- ---------------- ---------------- ---------------
(In thousands)
Unrealized gains (losses)
on investment securities:
Unrealized holding $4,165 $ (1,654) $ (2,511) $ (5,586) $2,043 $ (3,543)
gains (losses) arising
during period
Less reclassification
adjustment for gains
realized in net income 743 (297) 446 5 (2) 3
------ -------- ------ -------- ------ --------
Other comprehensive
income (loss), net $3,422 $ (1,357) $2,065 $ (5,581) $2,041 $ (3,540)
====== ======== ====== ======== ====== ========
14
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE 8. 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 adopted SFAS 123(R) in the first quarter of fiscal year
2006, the adoption of which did not have an impact on its operating results and
financial condition.
At September 30, 2006, the Company has one stock-based employee
compensation plan. Prior to the adoption of SFAS 123(R), 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 the nine-month period
ended September 30, 2006 or during the fiscal year ended December 31, 2005. We
have no plans to grant significant stock options, if any, during the last three
months of 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.
NOTE 9. Employee Benefit Plans
The Company has a Retirement Income Plan (the "Plan"), a
noncontributory plan covering substantially all full-time, non-union United
States employees of the Company. The following interim-period information is
being provided in accordance with FASB Statement 132(R).
For The For The
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- -----------------------------------
2006 2005 2006 2005
--------------- -------------- ---------------- ----------------
Service cost $ 90,357 $ 79,381 $ 262,714 $ 224,762
Interest cost 37,531 35,425 112,062 98,850
Expected return on plan assets (37,710) (38,940) (113,420) (111,880)
Amortization and Deferral:
Transition amount -- -- -- --
Prior service cost 4,457 4,593 13,914 13,779
(Gain)/loss 15,429 11,228 44,858 28,863
Net periodic pension cost 110,063 91,687 320,126 254,374
During the fiscal year ending December 31, 2006, we expect to
contribute approximately $333,000 to the Plan. We contributed $56,000, $221,000
and $56,000 in April, July and October 2006, respectively. During fiscal year
2005, we contributed approximately $112,000 to the Plan.
15
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE 10. New Accounting Pronouncements
In September 2006 the FASB issued SFAS No. 157, "Fair Value
Measurements." The Statement is effective for all financial statements issued
for fiscal years beginning after November 15, 2007. The Statement defines fair
value as the price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date, establishes a framework for measuring fair value, and expands
disclosures about fair value measurements. Adoption of SFAS No. 157 is not
expected to have a material impact on the Company's results of operations or
financial condition.
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting
for Defined Benefit Pension and Other Postretirement Plans." The Statement
requires an employer that is a business entity and sponsors one or more
single-employer defined benefit plans to: (1) recognize the funded status of a
benefit plan - measured as the difference between plan assets at fair value and
the benefit obligation - in its statement of financial position, with the
corresponding credit or charge, net of taxes, upon initial adoption to Other
Comprehensive Income; (2) recognized as a component of other comprehensive
income, net of tax, the gains or losses and prior service costs or credits that
arise during the period but are not recognized as components of net periodic
benefit cost pursuant to SFAS No. 87, "Employers' Accounting for Pensions", or
SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions"; (3) measure defined benefit plan assets and obligations as of the
date of the employer's fiscal year end; and (4) expand disclosures in the notes
to the financial statements about certain effects on net periodic benefit cost.
The Statement also amends SFAS No. 132 (revised 2003), "Employers' Disclosures
about Pensions and Other Postretirement Benefits", and SFAS No. 88, "Employers'
Accounting for Settlements and Curtailments of Defined Benefit Pension Plans for
Termination Benefits". An employer who has publicly traded equity securities,
such as the Company, is required to initially recognize the funded status of a
defined benefit postretirement plan and to provide the required disclosures as
of the end of its fiscal year ending after December 15, 2006. For the Company,
this is for the year ended December 31, 2006. The requirement to measure plan
assets and benefit obligations as of the date of the employer's fiscal year end
is effective for fiscal years ending after December 15, 2008. Based upon the
advice of our consultants, management believes that the adoption of this
statement for the year ended December 31, 2006 will have no significant effect
on Other Comprehensive Income and stockholders' equity.
On July 13, 2006, the FASB issued FASB Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes" ("FIN No. 48"): an interpretation
of FASB No. 109. FIN No. 48 clarifies the accounting for uncertainty involved in
the recognition and measurement of a tax position taken or expected to be taken
in a tax return. FIN No. 48 is effective for fiscal years beginning after
December 15, 2006. The application of FIN No. 48 is not expected to have an
impact on the Company's financial condition or results of operations.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing
of Financial Assets-an amendment of FASB Statement No. 140." This statement
requires an entity to recognize a servicing asset or servicing liability each
time it undertakes an obligation to service a financial asset, and that the
servicing assets and servicing liabilities be initially measured at fair value.
The statement also permits an entity to choose a subsequent measurement method
for each class of separately recognized servicing assets and servicing
liabilities. SFAS No. 156 is effective as of the beginning of the fiscal year
that begins after September 15, 2006. The application of SFAS No. 156 is not
expected to have a material impact on the Company's financial condition or
results of operations.
16
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE 10. - (continued)
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain
Hybrid Financial Instruments." The Statement amends SFAS No. 133, "Accounting
for Derivative Instruments and Hedging Activities" and SFAS No.140, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities." The Statement also resolves issues addressed in SFAS No. 133
Implementation Issue No. D1, "Application of Statement 133 to Beneficial
Interest in Securitized Financial Assets." SFAS No. 155 permits fair value
remeasurement for any hybrid financial instrument that contains an embedded
derivative that otherwise would require bifurcation, clarifies which
interest-only strips and principal-only strips are not subject to the
requirements of SFAS No. 133, establishes a requirement to evaluate interests in
securitized financial assets to identify interests that are freestanding
derivatives or that are hybrid financial instruments that contain as embedded
derivative requiring bifurcation, and clarifies that concentrations of credit
risk in the form of subordination are not embedded derivatives. The Statement
eliminates the interim guidance in SFAS No. 133 Implementation Issue No. D1,
which provided that beneficial interests in securitized financial assets are not
subject to the provisions of SFAS No. 133. In October 2006, the FASB
recommended a narrow scope exception for asset backed securities, including
mortgage-backed securities, created from pools of loans containing embedded call
features, that (a) only contain an embedded derivative that is tied to the
prepayment risk of the underlying prepayable financial assets, and (b) the
investor does not control the right to accelerate the settlement. The Statement
is effective for all financial instruments acquired or issued after the
beginning of an entity's first fiscal year that begins after September 15, 2006.
Since the Statement is effective for purchases made by the Company after
December 31, 2006, management is unable, at this time, to determine the impact
of this statement.
In September 2006, the SEC staff issued Staff Accounting Bulletin No.
108, "Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements." SAB 108 was issued to
provide consistency between how registrants quantify financial statement
misstatements. Historically, there have been two widely-used methods for
quantifying the effects of financial statement misstatements. These methods are
referred to as the "roll-over" and "iron curtain" method. The roll-over method
quantifies the amount by which the current year income statement is misstated.
Exclusive reliance on an income statement approach can result in the
accumulation of errors on the balance sheet that may not have been material to
any individual income statement, but which may misstate one or more balance
sheet accounts. The iron curtain method quantifies the error as the cumulative
amount by which the current year balance sheet is misstated. Exclusive reliance
on a balance sheet approach can result in disregarding the effects of errors in
the current year income statement that results from the correction of an error
existing in previously issued financial statements. We currently use the
roll-over method for quantifying identified financial statement misstatements.
SAB 108 established an approach that requires quantification of
financial statement misstatements based on the effects of the misstatement on
each of the Company's financial statements and the related financial statement
disclosures. This approach is commonly referred to as the "dual approach"
because it requires quantification of errors under both the roll-over and iron
curtain methods. SAB 108 allows registrants to initially apply the dual approach
either by (1) retroactively adjusting prior financial statements as if the dual
approach had always been used or by (2) recording the cumulative effect of
initially applying the dual approach as adjustments to the carrying values of
assets and liabilities as of January 1, 2006 with an offsetting adjustment
recorded to the opening balance of retained earnings. Use of this "cumulative
effect" transition
17
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE 10. - (continued)
method requires detailed disclosure of the nature and amount of each individual
error being corrected through the cumulative adjustment and how and when it
arose. SAB 108 is effective for fiscal years ending after November 15, 2006. The
Company does not expect the adoption of SAB 108 will have a material effect on
the Company's results of operations or financial condition as management is not
aware of any prior year misstatements in the Company's financial statements.
Internal Control Over Financial Reporting
The current objective of the Bank's Internal Control Program is to
allow management to comply with FDICIA requirements and with Section 302 of the
Sarbanes-Oxley Act of 2002 (the "Act"). Section 302 of the Act requires the CEO
and CFO of the Company to (i) certify that the annual and quarterly reports
filed with the Securities and Exchange Commission are accurate and (ii)
acknowledge that they are responsible for establishing, maintaining and
periodically evaluating the effectiveness of the disclosure controls and
procedures. Section 404 of the Act requires management to report on internal
control over financial reporting. Presently, the SEC requires the Company to
first comply with Section 404 by 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.
18
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion and analysis is intended to provide a better
understanding of the consolidated financial condition and results of operations
of Berkshire Bancorp Inc., a Delaware corporation. References herein to
"Berkshire", the "Company" or "we" and similar pronouns, shall be deemed to
refer to Berkshire Bancorp Inc. and its consolidated subsidiaries unless the
context otherwise requires. References herein to per share amounts refer to
diluted shares. References to Notes herein are references to the "Notes to
Consolidated Financial Statements" of the Company located in Item 1 herein.
The accompanying financial statements of Berkshire Bancorp Inc. and
subsidiaries includes the accounts of the parent company, Berkshire Bancorp
Inc., and its wholly-owned subsidiaries: The Berkshire Bank, Greater American
Finance Group, Inc. and East 39, LLC.
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 banking 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 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.
19
The following table presents the total dollar amount of interest income
from average interest-earning assets and the resultant yields, as well as the
interest expense on average interest-bearing liabilities, expressed in both
dollars and rates.
For The Three Months Ended September 30,
-----------------------------------------------------------------------------------
2006 2005
---------------------------------------- ----------------------------------------
Interest Interest
Average and Average Average and Average
Balance Dividends Yield/Rate Balance Dividends Yield/Rate
------- --------- ---------- ------- --------- ----------
(Dollars in Thousands)
INTEREST-EARNING ASSETS:
Loans (1) $330,117 $ 6,059 7.34% $284,282 $ 4,738 6.67%
Investment securities 528,760 5,989 4.53 646,601 6,452 3.99
Other (2)(5) 8,484 93 4.38 7,982 60 3.01
-------- -------- -------- -------- -------- --------
Total interest-earning assets 867,361 12,141 5.60 938,865 11,250 4.79
-------- --------
Noninterest-earning assets 49,339 44,063
--------- --------
Total Assets $916,700 $982,928
========= ========
INTEREST-BEARING LIABILITIES:
Interest bearing deposits 200,264 1,406 2.81% 239,469 1,109 1.85%
Time deposits 400,173 4,425 4.42 353,417 2,621 2.97
Other borrowings 144,697 1,678 4.64 225,670 2,149 3.81
-------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities 745,134 7,509 4.03 818,556 5,879 2.87
-------- -------- -------- --------
Demand deposits 47,176 44,419
Noninterest-bearing liabilities 15,570 8,182
Stockholders' equity (5) 108,820 111,771
--------- --------
Total liabilities and
stockholders' equity $916,700 $982,928
========= ========
Net interest income $ 4,632 $ 5,371
======== ========
Interest-rate spread (3) 1.57% 1.92%
======== =========
Net interest margin (4) 2.14% 2.29%
======== =========
Ratio of average interest-earning
assets to average interest
bearing liabilities 1.16 1.15
=========== ========
----------------------
(1) Includes nonaccrual loans.
(2) Includes interest-bearing deposits, federal funds sold and securities
purchased under agreements to resell.
(3) Interest-rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest bearing
liabilities.
(4) Net interest margin is net interest income as a percentage of average
interest-earning assets.
(5) Average balances are daily average balances except for the parent company
which have been calculated on a monthly basis.
20
For The Nine Months Ended September 30,
-----------------------------------------------------------------------------------
2006 2005
---------------------------------------- ----------------------------------------
Interest Interest
Average and Average Average and Average
Balance Dividends Yield/Rate Balance Dividends Yield/Rate
------- --------- ---------- ------- --------- ----------
(Dollars in Thousands)
INTEREST-EARNING ASSETS:
Loans (1) $ 317,612 $ 17,148 7.20% $ 286,888 $ 14,279 6.64%
Investment securities 564,102 18,393 4.35 661,744 19,104 3.85
Other (2)(5) 8,404 251 3.98 11,158 212 2.53
---------- --------- ------------ ---------- -------- ---------
Total interest-earning assets 890,118 35,792 5.36 959,790 33,595 4.67
------------ ---------
Noninterest-earning assets 47,491 43,915
---------- ----------
Total Assets $ 937,609 $1,003,705
========== ==========
INTEREST-BEARING LIABILITIES:
Interest bearing deposits 208,545 3,772 2.41% 280,068 3,615 1.72%
Time deposits 408,203 12,259 4.00 319,140 6,230 2.60
Other borrowings 151,635 5,030 4.42 242,904 6,433 3.53
---------- --------- ------------ ---------- -------- --------
Total interest-bearing
liabilities 768,383 21,061 3.65 842,112 16,278 2.58
--------- ------------ -------- --------
Demand deposits 47,535 45,155
Noninterest-bearing liabilities 12,120 7,308
Stockholders' equity (5) 109,571 109,130
---------- ----------
Total liabilities and
stockholders' equity $ 937,609 $1,003,705
========== ==========
Net interest income $ 14,731 $ 17,317
========= ========
Interest-rate spread (3) 1.71% 2.09%
============ ========
Net interest margin (4) 2.21% 2.41%
============ ========
Ratio of average interest-earning
assets to average interest
bearing liabilities 1.16 1.14
========== ==========
----------------------
(1) Includes nonaccrual loans.
(2) Includes interest-bearing deposits, federal funds sold and securities
purchased under agreements to resell.
(3) Interest-rate spread represents the difference between the average yield on
interest-earning assets and the average cost of interest bearing
liabilities.
(4) Net interest margin is net interest income as a percentage of average
interest-earning assets.
(5) Average balances are daily average balances except for the parent company
which have been calculated on a monthly basis.
21
Results of Operations
Results of Operations for the Three and Nine Months Ended September 30, 2006
Compared to the Three and Nine Months Ended September 30, 2005.
General. Berkshire Bancorp Inc., a bank holding company registered under the
Bank Holding Company Act of 1956, has one wholly-owned banking subsidiary, The
Berkshire Bank, a New York State chartered commercial bank. The Bank is
headquartered in Manhattan and has eleven branch locations; six branches in New
York City, four branches in Orange and Sullivan counties New York, and one
branch in Ridgefield, New Jersey which opened in May 2006.
Net Income. Net income for the three-month period ended September 30, 2006 was
$857,000, or $.xx per share, as compared to $1.30 million, or $.19 per share,
for the three-month period ended September 30, 2005. Net income for the
nine-month period ended September 30, 2006 was $3.27 million, or $.xx per share,
as compared to $4.35 million, or $.63 per share, for the nine-month period ended
September 30, 2005.
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 September 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 during
2004, 2005 and 2006 have moved the prime rate to its present level of 8.25%. The
difference between the yield on short-term, 3-month U.S. Treasury Notes, and
long-term, 10-year U.S. Treasury Bonds, referred to as the yield curve is at
historic lows.
Net Interest Income. The Company's primary source of revenue is net interest
income, or the difference between interest income on earning assets, such as
loans and investment securities, and interest expense on interest-bearing
liabilities such as deposits and borrowings.
For the quarter ended September 30, 2006, net interest income decreased
by $739,000 to $4.63 million from $5.37 million for the quarter ended September
30, 2005. The quarter over quarter decrease in net interest income was the
result of the 116 basis point increase in the average rate paid on the average
amount of interest-bearing liabilities to 4.03% in the 2006 quarter from 2.87%
in the 2005 quarter and the smaller, 81 basis point increase in the average
yield earned on the average amount of interest-earning assets, and the $71.50
million decrease in the average amount of interest-earning assets to $867.36
million in the 2006 quarter from $938.87 million in the 2005 quarter. Partially
offsetting these factors was the $73.42 million decrease in the average amount
of interest-bearing liabilities to $745.13 million in 2006 from $818.56 million
in 2005. The interest-rate spread, the difference between the average yield on
interest-earning assets and the average cost of interest-bearing liabilities,
narrowed by 35 basis points to 1.57% in the 2006 quarter from 1.92% in the 2005
quarter.
For the nine-month period ended September 30, 2006, net interest income
decreased by $2.59 million to $14.73 million from $17.32 million for the
nine-month period ended September 30, 2005. The period over period decrease in
net interest income was the result of the 107 basis point increase in the
average rate paid on the average amount of interest-bearing liabilities to 3.65%
in the 2006 period from 2.58% in the 2005 period, and the smaller, 69 basis
point increase in the average yield earned on the average amount of
interest-earning assets, and the $69.67 million decrease in the average amount
of interest-earning assets to $890.12 million in the 2006 period from $959.79
million in the 2005 period. Partially offsetting these factors was the $73.73
million decrease in the average amount of interest-bearing liabilities to
$768.38 million in the 2006
22
period from $842.11 million in the 2005 period. The interest-rate spread
narrowed by 38 basis points to 1.71% in the 2006 period from 2.09% in the 2005
period.
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 2005 and 2006 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 have and will continue to increase as
well.
We have scaled back our use of borrowed funds and the size of our
investment portfolio during fiscal 2006, a period in which short-term rates
have, at times, exceeded the rates available on long-term investments.
Net Interest Margin. Net interest margin, or annualized net interest income as a
percentage of average interest-earning assets, declined by 15 basis points to
2.14% in the third quarter of 2006 from 2.29% in the third quarter of 2005, and
declined by 20 basis points to 2.21% in the nine-month period of 2006 from 2.41%
in the nine-month period of 2005. We seek to secure and retain customer deposits
with competitive products and rates, and to make strategic use of the prevailing
interest rate environment to borrow funds at what we believe to be attractive
rates. We typically invest such deposits and borrowed funds in a prudent mix of
fixed and adjustable rate loans, investment securities and short-term
interest-earning assets which provided an aggregate average yield of 5.60% and
5.36% in the three and nine months ended September 30, 2006, respectively,
compared to an aggregate average yield of 4.79% and 4.67% in the three and nine
months ended September 30, 2005, respectively.
The increased yield on interest-earning assets is the result of the
rising interest rate environment discussed above which triggers the upward rate
adjustment in our portfolio of adjustable rate loans and investment securities,
and the increase in our loan portfolio as a percentage of our total
interest-earning assets. The decrease in net interest margin is the result of
the more rapid rise in the cost of interest-bearing liabilities.
For the three months ended September 30, 2006, the average amounts of
loans increased by $45.84 million to $330.12 million from $284.28 million for
the three months ended September 30, 2004. The average yield on such loans
increased by 67 basis points to 7.34% in the 2006 quarter from 6.67% in the 2005
quarter. In the 2006 quarter, the average amount of investment securities
decreased by $117.84 million, to $528.76 million from $646.60 million in the
2005 quarter and the average yield on investment securities increased to 4.53%
during the three months ended September 30, 2006 from 3.99% during the three
months ended September 30, 2005.
For the nine month period ended September 30, 2006, the average amounts
of loans increased by $30.72 million to $317.61 million from $286.89 million for
the nine month period ended September 30, 2005. The average yield on such loans
increased by 56 basis points to 7.20% in the first nine months of 2006 from
6.64% in the first nine months of 2005. In the 2006 period, the average amount
of investment securities and other interest-earning assets decreased by $97.64
million and $2.75 million, respectively, to $564.10 million and $8.40 million,
respectively, from $661.74 million and $11.16 million, respectively, in the 2005
period. The average yield on investment securities and other interest-earning
increased to 4.35% and 3.98%, respectively, during the nine months ended
September 30, 2006, from 3.85% and 2.53%, respectively, during the nine months
ended September 30, 2005.
23
Interest Income. Total interest income for the quarter ended September 30, 2006
increased by $891,000, or 7.92%, to $12.14 million from $11.25 million for the
quarter ended September 30, 2005. The increase in total interest income was due
to higher average balances and average yields in our loan portfolio and higher
average yields on total interest-earning assets. Loans and investment securities
contributed $6.06 million and $5.99 million, respectively, of interest income in
the 2006 quarter compared to $4.74 million and $6.45 million, respectively in
the 2005 quarter.
Total interest income for the nine months ended September 30, 2006
increased by $2.20 million, or 6.54%, to $35.79 million from $33.60 million for
the nine months ended September 30, 2005. The increase in total interest income
was due to higher average balances and average yields in our loan portfolio and
higher average yields on total interest-earning assets. Loans and investment
securities contributed $17.15 million and $18.39 million, respectively, of
interest income in the 2006 period compared to $14.28 million and $19.10
million, respectively in the 2005 period.
--------------------------------------------------------
Three Months Ended September 30,
--------------------------------------------------------
2006 2005
------------------------- --------------------------
Interest % of Interest % of
Income Total Income Total
(In thousands, except percentages)
Loans $ 6,059 49.91% $ 4,738 42.12%
Investment Securities 5,989 49.33 6,452 57.35
Other 93 0.76 60 0.53
------- ------ -------- ------
Total Interest Income $12,141 100.00% $ 11,250 100.00%
--------------------------------------------------------
Nine Months Ended September 30,
--------------------------------------------------------
2006 2005
------------------------- --------------------------
Interest % of Interest % of
Income Total Income Total
(In thousands, except percentages)
Loans $17,148 47.91% $14,279 42.50%
Investment Securities 18,393 51.39 19,104 56.87
Other 251 0.70 212 0.63
------- ------ -------- ------
Total Interest Income $35,792 100.00% $33,595 100.00%
Loans, which are inherently risky and therefore command a higher return
than our conservative portfolio of investment securities, have increased as a
percentage of total average interest-earning assets. During the three and nine
months ended September 30, 2006, the average amount of our loan portfolio
represented 38.06% and 35.68%, respectively, of total interest-earning assets
compared to 30.28% and 29.89%, respectively, for the three and nine months ended
September 30, 2005. The average amount of investment securities have decreased
to 60.96% and 63.37% of total interest-earning assets during the three and nine
months of 2006, respectively, compared to 68.87% and 68.95%, respectively,
during the three and nine months ended September 30, 2005. 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.
24
------------------------------------------------------------
Three Months Ended September 30,
------------------------------------------------------------
2006 2005
------------------------------ --------------------------
Average % of Average % of
Amount Total Amount Total
(In thousands, except percentages)
Loans $330,117 38.06% $284,282 30.28%
Investment Securities 528,760 60.96 646,601 68.87
Other 8,484 0.98 7,982 0.85
-------- ------ -------- ------
Total Interest-Earning Assets $867,361 100.00% $938,865 100.00%
------------------------------------------------------------
Nine Months Ended September 30,
------------------------------------------------------------
2006 2005
------------------------------ --------------------------
Average % of Average % of
Amount Total Amount Total
(In thousands, except percentages)
Loans $317,612 35.68% $286,888 29.89%
Investment Securities 564,102 63.37 661,744 68.95
Other 8,404 0.95 11,158 1.16
-------- ------ -------- ------
Total Interest-Earning Assets $890,118 100.00% $959,790 100.00%
Interest Expense. Total interest expense for the quarter ended September 30,
2006 increased by $1.63 million, or 27.72%, to $7.51 million from $5.88 million
for the quarter ended September 30, 2005. The increase in interest expense was
due primarily to the increase in the average rates paid on such liabilities,
4.03% and 2.87% in the 2006 and 2005 quarters, respectively, partially offset by
the $73.42 million decline in the average amount of interest-bearing
liabilities. If interest rates move higher, interest expense is likely to
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 and
April 2005, we sold $15.46 million and $7.22 million, respectively, of floating
rate junior subordinated debentures (the "Debentures") and used the net proceeds
to augment the Bank's capital to allow for business expansion. The additional
interest expense on these Debentures, which is included in other borrowings was,
approximately $444,000 and $354,000 during the three months ended September 30,
2006 and 2005, respectively.
-------------------------------------------------------------
Three Months Ended September 30,
-------------------------------------------------------------
2006 2005
------------------------------ --------------------------
Interest % of Interest % of
Expense Total Expense Total
(In thousands, except percentages)
Interest-Bearing Deposits $1,406 18.72% $1,109 18.86%
Time Deposits 4,425 58.93 2,621 44.59
Other Borrowings 1,678 22.35 2,149 36.55
-------- ------ -------- -------
Total Interest Expense $7,509 100.00% $5,879 100.00%
Total interest expense for the nine-month period ended September 30, 2006
increased by $4.78 million, or 29.38%, to $21.06 million from $16.28 million for
the nine-month period ended September 30, 2005. The increase in interest expense
was due primarily to the increase in the average rates paid on such liabilities,
3.65% and 2.58% in the 2006 and 2005 periods, respectively, partially offset by
the $73.73 million decline in the average amount of interest-bearing
liabilities. The interest expense on the Debentures, which is included in other
borrowings, was approximately $1.30 million and $903,000 during the 2006 and
2005 nine-month periods, respectively.
25
--------------------------------------------------------------
Nine Months Ended September 30,
--------------------------------------------------------------
2006 2005
------------------------------ ---------------------------
Interest % of Interest % of
Expense Total Expense Total
(In thousands, except percentages)
Interest-Bearing Deposits $ 3,772 17.91% $ 3,615 22.21%
Time Deposits 12,259 58.21 6,230 38.27
Other Borrowings 5,030 23.88 6,433 39.52
------- ------ ------- ------
Total Interest Expense $21,061 100.00% $16,278 100.00%
Non-Interest Income. Non-interest income consists primarily of realized gains on
sales of marketable securities and service fee income. For the three and nine
months ended September 30, 2006, non-interest income amounted to $359,000 and
$1.72 million, respectively, compared to non-interest income of $300,000 and
$854,000 for the three and nine months ended September 30, 2005, respectively.
------------------------------------------------------------------
Three Months Ended September 30,
------------------------------------------------------------------
2006 2005
-------------------------------- ------------------------------
Non-Interest % of Non-Interest % of
Income Total Income Total
(In thousands, except percentages)
Service Charges on Deposits $ 148 41.23% $ 158 52.67%
Investment Securities gains -- -- -- --
Other 211 58.77 142 47.33
------ ------ ------ ------
Total Non-Interest Income $ 359 100.00% $ 300 100.00%
------------------------------------------------------------------
Nine Months Ended September 30,
------------------------------------------------------------------
2006 2005
-------------------------------- ------------------------------
Non-Interest % of Non-Interest % of
Income Total Income Total
(In thousands, except percentages)
Service Charges on Deposits $ 434 25.28 $ 436 51.05%
Investment Securities gains 743 43.27 5 0.59
Other 540 31.45 413 48.36
------ ------ ------ ------
Total Non-Interest Income $ 1,717 100.00% $ 854 100.00%
Non-Interest Expense. Non-interest expense includes salaries and employee
benefits, occupancy and equipment expenses, legal and professional fees and
other operating expenses associated with the day-to-day operations of the
Company. Total non-interest expense for the three and nine-month periods ended
September 30, 2006 was $3.40 million and $10.19 million, respectively, compared
to $3.22 million and $9.79 million for the three and nine month-periods ended
September 30, 2005, respectively. The increases in the 2006 periods are
primarily due to the expansion of our business. We have added space and staff to
maintain and enhance customer service levels and to insure our compliance with
various regulatory matters.
26
------------------------------------------------------------------
Three Months Ended September 30,
------------------------------------------------------------------
2006 2005
------------------------------- -------------------------------
Non-Interest % of Non-Interest % of
Expense Total Expense Total
(In thousands, except percentages)
Salaries and Employee Benefits $ 2,149 63.21% $ 1,996 61.98%
Net Occupancy Expense 489 14.38 433 13.44
Equipment Expense 112 3.29 99 3.07
FDIC Assessment 22 0.65 70 2.17
Data Processing Expense 90 2.65 51 1.58
Other 538 15.82 572 17.76
------- ------ ------- ------
Total Non-Interest Expense $ 3,400 100.00% $ 3,221 100.00%
------------------------------------------------------------------
Nine Months Ended September 30,
------------------------------------------------------------------
2006 2005
------------------------------- -------------------------------
Non-Interest % of Non-Interest % of
Expense Total Expense Total
(In thousands, except percentages)
Salaries and Employee Benefits $ 6,326 62.08% $ 5,972 60.99%
Net Occupancy Expense 1,455 14.28 1,291 13.19
Equipment Expense 316 3.10 293 2.99
FDIC Assessment 65 0.64 206 2.10
Data Processing Expense 271 2.66 144 1.47
Other 1,757 17.24 1,886 19.26
------- ------ ------- ------
Total Non-Interest Expense $10,190 100.00% $ 9,792 100.00%
Provision for Income Tax. During the three and nine-month periods ended
September 30, 2006, the Company recorded income tax expense of $689,000 and
$2.85 million, respectively, compared to income tax expense of $1.11 million and
$3.90 million, respectively, for the three and nine-month periods ended
September 30, 2005. The tax provisions for federal, state and local taxes
recorded for the first nine months of 2006 and 2005 represent effective tax
rates of 46.55% and 47.28%, respectively.
Common Stock Repurchases
On May 15, 2003, The Company's Board of Directors authorized the
purchase of up to an additional 450,000 shares of its Common Stock in the open
market, from time to time, depending upon prevailing market conditions, thereby
increasing the maximum number of shares which may be purchased by the Company
from 1,950,000 shares of Common Stock to 2,400,000 shares of Common Stock. Since
1990 through December 31, 2004, the Company has purchased a total of 1,844,646
shares of its Common Stock. At September 30, 2006, there were 551,091 shares of
Common Stock which may yet be purchased under our stock repurchase plan. We have
not repurchased shares of the Company's Common Stock during the nine months
ended September 30, 2006 or in the fiscal year ended December 31, 2005.
27
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.
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
28
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 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
29
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 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.
30
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 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Interest Rate Risk. Fluctuations in market interest rates can have a material
effect on the Company's net interest income because the yields earned on loans
and investments may not adjust to market rates of interest with the same
frequency, or with the same speed, as the rates paid by the Bank on its
deposits.
Most of the Bank's deposits are either interest-bearing demand deposits
or short term certificates of deposit and other interest-bearing deposits with
interest rates that fluctuate as market rates change. Management of the Bank
seeks to reduce the risk of interest rate fluctuations by concentrating on loans
and securities investments with either short terms to maturity or with
adjustable rates or other features that cause yields to adjust based upon
interest rate fluctuations. In addition, to cushion itself against the potential
adverse effects of a substantial and sustained increase in market interest
rates, the Bank has purchased off balance sheet interest rate cap contracts
which generally provide that the Bank will be entitled to receive payments from
the other party to the contract if interest rates exceed specified levels. These
contracts are entered into with major financial institutions.
As additional interest rate management strategy, the Bank borrows funds
from the Federal Home Loan Bank, approximately $58.75 million at September 30,
2006, at fixed rates for a period of one to five years.
The Company seeks to maximize its net interest margin within an
acceptable level of interest rate risk. Interest rate risk can be defined as the
amount of the forecasted net interest income that may be gained or lost due to
favorable or unfavorable movements in interest rates. Interest rate risk, or
sensitivity, arises when the maturity or repricing characteristics of assets
differ significantly from the maturity or repricing characteristics of
liabilities.
31
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 September 30, 2006
(in thousands, except for percentages)
----------------------------------------------------------------------------------------
3 Months 3 Through 1 Through Over
or Less 12 Months 3 Years 3 Years Total
---------------- ---------------- ---------------- ---------------- ------------
Federal funds sold -- -- -- -- --
(Rate)
Interest bearing deposits
in banks 4,312 -- -- -- 4,312
(Rate) 4.28% 4.28%
Loans (1)(2)
Adjustable rate loans 73,049 8,529 25,512 29,283 136,373
(Rate) 8.91% 6.87% 6.86% 6.90% 7.97%
Fixed rate loans 8,221 10,548 27,506 171,696 217,971
(Rate) 7.44% 6.75% 7.60% 6.57% 6.74%
--------- --------- --------- --------- -----------
Total loans 81,270 19,077 53,018 200,979 354,344
Investments (3)(4) 355,625 48,816 17,131 87,408 508,980
(Rate) 4.28% 3.66% 5.56% 4.97% 4.38%
--------- --------- --------- --------- -----------
Total rate-sensitive assets 441,207 67,893 70,149 288,387 867,636
--------- --------- --------- --------- -----------
Deposit accounts (5)
Savings and NOW 180,795 -- -- -- 180,795
(Rate) 3.05% 3.05%
Money market 16,736 -- -- -- 16,736
(Rate) 0.73% 0.73%
Time Deposits 143,489 261,943 6,184 2 411,618
(Rate) 3.87% 4.98% 2.89% 1.74% 4.56%
--------- --------- --------- --------- ----------
Total deposit accounts 341,020 261,943 6,184 2 609,149
Repurchase Agreements 40,357 10,000 -- -- 50,357
(Rate) 3.60% 4.77% 3.83%
Other borrowings 874 9,026 28,137 43,392 81,429
(Rate) 2.67% 4.23% 3.38% 6.75% 5.26%
--------- --------- --------- --------- ----------
Total rate-sensitive
liabilities 382,251 280,969 34,321 43,394 740,935
--------- --------- --------- --------- ----------
Interest rate caps 20,000 (10,000) (10,000)
Gap (repricing differences) 38,956 (203,076) 45,828 244,993 126,701
========= ========= ========= ========= ==========
Cumulative Gap 38,956 (164,120) (118,292) 126,701
========= ========= ========= =========
Cumulative Gap to Total Rate
Sensitive Assets 5.26% (22.15)% (15.97)% 17.10%
========= ========= ========= =========
---------------
(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.
32
Provision for Loan Losses.
The allowance for loan losses is the estimated amount considered
necessary to cover credit losses inherent in the loan portfolio at the balance
sheet date. The allowance is established through the provision for loan losses
that is charged against income. In determining the allowance for loan losses,
management makes significant estimates and therefore has identified the
allowance as a critical accounting policy. The methodology for determining the
allowance for loan losses is considered a critical accounting policy by
management due to the high degree of judgment involved, the subjectivity of the
assumptions utilized, and the potential for changes in the economic environment
that could result in changes to the amount of the recorded allowance for loan
losses.
The allowance for loan losses has been determined in accordance with
accounting principles generally accepted in the United States of America, under
which we are required to maintain an allowance for probable losses at the
balance sheet date. We are responsible for the timely and periodic determination
of the amount of the allowance required. Management believes that the allowance
for loan losses is adequate to cover specifically identifiable losses, as well
as estimated losses inherent in our portfolio for which certain losses are
probable but not specifically identifiable.
Management performs a quarterly evaluation of the adequacy of the
allowance for loan losses. The analysis of the allowance for loan losses has two
components: specific and general allocations. Specific allocations are made for
loans determined to be impaired. Impairment is measured by determining the
present value of expected future cash flows or, for collateral-dependent loans,
the fair value of the collateral adjusted for market conditions and selling
expenses. The general allocation is determined by segregating the remaining
loans by type of loan, risk weighting (if applicable) and payment history.
Management also analyzes historical loss experience, delinquency trends, general
economic conditions, geographic concentrations, and industry and peer
comparisons. This analysis establishes factors that are applied to the loan
groups to determine the amount of the general allocations. This evaluation is
inherently subjective as it requires material estimates that may be susceptible
to significant revisions based upon changes in economic and real estate market
conditions. Actual loan losses may be significantly more than the allowance for
loan losses management has established which could have a material negative
effect on the Company's financial results.
On a quarterly basis, the management committee reviews the current
status of various loan assets in order to evaluate the adequacy of the allowance
for loan losses. In this evaluation process, specific loans are analyzed to
determine their potential risk of loss. This process includes all loans,
concentrating on non-accrual and classified loans. Each non-accrual or
classified loan is evaluated for potential loss exposure. Any shortfall results
in a recommendation of a specific allowance if the likelihood of loss is
evaluated as probable. To determine the adequacy of collateral on a particular
loan, an estimate of the fair market value of the collateral is based on the
most current appraised value available. This appraised value is then reduced to
reflect estimated liquidation expenses.
The Company's primary lending emphasis has been the origination of
commercial and residential mortgages and commercial and consumer loans and lines
of credit. The bank also originates home equity loans and home equity lines of
credit. These activities resulted in a loan concentration in commercial and
residential mortgages. As a substantial amount of our loan portfolio is
collateralized by real estate, appraisals of the underlying value of property
securing loans are critical in determining the amount of the allowance required
for specific loans. Assumptions for appraisal valuations are instrumental in
determining the value of properties. Overly optimistic assumptions or negative
changes to assumptions could significantly impact the valuation of a property
33
securing a loan and the related allowance determined. The assumptions supporting
such appraisals are carefully reviewed by management to determine that the
resulting values reasonably reflect amounts realizable on the related loans.
Based on the composition of our loan portfolio, management believes the primary
risks are increases in interest rates, a decline in the economy, generally, and
a decline in real estate market values in the New York metropolitan area. Any
one or combination of these events may adversely affect our loan portfolio
resulting in increased delinquencies, loan losses and future levels of loan loss
provisions. Management considers it important to maintain the ratio of our
allowance for loan losses to total loans at an adequate level given current
economic conditions, interest rates, and the composition of the portfolio.
The provision for loan losses reflects probable losses resulting from
the actual growth and change in composition of our loan portfolio. Management
believes the allowance for loan losses reflects the inherent credit risk in our
portfolio, the level of our non-performing loans and our charge-off experience.
Although management believes that we have established and maintained
the allowance for loan losses at adequate levels, additions may be necessary if
future economic and other conditions differ substantially from the current
operating environment. Although management uses the best information available,
the level of the allowance for loan losses remains an estimate that is subject
to significant judgment and short-term change. In addition, the Federal Deposit
Insurance Corporation, New State Banking Department, and other regulatory bodies
as an integral part of their examination process, will periodically review our
allowance for loan losses. Such agencies may require us to recognize adjustments
to the allowance based on its judgments about information available to them at
the time of their examination.
For the three and nine months ended September 30, 2006, we charged-off
loans of $41,000 and $42,000, respectively, and recovered loans of $9,000 and
$14,000, respectively. For the three and nine months ended September 30, 2005,
we charged-off loans of $0 and $25,000, respectively, and recovered loans of
$3,000 and $92,000, respectively. All recovered amounts in 2006 and 2005 were
returned to the provision for loan loss reserves.
34
The following table sets forth information with respect to activity in
the Company's allowance for loan losses during the periods indicated (in
thousands, except percentages):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2006 2005 2006 2005
---- ---- ---- ----
Average loans outstanding $330,117 $284,282 $317,612 $286,888
======== ======== ======== ========
Allowance at beginning of period 3,360 3,081 3,266 2,927
Charge-offs:
Commercial and other loans 41 -- 42 25
Real estate loans -- -- -- --
-------- -------- -------- --------
Total loans charged-off 41 -- 42 25
-------- -------- -------- --------
Recoveries:
Commercial and other loans 9 3 14 92
Real estate loans -- -- -- --
-------- -------- -------- --------
Total loans recovered 9 3 14 92
-------- -------- -------- --------
Net recoveries (charge-offs) (32) 3 (28) 67
-------- -------- -------- --------
Provision for loan losses
charged to operating expenses 45 45 135 135
-------- -------- -------- --------
Allowance at end of period 3,373 3,129 3,373 3,129
-------- -------- -------- --------
Ratio of net recoveries (charge-offs)
to average loans outstanding (0.01)% 0.00% (0.01)% 0.02%
======== ======== ======== ========
Allowance as a percent of total loans 0.95% 1.11% 0.95% 1.11%
======== ======== ======== ========
Total loans at end of period $354,344 $282,245 $354,344 $282,245
======== ======== ======== ========
Loan Portfolio.
Loan Portfolio Composition. The Company's loans consist primarily of mortgage
loans secured by residential and non-residential properties as well as
commercial loans which are either unsecured or secured by personal property
collateral. Most of the Company's commercial loans are either made to
individuals or personally guaranteed by the principals of the business to which
the loan is made. At September 30, 2006, we had total gross loans of $354.34
million, deferred loans fees of $1.18 million and an allowance for loan losses
of $3.37 million. From time to time, the Bank may originate residential mortgage
loans and then sell them on the secondary market, normally recognizing fee
income in connection with the sale. During the three and nine-month periods
ended September 30, 2006, the Bank sold approximately $0 and $2.84 million,
respectively, of such loans and recorded in other income, gains of $0 and
$9,000, respectively, on such sales.
35
The following tables set forth information concerning the Company's
loan portfolio by type of loan at the dates indicated:
September 30, December 31,
2006 2005
------------- --------------
Amount Amount
------ ------
(in thousands)
Commercial and professional loans $ 54,080 $ 33,370
Secured by real estate
1-4 family 142,513 139,931
Multi family 3,940 2,874
Non-residential (commercial) 150,971 132,142
Consumer 2,840 2,018
-------- --------
Total loans 354,344 310,335
Less:
Deferred loan fees (1,177) (1,105)
Allowance for loan losses (3,373) (3,266)
-------- --------
Loans, net $349,794 $305,964
======== ========
It is the Bank's policy to discontinue accruing interest on a loan when
it is 90 days past due or if management believes that continued interest
accruals are unjustified. The Bank may continue interest accruals if a loan is
more than 90 days past due if the Bank determines that the nature of the
delinquency and the collateral are such that collection of the principal and
interest on the loan in full is reasonably assured. When the accrual of interest
is discontinued, all accrued but unpaid interest is charged against current
period income. Once the accrual of interest is discontinued, the Bank records
interest as and when received until the loan is restored to accruing status. If
the Bank determines that collection of the loan in full is in reasonable doubt,
then amounts received are recorded as a reduction of principal until the loan is
returned to accruing status. At September 30, 2006 and 2005, we did not have any
loans past due more than 90 days and still accruing interest.
36
Capital Adequacy
Quantitative measures established by regulation to ensure capital
adequacy require the Company and the Bank to maintain minimum amounts and ratios
of total and Tier I capital (as defined in the regulations) to risk-weighted
assets (as defined), and Tier I capital (as defined) to average assets (as
defined). As of September 30, 2006, the most recent notification from the FDIC
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be categorized as well capitalized, the Bank must
maintain certain Total risk-based, Tier I risk-based, and Tier I leverage
ratios. There are no conditions or events since the notification that management
believes have changed the Bank's category.
The following tables set forth the actual and required regulatory
capital amounts and ratios of the Company and the Bank as of September 30, 2006
and December 31, 2005 (dollars in thousands):
To be well
capitalized under
For Capital prompt corrective
Actual Adequacy Purposes action provisions
------------------ -------------------- ---------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
September 30, 2006
Total Capital (to Risk-Weighted Assets)
Company $127,427 25.6% $39,777 >=8.0% -- N/A
Bank 98,202 20.7% 37,966 >=8.0% 42,381 >=10.0%
Tier I Capital (to Risk-Weighted Assets)
Company 124,064 25.0% 19,889 >=4.0% -- N/A
Bank 94,829 20.0% 18,983 >=4.0% 25,429 >=6.0%
Tier I Capital (to Average Assets)
Company 124,064 13.2% 37,504 >=4.0% -- N/A
Bank 94,829 10.9% 34,938 >=4.0% 44,735 >=5.0%
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%
37
Liquidity
The management of the Company's liquidity focuses on ensuring that
sufficient funds are available to meet loan funding commitments, withdrawals
from deposit accounts, the repayment of borrowed funds, and ensuring that the
Bank and the Company comply with regulatory liquidity requirements. Liquidity
needs of the Bank have historically been met by deposits, investments in federal
funds sold, principal and interest payments on loans, and maturities of
investment securities.
For the Company, liquidity means having cash available to fund
operating expenses, to pay shareholder dividends, when and if declared by the
Company's Board of Directors and to pay the interest on the Debentures issued in
May 2004 and April 2005. The ability of the Company to meet all of its
obligations, including the payment of dividends, is not dependent upon the
receipt of dividends from the Bank. At September 30, 2006, the Company,
excluding the Bank, had cash and cash equivalents of approximately $11.15
million and investment securities available for sale of $14.04 million.
The Company maintains financial instruments with off-balance sheet risk
in the normal course of business to meet the financing needs of its customers.
These financial instruments, approximately $43.11 million at September 30, 2006,
include commitments to extend credit and stand-by letters of credit.
At September 30, 2006, the Company had outstanding commitments of
approximately $474.13 million; including $411.62 million of time deposits,
$58.75 million of Federal Home Loan Bank debt and $3.76 million of operating
leases. These commitments include $416.19 million that mature or renew within
one year, $35.63 million that mature or renew after one year and within three
years, $21.78 million that mature or renew after three years and within five
years and $529,000 that mature or renew after five years.
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.
38
ITEM 4 - CONTROLS AND PROCEDURES
Evaluation of the Company's Disclosure Controls and Internal Control. As of the
end of the period covered by this Quarterly Report on Form 10-Q, the Company
evaluated the effectiveness of the design and operation of its "disclosure
controls and procedures" as defined in Rule 13a-15(e) of the Securities Exchange
Act of 1934 ("Disclosure Controls"). This evaluation ("Controls Evaluation") was
done under the supervision and with the participation of the Company's
management, including the Chief Executive Officer ("CEO") who is also the Chief
Financial Officer ("CFO").
Limitations on the Effectiveness of Controls. The Company's management,
including the CEO/CFO, does not expect that its Disclosure Controls and/or its
"internal control over financial reporting" as defined in Rule 13(a)-15(f) of
the Securities Exchange Act of 1934 ("Internal Control") will prevent all error
and all fraud. A control system, no matter how well conceived and operated, can
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 SEC's
rules and forms. In accordance with SEC requirements, the CEO/CFO notes that
during the fiscal quarter ended September 30, 2006, no changes in Internal
Control have occurred that have materially affected or are reasonably likely to
materially affect Internal Control.
39
PART II. OTHER INFORMATION
Item 6. Exhibits
Exhibit
Number Description
------- -----------
10.1 Amendment No. 1, dated August 17, 2006,
to Deferred Compensation Plan of The
Berkshire Bank, dated June 27, 2006. +
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.
40
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BERKSHIRE BANCORP INC.
----------------------
(Registrant)
Date: November 1, 2006 By: /s/ Steven Rosenberg
---------------- -----------------------
Steven Rosenberg
President and Chief
Financial Officer
41
EXHIBIT INDEX
Exhibit Sequential
Number Description Page Number
------ ----------- -----------
10.1 Amendment No. 1, dated August 17, 2006, 43
to Deferred Compensation Plan of The
Berkshire Bank, dated June 27, 2006. +
31 Certification of Principal Executive 44
and Financial Officer pursuant to
Section 302 Of The Sarbanes-Oxley Act
of 2002.
32 Certification of Principal Executive 45
and Financial Officer pursuant to
Section 906 Of The Sarbanes-Oxley Act
of 2002.
42
STATEMENT OF DIFFERENCES
The greater-than-or-equal-to sign shall be expressed as...................... >=