UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended DECEMBER 31, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 0-13649
BERKSHIRE BANCORP INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-2563513
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
160 BROADWAY, NEW YORK, NEW YORK 10038
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 791-5362
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH TRADED
-------------------------------------- --------------------------------------
COMMON STOCK, PAR VALUE $.10 PER SHARE THE NASDAQ STOCK MARKET LLC
(THE NASDAQ GLOBAL MARKET)
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the Registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the Registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. (See definition of "accelerated
filer and large accelerated filer in Rule 12b-2 of the Exchange Act.) Large
accelerated filer [ ] Accelerated filer [ ] Non-accelerated filer [X]
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Act. Yes [ ] No [X]
Aggregate market value of voting and non-voting common stock held by
non-affiliates of the Registrant as of June 30, 2006: $61,475,934.
Number of shares of Common Stock outstanding as of March 23, 2007: 6,902,706.
DOCUMENTS INCORPORATED BY REFERENCE: None
FORWARD-LOOKING STATEMENTS. STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-K THAT
ARE NOT BASED ON HISTORICAL FACT MAY BE "FORWARD-LOOKING STATEMENTS" WITHIN THE
MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. WORDS SUCH AS
"BELIEVE", "MAY", "WILL", "EXPECT", "ESTIMATE", "ANTICIPATE", "CONTINUE" OR
SIMILAR TERMS IDENTIFY FORWARD-LOOKING STATEMENTS. A WIDE VARIETY OF FACTORS
COULD CAUSE THE COMPANY'S ACTUAL RESULTS AND EXPERIENCES TO DIFFER MATERIALLY
FROM THE RESULTS EXPRESSED OR IMPLIED BY THE COMPANY'S FORWARD-LOOKING
STATEMENTS. SOME OF THE RISKS AND UNCERTAINTIES THAT MAY AFFECT OPERATIONS,
PERFORMANCE, RESULTS OF THE COMPANY'S BUSINESS, THE INTEREST RATE SENSITIVITY OF
ITS ASSETS AND LIABILITIES, AND THE ADEQUACY OF ITS LOAN LOSS ALLOWANCE,
INCLUDE, BUT ARE NOT LIMITED TO: (I) DETERIORATION IN LOCAL, REGIONAL, NATIONAL
OR GLOBAL ECONOMIC CONDITIONS WHICH COULD RESULT, AMONG OTHER THINGS, IN AN
INCREASE IN LOAN DELINQUENCIES, A DECREASE IN PROPERTY VALUES, OR A CHANGE IN
THE HOUSING TURNOVER RATE; (II) CHANGES IN MARKET INTEREST RATES OR CHANGES IN
THE SPEED AT WHICH MARKET INTEREST RATES CHANGE; (III) CHANGES IN LAWS AND
REGULATIONS AFFECTING THE FINANCIAL SERVICES INDUSTRY; (IV) CHANGES IN
COMPETITION; (V) CHANGES IN CONSUMER PREFERENCES; (VI) CHANGES IN BANKING
TECHNOLOGY; (VII) ABILITY TO MAINTAIN KEY MEMBERS OF MANAGEMENT; (VIII) POSSIBLE
DISRUPTIONS IN THE COMPANY'S OPERATIONS AT ITS BANKING FACILITIES; (IX) COST OF
COMPLIANCE WITH NEW CORPORATE GOVERNANCE REQUIREMENTS; AND OTHER FACTORS
REFERRED TO IN THE SECTIONS OF THIS ANNUAL REPORT ENTITLED "BUSINESS" AND
"MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS."
CERTAIN INFORMATION CUSTOMARILY DISCLOSED BY FINANCIAL INSTITUTIONS,
SUCH AS ESTIMATES OF INTEREST RATE SENSITIVITY AND THE ADEQUACY OF THE LOAN LOSS
ALLOWANCE, ARE INHERENTLY FORWARD-LOOKING STATEMENTS BECAUSE, BY THEIR NATURE,
THEY REPRESENT ATTEMPTS TO ESTIMATE WHAT WILL OCCUR IN THE FUTURE.
THE COMPANY CAUTIONS READERS NOT TO PLACE UNDUE RELIANCE UPON ANY
FORWARD-LOOKING STATEMENT CONTAINED IN THIS ANNUAL REPORT. FORWARD-LOOKING
STATEMENTS SPEAK ONLY AS OF THE DATE THEY WERE MADE AND THE COMPANY ASSUMES NO
OBLIGATION TO UPDATE OR REVISE ANY SUCH STATEMENTS UPON ANY CHANGE IN APPLICABLE
CIRCUMSTANCES.
PART I
ITEM 1. BUSINESS
GENERAL. Berkshire Bancorp Inc., a Delaware corporation , is a bank
holding company registered under the Bank Holding Company Act of 1956. As used
in this Annual Report on Form 10-K, the term "Berkshire", the "Company" or "we"
and similar pronouns shall mean Berkshire Bancorp Inc. and its consolidated
subsidiaries unless the context otherwise requires. Berkshire's principal
activity is the ownership and management of its wholly-owned banking subsidiary,
The Berkshire Bank (the "Bank"), a New York State chartered commercial bank.
We file annual, quarterly and current reports, proxy statements and
other information with the Securities and Exchange Commission (the "SEC"). You
may read and copy our reports or other filings made with the SEC at the SEC's
Public Reference Room, located at 450 Fifth Street, N.W., Washington, DC 20549.
You can also access information that we file electronically on the SEC's website
at www.sec.gov.
We do not presently have a website. However, as soon as practicable
after filing with or furnishing to the SEC, we will provide at no cost, paper or
electronic copies of our Annual Reports on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K and amendments to those reports. Requests
should be directed to:
Berkshire Bancorp Inc.
Investor Relations
160 Broadway
New York, NY 10038
2
STOCK SPLIT AND STOCK DIVIDEND. At the Annual Meeting of Stockholders
held on May 18, 2004, the Company's stockholders approved an amendment to the
Company's Certificate of Incorporation effecting a one-for-ten reverse stock
split of the Company's issued and outstanding Common Stock (the "Reverse
Split"). Following the effectiveness of the Reverse Split, the Company's Board
of Directors declared a thirty-for-one forward stock split in the form of a
stock dividend in Common Stock which became effective immediately. The Company
paid approximately $463,000 to purchase fractional shares from stockholders as
part of the Reverse Split. The Company's Common Stock began trading on May 19,
2004 giving effect to these transactions.
TRUST PREFERRED SECURITIES. As of May 18 2004, the Company established
Berkshire Capital Trust I, a Delaware statutory trust, ("BCTI"). The Company
owns all the common capital securities of BCTI. BCTI issued $15.0 million of
preferred capital securities to investors in a private transaction and invested
the proceeds, combined with the proceeds from the sale of BCTI's common capital
securities, in the Company through the purchase of $15.464 million aggregate
principal amount of Floating Rate Junior Subordinated Debentures (the
"Debentures") issued by the Company. The Debentures, the sole assets of BCTI,
mature on July 23, 2034 and bear interest at a floating rate, three month LIBOR
plus 2.70%.
On April 1, 2005, the Company established Berkshire Capital Trust II, a
Delaware statutory trust, ("BCTII"). The Company owns all the common capital
securities of BCTII. BCTII issued $7.0 million of preferred capital securities
to investors in a private transaction and invested the proceeds, combined with
the proceeds from the sale of BCTII's common capital securities, in the Company
through the purchase of $7.217 million aggregate principal amount of Floating
Rate Junior Subordinated Debentures (the "2005 Debentures") issued by the
Company. The 2005 Debentures, the sole assets of BCTII, mature on May 23, 2035
and bear interest at a floating rate, three month LIBOR plus 1.95%. See Note A
of Notes to Consolidated Financial Statements for further discussion of Trust
Preferred Securities.
BUSINESS OF THE BANK - GENERAL. The Bank's principal business consists
of gathering deposits from the general public and investing those deposits
primarily in loans, debt obligations issued by the U.S. Government and its
agencies, debt obligations of business corporations, and mortgage-backed
securities. The Bank currently operates from six deposit-taking offices in New
York City, four deposit-taking offices in Orange and Sullivan Counties, New York
and one deposit-taking office in Ridgefield, NJ.
BRANCH LOCATIONS OF THE BERKSHIRE BANK
DECEMBER 31, 2006
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4 East 39th Street 2 South Church Street
New York, NY Goshen, NY
5 Broadway 214 Harriman Drive
New York, NY Goshen, NY
5010 13th Avenue 80 Route 17M
Brooklyn, NY Harriman, NY
1421 Kings Highway 60 Main Street
Brooklyn, NY Bloomingburg, NY
4917 16th Avenue 1119 Avenue J
Brooklyn, NY Brooklyn, NY
600 Broad Avenue
Ridgefield, NJ
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In September 2005, the Bank entered into a Branch Purchase and Deposit
Assumption Agreement (the "Agreement") with the Oritani Savings Bank
("Oritani"), a New Jersey Chartered Savings Bank. Pursuant to the Agreement
which closed in May 2006, the Bank (i) assumed certain commercial checking
account deposit liabilities, (ii) purchased certain fixed assets and the real
property of this Oritani bank branch located in Ridgefield, New Jersey for a
cash purchase price of $850,000 and (iii) opened a branch of The Berkshire Bank
at the Ridgefield, New Jersey location.
In August 2005, the Bank formed Berkshire 1031 Exchange, LLC ("Berkshire
1031"), a wholly owned limited liability company. Berkshire 1031 will act as a
qualified intermediary in connection with tax free exchanges under Section 1031
of the Internal Revenue Code of 1986, as amended. A qualified intermediary is an
individual or business entity that assists owners of property who wish to
exchange their property for property of a "like-kind" in a transaction that is
tax free in whole or part for federal (and in some cases state) income tax
purposes. In accordance with detailed procedures set forth in federal income tax
regulations, Berkshire 1031 will assist the owner in the sale of the owner's
property and the purchase of replacement property so that the transaction
qualifies as a non-taxable exchange of property.
PRINCIPAL LOAN TYPES. The Bank's principal loan types are residential
and commercial mortgage loans and commercial non-mortgage loans, both unsecured
and secured by personal property. The Bank's revenues come principally from
interest on loans and investment securities. The Bank's primary sources of funds
are deposits and proceeds from principal and interest payments on loans and
investment securities.
OPERATING PLAN. The Bank's operating plan concentrates on obtaining
deposits from a variety of businesses, professionals and retail customers and
investing those funds in conservatively underwritten loans. Due to the Bank's
underwriting criteria, its deposits have significantly exceeded the level of
satisfactory loans available for investment in recent years. Hence, the Bank
has, in recent years, invested a portion of its available funds in investment
and mortgage-backed securities.
MARKET AREA. The Bank draws its customers principally from the New York
City metropolitan area and the Villages of Goshen and Harriman, New York and
their surrounding communities, representing most of Orange County, NY. The Bank
also has a branch in Bloomingburg, New York, just over the border between Orange
and Sullivan Counties. Predominantly rural with numerous small towns, many
residents of Orange and Sullivan Counties work in New York City. Consequently,
the health of the economy in the New York City metropolitan area has, and will
continue to have a direct effect on the economic well being of residents and
businesses in these counties. With the completion of the transaction with
Oritani in May 2006, the Bank's market area expanded into northern New Jersey.
From time to time, the Bank may make loans or accept deposits from outside these
areas, but such transactions generally represent outgrowths of existing local
customer relationships.
COMPETITION. The Bank's principal competitors for deposits are other
commercial banks, savings banks, savings and loan associations and credit unions
in the Bank's market areas, as well as money market mutual funds, insurance
companies, securities brokerage firms and other financial institutions, many of
which are substantially larger in size than the Company. The Bank's competition
for loans comes principally from commercial banks, savings banks, savings and
loan associations, mortgage bankers, finance companies and other institutional
lenders. Many of the institutions which compete with the Bank have much greater
financial and marketing resources than the Bank. The Bank's principal methods of
competition include loan and deposit pricing, maintaining close ties with its
local communities, the quality of the personal service it provides, the types of
business services it provides, and other marketing programs.
OPERATIONS OF THE BANK. Reference is made to the information set forth
in Item 7 herein ("Management's Discussion and Analysis of Financial Condition
and Results of Operations") for information as to various aspects of the Bank's
operations, activities and conditions.
4
SUBSIDIARY ACTIVITIES. The Bank is permitted under New York State law
and federal law to own subsidiaries for certain limited purposes, generally to
engage in activities which are permissible for a subsidiary of a national bank.
The Bank has two subsidiaries, Berkshire Agency, Inc., a company engaged in the
title insurance agency business, and Berkshire 1031, a company that acts as a
qualified intermediary in connection with tax free exchanges under Section 1031
of the Internal Revenue Service Code.
REGULATION. Berkshire is a bank holding company under federal law and
registered as such with the Federal Reserve. The Bank is a commercial bank
chartered under the laws of New York State. It is subject to regulation at the
state level by the New York Superintendent of Banks and the New York Banking
Board, while at the federal level its primary regulator is the Federal Deposit
Insurance Corporation (the "FDIC").
Both Berkshire and the Bank are subject to extensive state and federal
regulation of their activities. The following discussion summarizes certain
banking laws and regulations that affect Berkshire and the Bank. Proposals to
change these laws and regulations are frequently proposed in Congress, in the
New York State legislature, and before state and federal bank regulatory
agencies. The likelihood and timing of any changes and the impact such changes
might have on the Company are impossible to determine with any certainty. A
change in applicable laws or regulations, or a change in the way such laws or
regulations are interpreted by regulatory agencies or courts, may have a
material impact on the business, operations and earnings of the Company, the
nature and effect of which cannot be predicted.
BANK HOLDING COMPANY REGULATION. The Federal Reserve is authorized to
make regular examinations of the Company and its nonbank subsidiaries. Under
federal law and Federal Reserve regulations, the activities in which the Company
and its nonbank subsidiaries may engage are limited. The Company may not acquire
direct or indirect ownership or control of more than 5% of the voting shares of
any company, including a bank, without the prior approval of the Federal
Reserve, except as specifically authorized under federal law and Federal Reserve
regulations. The Company, subject to the approval of the Federal Reserve, may
acquire more than 5% of the voting shares of non-banking corporations if those
corporations engage in activities which the Federal Reserve deems to be so
closely related to banking or managing or controlling banks as to be a proper
incident thereto. These limitations also apply to activities in which the
Company engages directly rather than through a subsidiary.
The Federal Reserve has enforcement powers over the Company and its
non-bank subsidiaries. This allows the Federal Reserve, among other things, to
stop activities that represent unsafe or unsound practices or constitute
violations of law, rules, regulations, administrative orders or written
agreements with a federal bank regulator. These powers may be exercised through
the issuance of cease-and-desist orders, the imposition of civil money penalties
or other actions.
FEDERAL RESERVE CAPITAL REQUIREMENTS. The Federal Reserve requires that
the Company, as a bank holding company, must maintain certain minimum ratios of
capital to assets. The Federal Reserve's regulations divide capital into two
categories. Primary capital includes common equity, surplus, undivided profits,
perpetual preferred stock, mandatory convertible instruments, the allowance for
loan and lease losses, contingency and other capital reserves, and minority
interests in equity accounts of consolidated subsidiaries. Secondary capital
includes limited-life preferred stock, subordinated notes and debentures and
certain unsecured long term debt.
The Federal Reserve requires that bank holding companies maintain a
minimum ratio of primary capital to total assets of 5.5% and a minimum level of
total capital (primary plus secondary capital) equal to 6% of total assets. In
calculating capital ratios, the allowance for loan losses, which is a component
of primary capital, is added back in determining total assets. Certain capital
components, such as debt and perpetual preferred stock, are includable as
capital only if they satisfy certain definitional tests.
5
The Company must also meet a risk-based capital standard. Capital, for
the risk-based capital requirement, is divided into Tier I capital and
Supplementary capital, determined as discussed below in connection with the FDIC
capital requirements imposed on the Bank. The Federal Reserve requires that the
Bank maintain a ratio of total capital (defined as Tier I plus Supplementary
capital) to risk-weighted assets of at least 8%, of which at least 4% must be
Tier I capital. Risk weighted assets are also determined in a manner comparable
to the determination of risk-weighted assets under FDIC regulations as discussed
below.
At December 31, 2006 and 2005, the Company met the definition of a "well
capitalized" bank holding company.
INTER-STATE BANKING. Bank holding companies may generally acquire banks
in any state. Federal law also permits a bank to merge with an out-of-state bank
and convert any offices into branches of the resulting bank if both states have
not opted out of interstate branching; permits a bank to acquire branches from
an out-of-state bank if the law of the state where the branches are located
permits the interstate branch acquisition; and permits banks to establish and
operate new interstate branches whenever the host state opts-in to that
authority. Bank holding companies and banks that want to engage in such
activities must be adequately capitalized and managed.
The New York Banking Law generally authorizes interstate branching in
New York as a result of a merger, purchase of assets or similar transaction. An
out of state bank may not first enter New York by opening a new branch in New
York, but once a branch is acquired as described in the preceding sentence,
additional new branches may be opened state wide.
REGULATION OF THE BANK. In general, the powers of the Bank are limited
to the express powers described in the New York Banking Law and powers
incidental to the exercise of those express powers. The Bank is generally
authorized to accept deposits and make loans on terms and conditions determined
to be acceptable to the Bank. Loans may be unsecured, secured by real estate, or
secured by personal property. The Bank may also invest assets in bonds, notes or
other debt securities which are not in default and certain limited classes of
equity securities including certain publicly traded equity securities in an
amount aggregating not more than 2% of assets or 20% of capital. The Bank may
also engage in a variety of other traditional activities for commercial banks,
such as the issuance of letters of credit.
The exercise of these state-authorized powers is limited by FDIC
regulations and other federal laws and regulations. In particular, FDIC
regulations limit the investment activities of state-chartered, FDIC-insured
banks such as the Bank.
Under FDIC regulations, the Bank generally may not directly or
indirectly acquire or retain any equity investment that is not permissible for a
national bank. In addition, the Bank may not directly or indirectly through a
subsidiary, engage as "principal" in any activity that is not permissible for a
national bank unless the FDIC has determined that such activities would pose no
risk to the applicable FDIC insurance fund and the Bank is in compliance with
applicable regulatory capital requirements. FDIC regulations permit real estate
investments under certain circumstances. The Bank does not engage in real estate
investing activity.
LOANS TO ONE BORROWER. With certain exceptions, the Bank may not make
loans or other extensions of credit to a single borrower, or certain related
groups of borrowers, in an aggregate amount in excess of 15% of the Bank's net
worth, plus an additional 10% of the Bank's net worth if such amount is secured
by certain types of readily marketable collateral. In addition, the Bank is not
permitted to make a mortgage loan in excess of 15% of capital stock, surplus
fund and undivided profits.
FDIC CAPITAL REQUIREMENTS. The FDIC requires that the Bank maintain
certain minimum ratios of capital to assets. The FDIC's regulations divide
capital into two tiers. The first tier ("Tier I") includes common equity,
retained earnings, certain non-cumulative perpetual preferred stock (excluding
auction rate issues) and minority interests in equity accounts of consolidated
subsidiaries, minus goodwill and other intangible assets (except mortgage
6
servicing rights and purchased credit card relationships subject to certain
limitations). Supplementary ("Tier II") capital includes, among other items,
cumulative perpetual and long-term limited-life preferred stock, mandatory
convertible securities, certain hybrid capital instruments, term subordinated
debt and the allowance for loan, subject to certain limitations, less required
deductions.
The FDIC requires that the highest rated banks maintain a Tier I
leverage ratio (Tier I capital to adjusted total assets) of at least 3.0%. All
other banks subject to FDIC capital requirements must maintain a Tier I leverage
ratio of 4.0% to 5.0% or more. As of December 31, 2006 and 2005, the Bank's Tier
I leverage capital ratio was 10.9% and 10.1%, respectively.
The Bank must also meet a risk-based capital standard. The risk-based
standard requires the Bank to maintain total capital (defined as Tier I and
Supplementary capital) to risk-weighted assets of at least 8%, of which at least
4% must be Tier I capital. In determining the amount of risk-weighted assets,
all assets, plus certain off-balance sheet assets, are multiplied by a
risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in
the type of asset. As of December 31, 2006 and 2005, the Bank maintained a 18.6%
and 22.2% Tier I risk-based capital ratio and a 19.3% and 23.0% total risk-based
capital ratio, respectively.
In addition to the foregoing regulatory capital requirements, the FDIC
Improvements Act of 1991 created a "prompt corrective action" framework, under
which decreases in a depository institution's capital category trigger various
supervisory actions. Pursuant to implementing regulations adopted by the FDIC,
for purposes of the prompt corrective action provisions, a state-chartered,
nonmember bank, such as the Bank, is deemed to be well capitalized if it has: a
total risk-based capital ratio of 10% or greater; a Tier I risk-based capital
ratio of 6% or greater; and a leverage ratio of 5% or greater. As of December
31, 2006 and 2005, the Bank met the definition of a "well capitalized" financial
institution.
COMMUNITY REINVESTMENT ACT. The Bank must, under federal law, meet the
credit needs of its community, including low and moderate income segments of its
community. The FDIC is required, in connection with its examination of the Bank,
to assess whether the Bank has satisfied this requirement. Failure to satisfy
this requirement could adversely affect certain applications which the Bank may
make, such as branch applications, merger applications, and applications for
permission to purchase branches. In the case of Berkshire, the Federal Reserve
will assess the record of each subsidiary bank in considering certain
applications by Berkshire. The New York Banking Law contains similar provisions
applicable to the Bank. As of the most recent Community Reinvestment Act
examinations by the FDIC and the New York State Banking Department, the Bank
received "satisfactory" ratings.
DIVIDENDS FROM THE BANK TO THE COMPANY. One source of funds for
Berkshire to pay dividends to its stockholders is dividends from the Bank to
Berkshire. Under the New York Banking Law, the Bank may pay dividends to
Berkshire, without regulatory approval, equal to its net profits for the year in
which the payment is made, plus retained net profits for the two previous years,
subject to certain limits not generally relevant. The Bank's retained net
profits for the 2005 and 2006 calendar years totaled approximately $11.43
million.
Under federal law, the Bank may not make any capital distribution to
Berkshire, including any dividend or repurchase of the Bank's stock, if, after
making such distribution, the Bank fails to meet the required minimum capital
ratio requirements discussed below. The FDIC may prohibit the Bank from paying
dividends if, in its opinion, the payment of dividends would constitute an
unsafe or unsound practice.
TRANSACTIONS WITH RELATED PARTIES. The Company, its direct non-banking
subsidiaries and other companies controlled by stockholders who control the
Company are affiliates, within the meaning of the Federal Reserve Act, of the
Bank and its subsidiaries. The Bank's authority to engage in transactions with
its "affiliates" is limited by Sections 23A and 23B of the Federal Reserve Act.
Section 23A limits the aggregate amount of transactions with any individual
affiliate to 10% of the capital and surplus of the Bank and also limits the
7
aggregate amount of transactions with all affiliates to 20% of the Bank's
capital and surplus. Extensions of credit to affiliates must be secured by
certain specified collateral, and the purchase of low quality assets from
affiliates is generally prohibited. Section 23B provides that certain
transactions with affiliates, including loans and asset purchases, must be on
terms and under circumstances, including credit standards, that are at least as
favorable to the Bank as those prevailing at the time for comparable
transactions with non-affiliated companies. In the absence of comparable
transactions, such transactions may only occur under terms and circumstances,
including credit standards, that in good faith would be offered to or would
apply to non-affiliated companies.
In accordance with banking regulations, the Bank may make loans to its
and the Company's directors, executive officers, and 10% stockholders, as well
as to entities controlled by them, subject to specific federal and state limits.
Among other things, these loans must (a) be made on terms that are substantially
the same as, and follow credit underwriting procedures that are not less
stringent than, those prevailing for comparable transactions with unaffiliated
persons and that do not involve more than the normal risk of repayment or
present other unfavorable features and (b) not exceed certain limitations on the
amount of credit extended to such persons, individually and in the aggregate,
which limits are based, in part, on the amount of the Bank's capital. In
addition, extensions of credit in excess of certain limits must be approved by
the Bank's Board of Directors. However, the Bank may make loans to executive
officers, directors and principal stockholders on preferential terms, provided
the extension of credit is made pursuant to a benefit or compensation program of
the Bank that is widely available to employees of the Bank or its affiliates and
does not give preference to any insider over other employees of the Bank or
affiliate. The Bank has no such benefit or compensation programs.
ENFORCEMENT. The FDIC and the Banking Department have enforcement
authority over the Bank. The Superintendent may order the Bank to appear and
explain an apparent violation of law, to discontinue unauthorized or unsafe
practices and to keep prescribed books and accounts. If any director or officer
of the Bank has violated any law, or has continued unauthorized or unsafe
practices in conducting the business of the Bank after having been notified by
the Superintendent to discontinue such practices, the New York Banking Board may
remove the individual from office after notice and an opportunity to be heard.
The Superintendent also may take over control of the Bank under specified
statutory criteria.
The FDIC's enforcement authority includes, among other things, the
ability to assess civil money penalties, to issue cease and desist orders and to
remove directors and officers. As indicated above, the FDIC is required to take
prompt action to correct deficiencies in banks which do not satisfy specified
FDIC capital ratio requirements. Dividends, other capital distributions or the
payment of management fees to any controlling person are prohibited if,
following such distribution or payment, a bank would be undercapitalized. An
undercapitalized bank must file a plan to restore its capital within 45 days
after being notified that it is undercapitalized. Undercapitalized,
significantly undercapitalized and critically undercapitalized institutions are
subject to increasing prohibitions on permitted activities, and increasing
levels of regulatory supervision, based upon the severity of their capital
problems. The FDIC is required to monitor closely the condition of an
undercapitalized bank. Enforcement action taken by the FDIC can escalate to the
appointment of a conservator or receiver of a critically undercapitalized bank.
INSURANCE OF ACCOUNTS. Deposit insurance premiums payable to the FDIC
are based upon the perceived risk of the institution to the FDIC insurance fund.
The FDIC assigns an institution to one of three capital categories: (a) well
capitalized, (b) adequately capitalized or (c) undercapitalized. The FDIC also
assigns an institution to one of three supervisory categories based on an
evaluation by the institution's primary federal regulator and information that
the FDIC considers relevant to the institution's financial condition and the
risk posed to the deposit insurance funds. Deposit insurance premiums depend on
an institution's capital and supervisory categories. At present, the Bank pays
no deposit insurance premium based upon its risk-based categorization.
8
However, the Bank must pay a share of the cost of the bonds issued in
the late 1980s to recapitalize the now defunct Federal Savings and Loan
Insurance Corporation. The Bank must pay an annual assessment for this purpose,
which for fiscal 2006 and 2005 was equal to 0.0127% and 0.0444%, respectively,
of its insured deposits and which is recorded as a deposit insurance premium
expense for financial statement purposes. Beginning in 2007, the assessment was
revised to 0.0122% of the Bank's insured deposits.
RESERVE REQUIREMENTS. The Bank must maintain non-interest-earning
reserves against its transaction accounts (primarily NOW and regular checking
accounts). The Bank is generally able to satisfy reserve requirements with cash
on hand and other non-interest bearing deposits which it maintains for other
purposes, so the reserve requirements do not impose a material financial burden
on the Bank.
GOVERNMENTAL POLICIES. Our earnings are significantly affected by the
monetary and fiscal policies of governmental authorities, including the Federal
Reserve. Among the instruments of monetary policy used by the Federal Reserve to
implement these objectives are open-market operations in U.S. Government
securities and Federal funds, changes in the discount rate on member bank
borrowings and changes in reserve requirements against member bank deposits.
These instruments of monetary policy are used in varying combinations to
influence the overall level of bank loans, investments and deposits, and the
interest rates charged on loans and paid for deposits. The Federal Reserve
frequently uses these instruments of monetary policy, especially its open-market
operations and the discount rate, to influence the level of interest rates and
to affect the strength of the economy, the level of inflation or the price of
the dollar in foreign exchange markets. The monetary policies of the Federal
Reserve have had a significant effect on the operating results of banking
institutions in the past and are expected to continue to do so in the future. It
is not possible to predict the nature of future changes in monetary and fiscal
policies, or the effect which they may have on our business and earnings.
PERSONAL HOLDING COMPANY STATUS. For the fiscal years ended December 31,
2006, 2005 and 2004, the Company has been deemed to be a Personal Holding
Company (a "PHC"), as defined in the Internal Revenue Code. As a PHC, we may be
required to pay an additional income tax or issue a dividend to our shareholders
in an amount based upon the PHC Internal Revenue Code formulas, which is
primarily based upon net income. No such dividend was required to be paid in
fiscal 2006, 2005 and 2004. (See Dividends in Item 5).
EMPLOYEES. On March 23, 2007, Berkshire had one full time employee and
the Bank employed approximately 100 full time and 5 part time employees. The
Bank's employees are not represented by a collective bargaining unit, and the
Bank considers its relationship with its employees to be good.
9
ITEM 1A. RISK FACTORS.
Our business faces significant risks. These risks include those
described below and may include additional risks and uncertainties not presently
known to us or that we currently deem immaterial. Our business, financial
condition and results of operations could be materially adversely affected by
any of these risks, and the trading price of our common stock could decline.
WE OPERATE IN THE HIGHLY COMPETITIVE BANKING INDUSTRY AND THERE CAN BE NO
ASSURANCE THAT WE WILL BE ABLE TO COMPETE SUCCESSFULLY.
Our ability to maintain our history of strong financial performance and
return on investment to shareholders may depend in part on our ability to expand
our scope of available financial services as needed to meet the needs and
demands of our customers. Our business model focuses on using superior customer
service to provide traditional banking services to a growing customer base.
However, we operate in an increasingly competitive environment in which our
competitors now include securities dealers, brokers, mortgage bankers,
investment advisors and finance and insurance companies who seek to offer
one-stop financial services to their customers that may include services that we
have not been able or allowed to offer to our customers in the past. This
increasingly competitive environment is primarily a result of changes in
regulation, changes in technology and product delivery systems and the
accelerating pace of consolidation among financial services providers. We cannot
assure you that we will be able to continue to compete successfully in this
environment without expanding the scope of financial services we provide, or
that if we need to expand the scope of services that we provide, that we will be
able to do so successfully.
OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO COMPETE EFFECTIVELY IN A HIGHLY
COMPETITIVE MARKET AND GEOGRAPHIC AREA.
We face substantial competition in all phases of our operations from a
variety of different competitors. We encounter competition from other commercial
banks, savings and loan associations, mutual savings banks, credit unions and
other financial institutions. Our competitors, including credit unions, consumer
finance companies, factors, insurance companies and money market mutual funds,
compete with lending and deposit-gathering services offered by us. There is very
strong competition for financial services in the New York state areas in which
we currently conduct our business. This geographic area includes offices of many
of the largest financial institutions in the world. Many of those competing
institutions have much greater financial and marketing resources than we have.
Due to their size, many competitors can achieve larger economies of scale and as
a result may offer a broader range of products and services than we do. If we
are unable to offer competitive products and services, our earnings may be
negatively affected. Some of the financial services organizations with which we
compete are not subject to the same degree of regulation as is imposed on bank
holding companies like ourselves and on federally insured financial institutions
like our banking subsidiary, The Berkshire Bank. As a result, these nonbank
competitors have certain advantages over us in accessing funding and in
providing various services. The banking business in our current primary market
area is very competitive, and the level of competition we face may increase
further, which may limit our asset growth and profitability.
ECONOMIC CONDITIONS EITHER NATIONALLY OR LOCALLY IN AREAS IN WHICH OUR
OPERATIONS ARE CONCENTRATED MAY BE LESS FAVORABLE THAN EXPECTED.
Deterioration in local, regional, national or global economic conditions
could result in, among other things, an increase in loan delinquencies, a
decrease in property values, a change in housing turnover rate or a reduction in
the level of bank deposits. Particularly, a weakening of the real estate or
employment market in our primary market areas could result in an increase in the
number of borrowers who default on their loans and a reduction in the value of
the collateral securing their loans, which in turn could have an adverse effect
on our profitability. Substantially all of our real estate loans are
collateralized by properties located in these market areas, and substantially
all of our loans are made to borrowers who live in and conduct business in these
market areas. Any material economic deterioration in these market areas could
have an adverse impact on our profitability.
10
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 at a level believed adequate by
management to absorb losses inherent in the loan portfolio. In conjunction with
an internal loan review function that operates independently of the lending
function, management monitors the loan portfolio to identify risks on a timely
basis so that an appropriate allowance can be maintained. Based on an evaluation
of the loan portfolio, management presents a periodic review of the loan loss
reserve to the board of directors of the Bank, indicating any changes in the
reserve since the last review and any recommendations as to adjustments in the
reserve. In making its evaluation, in addition to the factors discussed below,
management considers the results of recent regulatory examinations, which
typically include a review of the allowance for loan losses as an integral part
of the examination process.
In establishing the allowance, management evaluates individual large
classified loans and nonaccrual loans, and determines an aggregate reserve for
those loans based on that review. An allowance for the remainder of the loan
portfolio is also determined based on historical loss experience within the
components of the portfolio. These allocations may be modified if current
conditions indicate that loan losses may differ from historical experience,
based on economic factors and changes in portfolio mix and volume.
11
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 7,700,000 shares have been issued and approximately
6,900,000 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 more than 50% of our outstanding shares. It may be difficult for a
stockholder to sell a significant number of shares at a time and at a price of
their choosing or for a third party to purchase sufficient shares on the open
market to cause a change in control of the Company, all of which could depress
the price of Berkshire Bancorp's common stock.
In addition, federal and state banking laws may restrict the ability of
the stockholders to approve a merger or business combination or obtain control
of the Company. This may tend to make it more difficult for shareholders to
replace existing management or may prevent shareholders from receiving a premium
for their shares of our common stock.
OUR COMMON STOCK IS NOT INSURED BY ANY GOVERNMENTAL AGENCY AND, THEREFORE,
INVESTMENT IN THEM INVOLVES RISK.
Our securities are not deposit accounts or other obligation of any bank,
and are not insured by the FDIC, or any other governmental agency, and are
subject to investment risk, including the possible loss of principal.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not Applicable
12
ITEM 2. PROPERTIES.
The following are Berkshire's and the Bank's principal facilities as of
March 9, 2007:
Approximate
Floor Area Approximate Lease
Location Operations (Sq. Ft.) Annual Rent Expiration
------------ ----------------- ----------- ----------- ----------------
New York, NY Executive Offices 1,500 $ 18,000 (1)(3)
New York, NY Main Bank Office
and Bank Branch 9,700 Owned Feb 2008
Brooklyn, NY Bank Branch 4,500 $ 200,418 March 2008
Brooklyn, NY Bank Branch 2,866 $ 59,130 March 2008
Brooklyn, NY Bank Branch 2,592 $ 108,212 December 2012
Brooklyn, NY Bank Branch 1,640 $ 72,000 June 2015
New York, NY Bank Branch 9,924 $ 353,315 June 2010 (2)(3)
Goshen, NY Bank Branch 10,680 Owned
Harriman, NY Bank Branch 1,623 Owned
Bloomingburg, NY Bank Branch 1,530 $ 20,871 August 2010
Ridgefield, NJ Bank Branch Owned
----------
(1) Rented on a month to month basis from a company affiliated with Mr.
Moses Marx, a director of the Company.
(2) Leased from a company affiliated with Mr. Marx, a director of the
Company.
(3) Management believes the annual rent paid is comparable to the annual
rent that would be paid to non-affiliated parties in a similar
commercial transaction for similar commercial space.
ITEM 3. LEGAL PROCEEDINGS.
In the ordinary course of operations, the Bank is a party to routine
litigation involving claims incidental to its banking business. Management
believes that no current litigation, threatened or pending, to which we or our
assets are a party, poses a substantial likelihood of potential loss or exposure
which would have a material adverse effect on the financial condition or results
of our operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not Applicable.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
The Company's Common Stock trades on the Nasdaq Global Market under the
symbol BERK. The following table sets forth, for the periods indicated, the high
and low sales prices for the Company's Common Stock as reported by NASDAQ.
FISCAL YEAR ENDED DECEMBER 31, 2005 HIGH LOW
----------------------------------- ------ -----
January 1, 2005 to March 31, 2005 22.04 19.51
April 1, 2005 to June 30, 2005 20.98 17.50
July 1, 2005 to September 30, 2005 18.75 17.02
October 1, 2005 to December 31, 2005 18.30 15.83
FISCAL YEAR ENDED DECEMBER 31, 2006 HIGH LOW
----------------------------------- ------ -----
January 1, 2006 to March 31, 2006 17.35 14.82
April 1, 2006 to June 30, 2006 17.23 15.18
July 1, 2006 to September 30, 2006 17.00 15.31
October 1, 2006 to December 31, 2006 17.12 15.14
As of the close of business on March 23, 2007, there were approximately
1,300 holders of record of the Company's Common Stock.
13
DIVIDENDS
For the fiscal years ended December 31, 2006, 2005 and 2004, the Company
has been deemed to be a PHC, as defined in the Internal Revenue Code. As a PHC,
we may be required to pay an additional income tax or issue a dividend to our
shareholders in an amount based upon applicable Internal Revenue Code formulas,
which is primarily based upon net income. No such dividend was required to be
paid in fiscal 2006, 2005 and 2004.
On March 23, 1999, the Board of Directors adopted a policy of paying
regular cash dividends in respect of the Common Stock of the Company, payable in
equal semi-annual installments. Pursuant to said policy, the Board of Directors
declared and the Company paid cash dividends, restated to reflect the reverse
split and stock dividend which occurred on May 18, 2004, as follows:
PER SHARE
DECLARATION DATE RECORD DATE PAYMENT DATE AMOUNT
---------------- ---------------- ---------------- ------------
April 1, 2004 April 19, 2004 April 28, 2004 $.05
October 5, 2004 October 22, 2004 October 29, 2004 $.06
March 21, 2005 April 22, 2005 April 29, 2005 $.07
October 7, 2005 October 21, 2005 October 28, 2005 $.08
March 9, 2006 April 18, 2006 April 27, 2006 $.08
October 10, 2006 October 20, 2006 October 27, 2006 $.08
The declaration, payment and amount of such dividends in the future are
within the discretion of the Board of Directors and will depend upon our
earnings, capital requirements, financial condition and other relevant factors.
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, 2005, the Company has purchased a total of 1,848,909
shares of its Common Stock. During fiscal year 2006, we purchased a total of
50,000 shares and at December 31, 2006 there were 501,091 shares of Common Stock
which may yet be purchased under our stock repurchase plan. Certain information
concerning the 50,000 shares purchased in 2006 is set forth below.
ISSUER PURCHASES OF EQUITY SECURITIES
TOTAL NUMBER OF MAXIMUM NUMBER
TOTAL SHARES (OR (OR APPROXIMATE
NUMBER UNITS) DOLLAR VALUE) OF
OF PURCHASED AS SHARES (OR UNITS)
SHARES AVERAGE PART OF THAT MAY YET BE
(OR PRICE PAID PUBLICLY PURCHASED UNDER
UNITS) PER SHARE ANNOUNCED PLANS THE PLANS OR
PURCHASED (OR UNIT) OR PROGRAMS PROGRAMS
--------- ----------- ----------------- -----------------
November 2006 50,000 $15.80 50,000 501,091
============= ====== ====== ====== =======
EQUITY COMPENSATION PLANS
See Part III, Item 12 for information concerning the Company's equity
compensation plans.
14
PERFORMANCE GRAPH
The following graph compares the cumulative total return on the
Company's Common Stock with the cumulative total return of The Nasdaq Stock
Market Bank Stocks Index and the Nasdaq Market Total Return Index for the
five-year period ended December 31, 2006. The graph assumes that the value of
the investment in the Company and the index was $100 on December 31, 2001 and
assumes that all dividends were reinvested.
RETURN TO SHAREHOLDERS OF BERKSHIRE BANCORP INC.
[GRAPHIC OMITTED]
* BERKSHIRE BANCORP INC. O NASDAQ BANK STOCKS INDEX # NASDAQ TOTAL RETURN INDEX
==================================================================
12/31/01 12/31/02 12/31/03 12/31/04 12/30/05 12/29/06
-----------------------------------------------------------------------------------------------
Berkshire Bancorp Inc. $100.00 121.16 176.42 216.95 181.05 175.79
-----------------------------------------------------------------------------------------------
NASDAQ Market $100.00 105.58 131.69 150.71 147.23 165.24
Bank Stock Index
-----------------------------------------------------------------------------------------------
NASDAQ Market $100.00 69.13 103.36 112.49 114.88 126.21
Total Return Index
===============================================================================================
15
ITEM 6. SELECTED FINANCIAL DATA.
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
FIVE YEAR FINANCIAL HIGHLIGHTS (A)(B)
The following is a summary of certain financial information with respect
to the Company at and for the fiscal years ended December 31, 2006, 2005, 2004,
2003 and 2002. This information is derived from and should be read in
conjunction with the Company's financial statements and notes thereto included
elsewhere in this Form 10-K.
------------------------------------------------
DECEMBER 31,
------------------------------------------------
2006 2005 2004 2003 2002
-------- -------- -------- -------- --------
(Dollars in thousands,except per share data)
BALANCE SHEET DATA:
Total Assets $948,656 $977,452 $972,649 $905,669 $683,738
Loans, net 367,152 305,964 284,052 292,163 273,182
Investment securities 515,231 599,972 631,592 569,848 371,458
Goodwill, net 18,549 18,549 18,549 18,549 18,549
Deposits 681,489 680,260 619,888 604,255 473,818
Borrowings 115,390 156,245 223,352 192,136 104,372
Subordinated debt 22,681 22,681 15,464 -- --
Stockholders' equity 115,777 108,710 107,619 103,490 98,525
STATEMENT OF OPERATIONS DATA:
Interest income 48,221 45,056 40,008 34,426 32,242
Interest expense 29,186 22,399 15,916 13,647 13,416
-------- -------- -------- -------- --------
Net interest income before
provision for loan losses 19,035 22,657 24,092 20,779 18,826
Provision for loan losses 410 180 180 240 387
-------- -------- -------- -------- --------
Net interest income 18,625 22,477 23,912 20,539 18,439
Investment securities gains 2,336 4 793 2,746 1,539
Other income 1,357 1,202 1,026 1,237 748
Other expenses 13,582 13,139 12,095 11,463 10,780
-------- -------- -------- -------- --------
Income before income taxes 8,736 10,544 13,636 13,059 9,946
Provision for income taxes 3,856 5,003 6,134 5,644 4,349
-------- -------- -------- -------- --------
Net income $ 4,880 $ 5,541 $ 7,502 $ 7,415 $ 5,597
======== ======== ======== ======== ========
Net income per share:
Basic $ .71 $ .81 $ 1.12 $ 1.12 $ .81
======== ======== ======== ======== ========
Diluted $ .70 $ .80 $ 1.10 $ 1.10 $ .81
======== ======== ======== ======== ========
Cash dividends per
common share $ .16 $ .15 $ .11 $ .09 $ .07
======== ======== ======== ======== ========
Selected Operating Ratios
Return on average assets 0.5% 0.6% 0.8% 0.9% 0.9%
Return on average equity 4.3% 5.1% 7.2% 7.2% 5.9%
Net interest margin 2.2% 2.4% 2.6% 2.7% 3.3%
Average equity/average assets 12.1% 11.1% 11.0% 12.7% 15.6%
Allowance for loan
losses/total loans 1.0% 1.1% 1.0% 0.9% 0.8%
(a) The prior years' amounts have been reclassified to conform to the
current years' presentation.
(b) The prior years' net income per share and cash dividends per common
share amounts have been retroactively restated to reflect the
one-for-ten reverse stock split and thirty-for-one forward stock split
which occurred on May 18, 2004.
16
ITEM 7. MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis is intended to provide a better
understanding of the consolidated financial condition and results of operations
of Berkshire Bancorp Inc. and subsidiaries for the fiscal years ended December
31, 2006, 2005 and 2004. All references to earnings per share, unless stated
otherwise, refer to earnings per diluted share. The discussion should be read in
conjunction with the consolidated financial statements and related notes (Notes
located in Item 8 herein). Reference is also made to Part I, Item 1 "Business"
herein.
SEGMENTS
Management has determined that the Company through its wholly owned bank
subsidiary, the Bank, operates in one business segment, community banking. The
Bank's principal business activity consists of gathering deposits from the
general public and investing those deposits in residential and commercial
mortgage loans and commercial non-mortgage loans, both unsecured and secured by
personal property. In addition, the Bank invests those deposits in debt
obligations issued by the U.S. Government, its agencies, business corporations
and mortgage-backed securities.
GENERAL
STOCK SPLIT AND STOCK DIVIDEND. At the Annual Meeting of Stockholders held on
May 18, 2004, the Company's stockholders approved the Reverse Split. Following
the effectiveness of the Reverse Split, the Company's Board of Directors
declared a stock dividend which became effective immediately. The Company paid
approximately $463,000 to purchase fractional shares from stockholders as part
of the Reverse Split. The Company's Common Stock began trading on May 19, 2004
giving effect to these transactions.
TRUST PREFERRED SECURITIES. As of May 18 2004, the Company established BCTI. The
Company owns all the common capital securities of BCTI. BCTI issued $15.0
million of preferred capital securities to investors in a private transaction
and invested the proceeds, combined with the proceeds from the sale of BCTI's
common capital securities, in the Company through the purchase of $15.464
million aggregate principal amount of the Floating Rate Junior Subordinated
Debentures issued by the Company. The Debentures, the sole assets of BCTI,
mature on July 23, 2034 and bear interest at a floating rate, three month LIBOR
plus 2.70%.
On April 1, 2005, the Company established BCTII. The Company owns all
the common capital securities of BCTII. BCTII issued $7.0 million of preferred
capital securities to investors in a private transaction and invested the
proceeds, combined with the proceeds from the sale of BCTII's common capital
securities, in the Company through the purchase of $7.217 million aggregate
principal amount of the 2005 Debentures issued by the Company. The 2005
Debentures, the sole assets of BCTII, mature on May 23, 2035 and bear interest
at a floating rate, three month LIBOR plus 1.95%. See Note A of Notes to
Consolidated Financial Statements for a further discussion of Trust Preferred
Securities.
BRANCH PURCHASE
In September 2005, the Bank entered into an Agreement with Oritani, a
New Jersey Chartered Savings Bank. Pursuant to the Agreement, which closed on
May 12, 2006, the Bank (i) assumed certain commercial checking account deposit
liabilities and (ii) purchased certain fixed assets and the real property of
this Oritani bank branch located in Ridgefield, New Jersey for a cash purchase
price of $850,000. Following the closing of the transaction, the Bank opened a
branch of The Berkshire Bank at the Ridgefield, New Jersey location.
17
NEW SUBSIDIARY
In August 2005, the Bank formed Berkshire 1031, a wholly owned limited
liability company. Berkshire 1031 will act as a qualified intermediary in
connection with tax free exchanges under Section 1031 of the Internal Revenue
Code of 1986, as amended. A qualified intermediary is an individual or business
entity that assists owners of property who wish to exchange their property for
property of a "like-kind" in a transaction that is tax free in whole or part for
federal (and in some cases state) income tax purposes. In accordance with
detailed procedures set forth in federal income tax regulations, Berkshire 1031
will assist the owner in the sale of the owner's property and the purchase of
replacement property so that the transaction qualifies as a non-taxable exchange
of property.
CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
The accounting and reporting policies of the Company conform with
accounting principles generally accepted in the United States of America and
general practices within the financial services industry. The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and the
assumptions that affect the amounts reported in the financial statements and the
accompanying notes. Actual results could differ from those estimates.
The Company considers that the determination of the allowance for loan
losses involves a higher degree of judgment and complexity than any of its other
significant accounting policies. The allowance for loan losses is calculated
with the objective of maintaining a reserve level believed by management to be
sufficient to absorb estimated credit losses. Management's determination of the
adequacy of the allowance is based on periodic evaluations of the loan portfolio
and other relevant factors. However, this evaluation is inherently subjective as
it requires material estimates, including, among others, expected default
probabilities, loss given default, the amounts and timing of expected future
cash flows on impaired loans, mortgages, and general amounts for historical loss
experience. The process also considers economic conditions, uncertainties in
estimating losses and inherent risks in the loan portfolio. All of these factors
may be susceptible to significant change. To the extent actual outcomes differ
from management estimates, additional provisions for loan losses may be required
that would adversely impact earnings in future periods.
With the adoption of Statement of Financial Accounting Standards
("SFAS") No. 142 ("SFAS No. 142") on January 1, 2002, the Company discontinued
the amortization of goodwill resulting from acquisitions. Goodwill is now
subject to impairment testing at least annually to determine whether write-downs
of the recorded balances are necessary. The Company tests for impairment based
on the goodwill maintained at the Bank. A fair value is determined for each
reporting unit based on at least one of three various market valuation
methodologies. If the fair values of the reporting units exceed their book
values, no write-down of recorded goodwill is necessary. If the fair value of
the reporting unit is less, an expense may be required on the Company's books to
write down the related goodwill to the proper carrying value. As of December 31,
2006, 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.
18
DISCUSSION OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
FISCAL YEAR ENDED DECEMBER 31, 2006 COMPARED TO FISCAL YEAR ENDED
DECEMBER 31, 2005. Net income was $4.88 million, or $.70 per diluted share, for
the fiscal year ended December 31, 2006, compared to $5.54 million, or $.80 per
diluted share, for the fiscal year ended December 31, 2005. Net loans increased
by approximately 20%. Investment securities and total assets decreased by
approximately 14% and 3%, respectively.
FISCAL YEAR ENDED DECEMBER 31,
----------------------------------------------------
2006 2005 %
INC/(DEC)
(In millions, except per share data and percentages)
TOTAL ASSETS $948.7 $977.7 (3)%
Loans, net 367.2 305.9 20%
Investment Securities 515.2 600.0 (14)%
TOTAL LIABILITIES 832.8 868.7 (4)%
Deposits 681.5 680.3 0%
Borrowings 138.1 178.9 (23)%
STOCKHOLDERS' EQUITY 115.8 109.0 6%
TOTAL INCOME 51.9 46.3 12%
Interest Income 48.2 45.1 7%
TOTAL EXPENSE 42.8 35.5 21%
Interest Expense 29.2 22.4 30%
Net Interest Income 19.0 22.7 (16)%
NET INCOME 4.9 5.5 (11)%
Diluted Income Per Share .70 .80 (13)%
BANK BRANCHES 11 10 --
19
FISCAL YEAR ENDED DECEMBER 31, 2005 COMPARED TO FISCAL YEAR ENDED
DECEMBER 31, 2004. Net income was $5.54 million, or $.80 per diluted share, for
the fiscal year ended December 31, 2005, compared to $7.50 million, or $1.10 per
diluted share, for the fiscal year ended December 31, 2004. Net loans and total
assets increased by approximately 8% and 1%, respectively, and investment
securities decreased by approximately 5%.
FISCAL YEAR ENDED DECEMBER 31,
----------------------------------------------------
2005 2004 %
INC/(DEC)
(In millions, except per share data and percentages)
TOTAL ASSETS $977.7 $972.6 1%
Loans, net 305.9 284.1 8%
Investment Securities 600.0 631.6 (5)%
TOTAL LIABILITIES 868.7 865.0 0%
Deposits 680.3 619.9 10%
Borrowings 178.9 238.8 (25)%
STOCKHOLDERS' EQUITY 109.0 107.6 1%
TOTAL INCOME 46.3 41.8 11%
Interest Income 45.1 40.0 13%
TOTAL EXPENSE 35.5 28.0 27%
Interest Expense 22.4 15.9 41%
Net Interest Income 22.7 24.1 (6)%
NET INCOME 5.5 7.5 (27)%
Diluted Income Per Share .80 1.10 (27)%
BANK BRANCHES 10 9 --
NET INTEREST INCOME
Net interest income, represents the difference between total interest
income earned on earning assets and total interest expense paid on
interest-bearing liabilities. The amount of interest income is dependent upon
many factors including: (i) the amount of interest-earning assets that the
Company can maintain based upon its funding sources; (ii) the relative amounts
of interest-earning assets versus interest-bearing liabilities; and (iii) the
difference between the yields earned on those assets and the rates paid on those
liabilities. Non-performing loans adversely affect net interest income because
they must still be funded by interest-bearing liabilities, but they do not
provide interest income. Furthermore, when we designate an asset as non-
performing, all interest which has been accrued but not actually received is
deducted from current period income, further reducing net interest income.
20
The Company's average balances, interest, and average yields are set forth on
the following table (in thousands, except percentages):
TWELVE MONTHS ENDED TWELVE MONTHS ENDED TWELVE MONTHS ENDED
DECEMBER 31, 2006 DECEMBER 31, 2005 DECEMBER 31, 2004
------------------------------- ------------------------------- -------------------------------
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE AND YIELD/ AVERAGE AND YIELD/ AVERAGE AND YIELD/
BALANCE DIVIDENDS RATE BALANCE DIVIDENDS RATE BALANCE DIVIDENDS RATE
--------- --------- ------- --------- --------- ------- --------- --------- -------
INTEREST-EARNING ASSETS:
Loans (1) $ 327,210 $ 23,844 7.29% $ 287,178 $ 19,399 6.76% $ 290,774 $ 18,825 6.47%
Investment securities 550,443 24,027 4.37 648,829 25,355 3.91 620,511 21,120 3.40
Other (2)(5) 8,509 350 4.11 10,765 302 2.81 4,376 63 1.44
--------- -------- ---- --------- -------- ---- --------- -------- ----
Total interest-earning assets 886,162 48,221 5.44 946,772 45,056 4.76 915,661 40,008 4.37
---- ---- ----
Noninterest-earning assets 46,882 44,497 40,592
--------- --------- ---------
Total Assets $ 933,044 $ 991,269 $ 956,253
========= ========= =========
INTEREST-BEARING LIABILITIES:
Interest bearing deposits 206,745 5,283 2.56 264,130 4,639 1.76 272,219 3,809 1.39
Time deposits 410,729 17,276 4.21 338,834 9,552 2.82 309,968 6,024 1.94
Other borrowings 144,722 6,627 4.58 225,657 8,208 3.64 223,208 6,083 2.73
--------- -------- ---- --------- -------- ---- --------- -------- ----
Total interest-bearing
liabilities 762,196 29,186 3.83 828,621 22,399 2.70 805,395 15,916 1.98
-------- ---- -------- ---- -------- ----
Demand deposits 47,890 44,739 38,896
Noninterest-bearing liabilities 9,731 8,310 7,163
Stockholders' equity (5) 113,227 109,599 104,799
--------- --------- ---------
Total liabilities and
stockholders' equity $ 933,044 $ 991,269 $ 956,253
========= ========= =========
Net interest income $ 19,035 $ 22,657 $ 24,092
======== ======== ========
Interest-rate spread (3) 1.61% 2.06% 2.39%
==== ==== ====
Net interest margin (4) 2.15% 2.39% 2.63%
==== ==== ====
Ratio of average interest-
earning assets to average
interest bearing liabilities 1.16 1.14 1.14
========= ========= =========
----------
(1) Includes nonaccrual loans.
(2) Includes interest-bearing deposits, federal funds sold and securities
purchased under agreements to resell.
(3) Interest-rate spread represents the difference between the average yield
on interest-earning assets and the average cost of interest bearing
liabilities.
(4) Net interest margin is net interest income as a percentage of average
interest-earning assets.
(5) Average balances for Berkshire Bancorp Inc. (parent only) have been
calculated on a monthly basis.
21
Changes in net interest income may also be analyzed by segregating the
volume and rate components of interest income and interest expense. The
following tables set forth certain information regarding changes in interest
income and interest expense of the Company for the years indicated. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (1) changes in rate (change
in rate multiplied by prior volume), (2) changes in volume (changes in volume
multiplied by prior rate) and (3) changes in rate-volume (change in rate
multiplied by change in volume) (in thousands):
TWELVE MONTHS ENDED DECEMBER 31, 2006
VERSUS
TWELVE MONTHS ENDED DECEMBER 31, 2005
INCREASE (DECREASE) DUE TO
---------------------------------------
Rate Volume Total
------- ------- -------
Interest-earning assets:
Loans $ 1,522 $ 2,923 $ 4,445
Investment securities 2,985 (4,313) (1,328)
Other 140 (92) 48
------- ------- -------
Total 4,647 (1,482) 3,165
------- ------- -------
Interest-bearing
liabilities:
Deposit accounts:
Interest bearing deposits 2,113 (1,469) 644
Time deposits 4,710 3,014 7,724
Other borrowings 2,121 (3,702) (1,581)
------- ------- -------
Total 8,944 (2,157) 6,787
------- ------- -------
Net interest income $(4,297) $ 675 $(3,622)
======= ======= =======
TWELVE MONTHS ENDED DECEMBER 31, 2005
VERSUS
TWELVE MONTHS ENDED DECEMBER 31, 2004
INCREASE (DECREASE) DUE TO
---------------------------------------
Rate Volume Total
------- ------- -------
Interest-earning assets:
Loans $ 843 $ (269) $ 574
Investment securities 3,165 1,070 4,235
Other 60 179 239
------- ------- -------
Total 4,068 980 5,048
------- ------- -------
Interest-bearing
liabilities:
Deposit accounts:
Interest bearing deposits 1,007 (177) 830
Time deposits 2,728 800 3,528
Other borrowings 2,031 94 2,125
------- ------- -------
Total 5,766 717 6,483
------- ------- -------
Net interest income $(1,698) $ 263 $(1,435)
======= ======= =======
22
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 $52.74 million at December 31,
2006, at fixed rates for a period of one to five years.
We seek to maximize our net interest margin within an acceptable level
of interest rate risk. Interest rate risk can be defined as the amount of the
forecasted net interest income that may be gained or lost due to favorable or
unfavorable movements in interest rates. Interest rate risk, or sensitivity,
arises when the maturity or repricing characteristics of assets differ
significantly from the maturity or repricing characteristics of liabilities.
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.
23
On a quarterly basis, the Bank's 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
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.
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 York 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 fiscal years ended December 31, 2006 and 2005, we charged-off
loans of $42,000 and $26,000, respectively, and recovered loans of $137,000 and
$185,000, respectively. All amounts recovered in fiscal 2006 and 2005 were
returned to the allowance for loan losses.
RESULTS OF OPERATIONS FISCAL YEAR ENDED DECEMBER 31, 2006 COMPARED TO FISCAL
YEAR ENDED DECEMBER 31, 2005.
GENERAL. References to per share amounts below, unless stated otherwise, refer
to diluted shares.
NET INCOME. Net income for the fiscal year ended December 31, 2006 was $4.88
million, or $.70 per share, as compared to $5.54 million, or $.80 per share, for
the fiscal year ended December 31, 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
24
to manage the interest rate and other risks inherent in the banking business.
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. Inflation fighting actions taken by the Federal Reserve Board
have moved short-term rates up while long-term rates have remained relatively
flat. The Company's rising cost of funds in 2006 on deposits and borrowings has
not been matched by the ability to increase the yields on assets.
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 fiscal year ended December 31, 2006, net interest income
decreased by $3.62 million to $19.04 million from $22.66 million for the fiscal
year ended December 31, 2005. The year over year decrease in net interest income
was the result of the 113 basis point increase in the average rate paid on the
average amount of interest-bearing liabilities to 3.83% in 2006 from 2.70% in
2005 and the smaller, 68 basis point increase in the average yield earned on the
average amount of interest-earning assets to 5.44% in 2006 from 4.76% in 2005.
Also contributing to the decrease in net interest income was the $60.61 million
decrease in the average amount of interest-earning assets to $886.16 million in
2006 from $946.77 million in 2005. Partially offsetting these factors was the
$66.43 million decrease in the average amount of interest-bearing liabilities to
$762.20 million in 2006 from $828.62 million in 2005.
The Company's interest-rate spread, the difference between the average
yield on interest-earning assets and the average cost of interest-bearing
liabilities, narrowed by 45 basis points to 1.61% in 2006 from 2.06% in 2005.
This decline is primarily due to the change in deposit mix, the $71.90 million
increase in higher cost CD's and the $57.39 million decrease in lower cost,
non-maturity deposit accounts in 2006 compared to 2005. If the current rate
environment continues, we expect to see continued pressure on the Company's
interest-rate spread and net interest income.
NET INTEREST MARGIN. Net interest margin, or annualized net interest income as a
percentage of average interest-earning assets, declined by 24 basis points to
2.15% in fiscal 2006 from 2.39% in fiscal 2005. We seek to secure and retain
customer deposits with competitive products and rates, while making strategic
use of the prevailing interest rate environment to borrow funds at what we
believe to be attractive rates. We invest such deposits and borrowed funds in a
prudent mix of fixed rate and adjustable rate loans, investment securities and
short-term interest-earning assets which provided an aggregate average yield of
5.44% and 4.76% in fiscal 2006 and 2005, respectively. The decrease in net
interest margin is primarily due to the decrease in net interest income,
partially offset by the decrease in average interest-earning assets.
The average amount of loans increased by $40.03 million to $327.21
million in 2006 from $287.18 million in 2005, and the average yield on such
loans increased by 53 basis points to 7.29% in fiscal 2006 from 6.76% in fiscal
2005. The average amount of investment securities decreased by $98.39 million to
$550.44 million in fiscal 2006 from $648.83 million in fiscal 2005. The average
yield on investment securities improved by 46 basis points, to 4.37% in 2006
from 3.91% in 2005. The average amount of other interest-earning assets,
primarily cash and short-term investments, decreased by $2.26 million to $8.51
million in 2006 from $10.77 million in 2005 and returned an average yield of
4.11% and 2.81% in fiscal 2006 and 2005, respectively.
INTEREST INCOME. Total interest income for the fiscal year ended December 31,
2006 increased by $3.17 million, or 7.02%, to $48.22 million from $45.06 million
for the fiscal year ended December 31, 2005. The increase in interest income was
primarily due to the increase in the yields on interest-earning assets,
partially offset by the decrease in the average amount of total interest-earning
assets. Loans contributed $23.84 million of interest income in fiscal 2006, an
increase of $4.44 million from the $19.40 million of interest income contributed
in fiscal 2005. Investment securities contributed $24.03 million of interest
income in fiscal 2006, a decrease of $1.33 million from the $25.36 million of
interest income earned on securities in fiscal 2005.
25
FISCAL 2006 FISCAL 2005
---------------------- --------------------
INTEREST % OF INTEREST % OF
INCOME TOTAL INCOME TOTAL
(In thousands, except percentages)
Loans $23,844 49.45% $19,399 43.06%
Investment Securities 24,027 49.82 25,355 56.27
Other 350 0.73 302 0.67
------- ------ ------- ------
Total Interest Income $48,221 100.00% $45,056 100.00%
Loans, which are inherently risky and therefore command a higher return
than our conservative portfolio of investment securities, grew to 36.92% of our
total average interest-earning assets in fiscal 2006 from 30.33% in fiscal 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.
FISCAL 2006 FISCAL 2005
------------------- --------------------
AVERAGE % OF AVERAGE % OF
AMOUNT TOTAL AMOUNT TOTAL
(In thousands, except percentages)
Loans $327,210 36.92% $287,178 30.33%
Investment Securities 550,443 62.12 648,829 68.53
Other 8,509 0.96 10,765 1.14
------- ------ ------- ------
Total Interest-Earning Assets $886,162 100.00% $946,772 100.00%
INTEREST EXPENSE. Total interest expense for the fiscal year ended December 31,
2006 increased by $6.79 million, or 30.30%, to $29.19 million from $22.40
million for the fiscal year ended December 31, 2005. The increase in interest
expense was due to the increase in the average rate paid on such liabilities,
3.83% and 2.70% in fiscal years 2006 and 2005, respectively, partially offset by
the decrease in the average amount of interest-bearing liabilities. As
short-term rates moved higher during 2006, interest expense increased as we
priced our deposit products to meet the competition and the adjustable rates
paid on other borrowings increased as well. In April 2005 and May 2004, we sold
$7.22 million and $15.46 million, respectively, of floating rate junior
subordinated debentures which mature in 2035 and 2034, respectively. The net
proceeds of said sales were used to augment the Bank's capital. The interest
expense on these debentures, which are included in other borrowings, was $1.77
million and $1.27 million during fiscal 2006 and 2005, respectively.
FISCAL 2006 FISCAL 2005
------------------------- -------------------
INTEREST % OF INTEREST % OF
EXPENSE TOTAL EXPENSE TOTAL
(In thousands, except percentages)
Interest-Bearing Deposits $ 5,283 18.10% $ 4,639 20.71%
Time Deposits 17,276 59.19 9,552 42.64
Other Borrowings 6,627 22.71 8,208 36.65
------- ------ ------- ------
Total Interest Expense $29,186 100.00% $22,399 100.00%
FISCAL 2006 FISCAL 2005
------------------- -------------------
AVERAGE % OF AVERAGE % OF
AMOUNT TOTAL AMOUNT TOTAL
(In thousands, except percentages)
Interest-Bearing Deposits $206,745 27.12% $264,130 31.88%
Time Deposits 410,729 53.89 338,834 40.89
Other Borrowings 144,722 18.99 225,657 27.23
------- ------ ------- ------
Total Interest-Bearing
Liabilities $762,196 100.00% $828,621 100.00%
26
NON-INTEREST INCOME. Non-interest income consists primarily of realized gains on
sales of marketable securities and service fee income. For the fiscal year ended
December 31, 2006, total non-interest income increased by $2.48 million to $3.69
million from $1.21 million for the fiscal year ended December 31, 2005. In 2006,
we recorded gains of $2.34 million on the sales and issuer redemptions of
investment securities. In 2005, such gains amounted to $4,000. Service charges
on deposit accounts were flat and other income increased by $156,000.
FISCAL 2006 FISCAL 2005
--------------------- ----------------------
NON-INTEREST % OF NON-INTEREST % OF
INCOME TOTAL INCOME TOTAL
(In thousands, except percentages)
Service Charges on Deposits $ 588 15.92% $ 589 48.84%
Investment Securities gains 2,336 63.26 4 0.33
Other 769 20.82 613 50.83
------- ------ ------- ------
Total Non-Interest Income $ 3,693 100.00% $ 1,206 100.00%
NON-INTEREST EXPENSE. Non-interest expense includes salaries and employee
benefits, occupancy and equipment expenses, legal and professional fees and
other operating expenses associated with the day-to-day operations of the
Company. Total non-interest expense for the year ended December 31, 2006
increased by $443,000, or 3.37%, to $13.58 million from $13.14 million for the
year ended December 31, 2005. The largest component of non-interest expense are
salaries and employee benefits which increased by $479,000 to $8.48 million in
fiscal 2006 from $8.00 million in fiscal 2005. The increase is due to the
addition of personnel in our internal control and compliance departments.
FISCAL 2006 FISCAL 2005
---------------------- ----------------------
NON-INTEREST % OF NON-INTEREST % OF
EXPENSE TOTAL EXPENSE TOTAL
------- ------ ------- ------
(In thousands, except percentages)
Salaries and Employee Benefits $ 8,481 62.44% $ 8,002 60.90%
Net Occupancy Expense 1,961 14.44 1,728 13.15
Equipment Expense 108 0.80 397 3.02
FDIC Assessment 85 0.63 272 2.07
Data Processing Expense 366 2.69 198 1.51
Other 2,581 19.00 2,542 19.35
------- ------ ------- ------
Total Non-Interest Expense $13,582 100.00% $13,139 100.00%
PROVISION FOR INCOME TAX. During the years ended December 31, 2006 and 2005, we
recorded income tax expense of $3.86 million and $5.00 million, respectively.
The tax provisions for federal, state and local taxes recorded for 2006 and 2005
represent effective tax rates of 44.14% and 47.45%, respectively.
27
RESULTS OF OPERATIONS FISCAL YEAR ENDED DECEMBER 31, 2005 COMPARED TO FISCAL
YEAR ENDED DECEMBER 31, 2004.
GENERAL. References to per share amounts below, unless stated otherwise, refer
to diluted shares.
NET INCOME. Net income for the fiscal year ended December 31, 2005 was $5.54
million, or $.80 per share, as compared to $7.50 million, or $1.10 per share,
for the fiscal year ended December 31, 2004.
The Company's net income is largely dependent on interest rate levels,
the demand for the Company's loan and deposit products and the strategies
employed to manage the interest rate and other risks inherent in the banking
business. From June 2003 through June 30, 2004, interest rates, as measured by
the prime rate, remained constant at 4.00%. On July 1, 2004, inflation fighting
actions taken by the Federal Reserve Board with respect to short-term interest
rates (the only rates it can control) resulted in a 25 basis point increase in
the prime rate to 4.25%, the first such increase in short-term rates in more
than four years. Similar 25 basis point moves in the federal funds rate taken by
the Federal Reserve Board during 2004 and 2005, the most recent occurring on
January 31, 2006, have moved the prime rate to its present level of 7.50%, the
longest sustained period of monetary policy tightening in more than a decade.
While short-term market rates have followed the upticks of federal
funds, long-term interest rates have declined during this period, a condition
referred to as a flattening yield curve. A flat or narrowing yield curve places
a squeeze on interest margins for financial institutions, like the Company, who
depend upon a spread between long- and short-term rates for interest margin
profits and the largest percentage of income.
NET INTEREST INCOME. The Company's primary source of revenue is net interest
income, or the difference between interest income on earning assets, such as
loans and investment securities, and interest expense on interest-bearing
liabilities such as deposits and borrowings.
For the fiscal year ended December 31, 2005, net interest income
decreased by $1.44 million, or 5.96%, to $22.66 million from $24.09 million for
the fiscal year ended December 31, 2004. The decrease in net interest income was
the result of the 28.84% growth in the average amount of interest-bearing
liabilities to $828.62 million during fiscal 2005 from $805.40 million in fiscal
2004 and the 72 basis point increase in the average rates paid on such
liabilities to 2.70% in 2005 from 1.98% in 2004. The decrease in net interest
income was partially offset by the 3.40% increase in the average amount of
interest-earning assets to $946.77 million during 2005 from $915.66 million in
2004 and the 39 basis point increase in the average yields earned on such
earning assets to 4.76% in 2005 from 4.37% in 2004.
Also contributing to the change in net interest income was the
interest-rate spread or the difference between the average yield on
interest-earning assets and the average cost of interest-bearing liabilities.
During fiscal 2005, the Company's interest-rate spread decreased by 33 basis
points to 2.06% from 2.39% during fiscal 2004. If interest rates remain at
current levels or increase slowly over time, we expect to see only moderate
pressure on the Company's interest-rate spread and net interest income.
Investment securities in our portfolio that have been sold, matured or called by
the issuer during fiscal 2004 and 2005 have been replaced with securities
carrying somewhat higher yields and, by design, shorter maturities to provide a
hedge against a rising interest rate environment. Rates paid on deposit accounts
are likely to increase in a rising rate environment due to competition for
deposits in the market place. The cost of borrowed funds with floating rather
than fixed interest rates will increase as well.
NET INTEREST MARGIN. Net interest margin, or annualized net interest income as a
percentage of average interest-earning assets, declined to 2.39% in fiscal 2005
from 2.63% in fiscal 2004. We seek to secure and retain customer deposits with
competitive products and rates, while making strategic use of the prevailing
interest rate environment to borrow funds at what we believe to be attractive
rates. We invest such deposits and borrowed funds in a prudent mix of fixed rate
and adjustable rate loans, investment securities and short-term interest-earning
28
assets which provided an aggregate average yield of 4.76% and 4.37% in fiscal
2005 and 2004, respectively.
The average amount of loans decreased slightly to $287.18 million in
fiscal 2005 from $290.77 million in fiscal 2004, however, the average yield on
the loan portfolio increased by 29 basis points to 6.76% in fiscal 2005 from
6.47% in fiscal 2004. During periods of low and stable interest rates borrowers
gravitate towards fixed-rate loans to lock in a low interest rate. Adjustable
rate loans are generally preferred when interest rates are trending higher as
they did in 2004 and 2005. One-to-four family mortgage loans, approximately 45%
and 54% of our loan portfolio at December 31, 2005 and 2004, respectively, are
particularly sensitive to changes in interest rates.
The average amount of investment securities increased by $28.32 million
to $648.83 million in fiscal 2005 from $620.51 million in fiscal 2004. The
average yield on investment securities improved by 51 basis points, to 3.91% in
2005 from 3.40% in 2004 and are likely to continue to increase in a rising
interest rate environment. The average amount of other interest-earning assets,
primarily short-term investments, increased by $6.39 million to $10.77 million
in 2005 from $4.38 million in 2004 and returned an average yield of 2.81% and
1.44% in fiscal 2005 and 2004, respectively.
INTEREST INCOME. Total interest income for the fiscal year ended December 31,
2005 increased by $5.05 million, or 12.62%, to $45.06 million from $40.01
million for the fiscal year ended December 31, 2004. The increase in interest
income was primarily due to the growth in the average amount of total
interest-earning assets. Loans contributed $19.40 million of interest income in
fiscal 2005, an increase of $574,000 from the $18.83 million of interest income
contributed in fiscal 2004. Investment securities contributed $25.36 million of
interest income in fiscal 2005, an increase of $4.24 million over the $21.12
million of interest income earned on loans in fiscal 2004.
FISCAL 2005 FISCAL 2004
-------------------- --------------------
INTEREST % OF INTEREST % OF
INCOME TOTAL INCOME TOTAL
(In thousands, except percentages)
Loans $19,399 43.06% $18,825 47.05%
Investment Securities 25,355 56.27 21,120 52.79
Other 302 0.67 63 0.16
------- ------ ------- ------
Total Interest Income $45,056 100.00% $40,008 100.00%
Loans, which are inherently risky and therefore command a higher return
than our conservative portfolio of investment securities, declined to 30.33% of
our total average interest-earning assets in fiscal 2005 from 31.76% in fiscal
2004. While we actively seek to originate new loans with qualified borrowers who
meet the Bank's underwriting standards, our strategy has been to maintain those
standards, sacrificing some current income to avoid possible large future losses
in the loan portfolio.
FISCAL 2005 FISCAL 2004
------------------- -------------------
AVERAGE % OF AVERAGE % OF
AMOUNT TOTAL AMOUNT TOTAL
(In thousands, except percentages)
Loans $287,178 30.33% $290,774 31.76%
Investment Securities 648,829 68.53 620,511 67.77
Other 10,765 1.14 4,376 0.47
------- ------ ------- ------
Total Interest-Earning Assets $946,772 100.00% $915,661 100.00%
29
INTEREST EXPENSE. Total interest expense for the fiscal year ended December 31,
2005 increased by $6.48 million, or 40.73%, to $22.40 million from $15.92
million for the fiscal year ended December 31, 2004. The increase in interest
expense was due to the growth in the average amount of interest-bearing
liabilities and the increase in the average rate paid on such liabilities, 2.70%
and 1.98% in fiscal years 2005 and 2004, respectively. As short-term rates moved
higher during 2005, interest expense increased as we priced our deposit products
to meet the competition and the adjustable rates paid on other borrowings
increased as well. In April 2005 and May 2004, we sold $7.22 million and $15.46
million, respectively, of floating rate junior subordinated debentures which
mature in 2035 and 2034, respectively. The net proceeds of said sales were used
to augment the Bank's capital. The additional interest expense on these
debentures, which is included in other borrowings, was $1.27 million and
$463,000 during fiscal 2005 and 2004.
FISCAL 2005 FISCAL 2004
-------------------- --------------------
INTEREST % OF INTEREST % OF
EXPENSE TOTAL EXPENSE TOTAL
(In thousands, except percentages)
Interest-Bearing Deposits $ 4,639 20.71% $ 3,809 23.93%
Time Deposits 9,552 42.64 6,024 37.85
Other Borrowings 8,208 36.65 6,083 38.22
------- ------ ------- ------
Total Interest Expense $22,399 100.00% $15,916 100.00%
FISCAL 2005 FISCAL 2004
------------------- -------------------
AVERAGE % OF AVERAGE % OF
AMOUNT TOTAL AMOUNT TOTAL
------- ------ ------- ------
(In thousands, except percentages)
Interest-Bearing Deposits $264,130 31.88% $272,219 33.80%
Time Deposits 338,834 40.89 309,968 38.49
Other Borrowings 225,657 27.23 223,208 27.71
------- ------ ------- ------
Total Interest-Bearing
Liabilities $828,621 100.00% $805,395 100.00%
NON-INTEREST INCOME. Non-interest income consists primarily of realized gains on
sales of marketable securities and service fee income. For the fiscal year ended
December 31, 2005, total non-interest income decreased by $613,000 to $1.21
million from $1.82 million for the fiscal year ended December 31, 2004. In 2004,
we recorded gains of $793,000 on the sales and issuer redemptions of investment
securities. In 2005, such gains amounted to $4,000. Service charges on deposit
accounts increased by $69,000 to $589,000 in fiscal 2005 from $520,000 in fiscal
2004.
FISCAL 2005 FISCAL 2004
--------------------- -----------------------
NON-INTEREST % OF NON-INTEREST % OF
INCOME TOTAL INCOME TOTAL
(In thousands, except percentages)
Service Charges on Deposits $ 589 48.84% $ 520 28.59%
Investment Securities gains 4 0.33 793 43.60
Other 613 50.83 506 27.81
------- ------ ------- ------
Total Non-Interest Income $ 1,206 100.00% $ 1,819 100.00%
NON-INTEREST EXPENSE. Non-interest expense includes salaries and employee
benefits, occupancy and equipment expenses, legal and professional fees and
other operating expenses associated with the day-to-day operations of the
Company. Total non-interest expense for the year ended December 31, 2005
increased by $1.04 million, or 8.63%, to $13.14 million from $12.10 million for
the year ended December 31, 2004. The largest component of non-interest expense
are salaries and employee benefits which increased by $1.12 million, or 16.21%,
to $8.00 million in fiscal 2005 from $6.89 million in fiscal 2004. The increase
is due to the addition of personnel in our internal control and compliance
departments.
30
FISCAL 2005 FISCAL 2004
---------------------- ----------------------
NON-INTEREST % OF NON-INTEREST % OF
EXPENSE TOTAL EXPENSE TOTAL
(In thousands, except percentages)
Salaries and Employee Benefits $ 8,002 60.90% $ 6,886 56.93%
Net Occupancy Expense 1,728 13.15 1,538 12.72
Equipment Expense 397 3.02 357 2.95
FDIC Assessment 272 2.07 115 0.95
Data Processing Expense 198 1.51 157 1.30
Other 2,542 19.35 3,042 25.15
------- ------ ------- ------
Total Non-Interest Expense $13,139 100.00% $12,095 100.00%
PROVISION FOR INCOME TAX. During the years ended December 31, 2005 and 2004, we
recorded income tax expense of $5.00 million and $6.13 million, respectively.
The tax provisions for federal, state and local taxes recorded for 2005 and 2004
represent effective tax rates of 47.45% and 44.98%, respectively.
INVESTMENT ACTIVITIES
GENERAL. The investment policy of the Bank is designed primarily to
provide satisfactory yields while maintaining adequate liquidity, a balance of
high quality, diversified investments, and minimal risk. The Bank does not as a
rule invest in equity securities. The largest component of the Bank's securities
investments, representing more than 50% of total investment securities, are debt
securities issued by U.S. Government agencies including the Federal Home Loan
Mortgage Corporation (Freddie Mac), the Federal National Mortgage Association
(Fannie Mae) or the Government National Mortgage Association (Ginnie Mae). The
remainder of the Bank's debt securities investments are primarily short term
debt securities issued by the United States or its agencies. The Bank maintains
a small portfolio of less than $4 million of high-yield corporate debt
securities. Recognizing the higher credit risks of these securities, the Bank
underwrites these securities in a manner similar to its loan underwriting
procedures.
As required by the Statement of Financial Accounting Standard No. 115
("SFAS No. 115"), securities are classified into three categories: trading,
held-to-maturity and available-for-sale. Securities that are bought and held
principally for the purpose of selling them in the near term are classified as
trading securities and are reported at fair value with unrealized gains and
losses included in trading account activities in the statement of income.
Securities that the Bank has the positive intent and ability to hold to maturity
are classified as held-to-maturity and reported at amortized cost. All other
securities are classified as available-for-sale. Available-for-sale securities
are reported at fair value with unrealized gains and losses included, on an
after-tax basis, as a separate component of net worth. The Bank does not have a
trading securities portfolio and has no current plans to maintain such a
portfolio in the future. The Bank generally classifies all newly purchased debt
securities as available for sale in order to maintain the flexibility to sell
those securities if the need arises. The Bank has a limited portfolio of
securities classified as held to maturity, represented principally by securities
purchased a number of years ago.
31
FEDERAL HOME LOAN BANK STOCK. The Bank owns stock of the Federal Home
Loan Bank of New York (the "FHLBNY") which is necessary for it to be a member of
the FHLBNY. Membership requires the purchase of stock equal to 1% of the Bank's
residential mortgage loans. If the Bank borrows from the FHLBNY, the Bank must
own stock at least equal to 5% of its borrowings.
The following table sets forth the cost and fair value of
available-for-sale and held-to-maturity securities as of the dates indicated:
DECEMBER 31,
--------------------------------------------------------------------
2006 2005 2004
-------------------- -------------------- --------------------
COST FAIR COST FAIR COST FAIR
VALUE VALUE VALUE
-------- -------- -------- -------- -------- --------
(In thousands)
AVAILABLE-FOR-SALE
U.S. Treasury Notes $ 5,002 $ 4,990 $ 14,985 $ 14,899 $ 24,896 $ 24,722
U.S. Government Agencies 322,986 317,164 448,196 439,645 471,018 467,271
Mortgage-backed securities 67,472 65,853 81,681 79,686 109,822 109,330
Corporate notes 44,366 44,038 54,590 52,304 21,089 21,627
Municipal securities 5,698 7,187 1,972 2,306 1,307 1,441
Marketable equity
securities and other 75,419 75,566 10,351 10,570 6,363 6,577
-------- -------- -------- -------- -------- --------
Total $520,943 $514,798 $611,775 $599,410 $634,495 $630,968
======== ======== ======== ======== ======== ========
HELD-TO-MATURITY
U.S. Government Agencies $ 433 $ 436 $ 562 $ 573 $ 624 $ 633
Total $ 433 $ 436 $ 562 $ 573 $ 624 $ 633
======== ======== ======== ======== ======== ========
32
The following tables summarize the Company's available-for-sale and
held- to-maturity securities:
DECEMBER 31, 2006
--------------------------------
WEIGHTED
AVERAGE
YIELD COST FAIR VALUE
---- -------- --------
(Dollars in thousands)
AVAILABLE-FOR-SALE
U.S. Treasury Notes
Due after one year through five years 4.62% $ 5,002 $ 4,990
-------- --------
5,002 4,990
-------- --------
U.S. Government Agencies Obligations
Due within one year 4.19 31,051 30,921
Due after one year through five years 4.14 200,964 197,212
Due after five years through ten years 4.61 76,931 75,325
Due after ten years 4.06 14,040 13,706
-------- --------
322,986 317,164
Municipal Obligations
Due after ten years 9.84 5,698 7,187
-------- --------
5,698 7,187
-------- --------
Mortgage-backed securities
Due after one year through five years 4.44 5,101 4,900
Due after five years through ten years 4.07 10,224 9,746
Due after ten years 5.00 52,147 51,207
-------- --------
67,472 65,853
Corporate Notes
Due within one year 5.30 15,439 15,438
Due after one year through five years 5.80 7,036 7,027
Due after five years through ten years 4.00 5,000 4,483
Due after ten years 6.79 16,891 17,090
44,366 44,038
Common Stocks 0.46 329 420
Preferred Stocks 4.44 71,741 71,797
Money market funds 4.37 305 305
Federal Home Loan Bank Stock 6.25 3,044 3,044
-------- --------
75,419 75,566
$520,943 $514,798
HELD-TO-MATURITY
U.S. Government Agencies Obligations
Due after five years through ten years 6.25 29 29
Due after ten years 6.58 404 407
-------- --------
$ 433 $ 436
======== ========
33
LOAN PORTFOLIO
LOAN PORTFOLIO COMPOSITION. The Company's loans consist primarily of
mortgage loans secured by residential and non-residential properties as well as
commercial loans which are either unsecured or secured by personal property
collateral. Most of the Company's loans are either made to individuals or
personally guaranteed by the principals of the business to which the loan is
made. At December 31, 2006, 2005 and 2004, the Company had total loans, net of
unearned income of $370.92 million, $309.23 million and $286.98 million,
respectively, and an allowance for loan losses of $3.77 million, $3.27 million
and $2.93 million, respectively. From time to time, the Bank may originate
residential mortgage loans, sell them on the secondary market, normally
recognizing fee income in connection with the sale.
Interest rates on loans are affected by the demand for loans, the supply
of money available for lending, credit risks, the rates offered by competitors
and other conditions. These factors are in turn affected by, among other things,
economic conditions, monetary policies of the federal government, and
legislative tax policies.
In order to manage interest rate risk, the Bank focuses its efforts on
loans with interest rates that adjust based upon changes in the prime rate or
changes in United States Treasury or similar indices. Generally, credit risks on
adjustable-rate loans are somewhat greater than on fixed-rate loans primarily
because, as interest rates rise, so do borrowers' payments, increasing the
potential for default. The Bank seeks to impose appropriate loan underwriting
standards in order to protect against these and other credit related risks
associated with its lending operations.
In addition to analyzing the income and assets of its borrowers when
underwriting a loan, the Bank obtains independent appraisals on all material
real estate in which the Bank takes a mortgage. The Bank generally obtains title
insurance in order to protect against title defects on mortgaged property.
COMMERCIAL AND MORTGAGE LOANS. The Bank originates commercial mortgage
loans secured by office buildings, retail establishments, multi-family
residential real estate and other types of commercial property. Substantially
all of the properties are located in the New York City metropolitan area.
The Bank generally makes commercial mortgage loans with loan to value
ratios not to exceed 75% and with terms to maturity that do not exceed 15 years.
Loans secured by commercial properties generally involve a greater degree of
risk than one- to four-family residential mortgage loans. Because payments on
such loans are often dependent on successful operation or management of the
properties, repayment may be subject, to a greater extent, to adverse conditions
in the real estate market or the economy. The Bank seeks to minimize these risks
through its underwriting policies. The Bank evaluates the qualifications and
financial condition of the borrower, including credit history, profitability and
expertise, as well as the value and condition of the underlying property. The
factors considered by the Bank include net operating income; the debt coverage
ratio (the ratio of cash net income to debt service); and the loan to value
ratio. When evaluating the borrower, the Bank considers the financial resources
and income level of the borrower, the borrower's experience in owning or
managing similar property and the Bank's lending experience with the borrower.
The Bank's policy requires borrowers to present evidence of the ability to repay
the loan without having to resort to the sale of the mortgaged property. The
Bank also seeks to focus its commercial mortgage loans on loans to companies
with operating businesses, rather than passive real estate investors.
COMMERCIAL LOANS. The Bank makes commercial loans to businesses for
inventory financing, working capital, machinery and equipment purchases,
expansion, and other business purposes. These loans generally have higher yields
than mortgages loans, with maturities of one year, after which the borrower's
financial condition and the terms of the loan are re-evaluated.
Commercial loans tend to present greater risks than mortgage loans
because the collateral, if any, tends to be rapidly depreciable, difficult to
sell at full value and is often easier to conceal. In order to limit these
risks, the Bank evaluates these loans based upon the borrower's ability to repay
the loan
34
from ongoing operations. The Bank considers the business history of the borrower
and perceived stability of the business as important factors when considering
applications for such loans. Occasionally, the borrower provides commercial or
residential real estate collateral for such loans, in which case the value of
the collateral may be a significant factor in the loan approval process.
RESIDENTIAL MORTGAGE LOANS (1 TO 4 FAMILY LOANS). The Bank makes
residential mortgage loans secured by first liens on one-to-four family
owner-occupied or rental residential real estate. At December 31, 2006 and 2005,
approximately $143.62 million and $142.81 million, respectively, or 39% and 46%,
respectively, of the Company's total loan portfolio consisted of such loans. The
Company offers both adjustable rate mortgages ("ARMS") and fixed-rate mortgage
loans. The relative proportion of fixed-rate loans versus ARMs originated by the
Bank depends principally upon current customer preference, which is generally
driven by economic and interest rate conditions and the pricing offered by the
Bank's competitors. At December 31, 2006 and 2005, approximately 14% and 4%,
respectively, of the Bank's residential one-to-four family owner-occupied first
mortgage portfolio were ARMs and approximately 86% and 96%, respectively, were
fixed-rate loans. The percentage represented by fixed-rate loans tends to
increase during periods of low interest rates. The ARMs generally carry annual
caps and life-of-loan ceilings, which limit interest rate adjustments.
The Bank's residential loan underwriting criteria are generally
comparable to those required by the Federal National Mortgage Association
("FNMA") and other major secondary market loan purchasers. Generally, ARM credit
risks are somewhat greater than fixed-rate loans primarily because, as interest
rates rise, the borrowers' payments rise, increasing the potential for default.
The Bank's teaser rate ARMs (ARMs with low initial interest rates that are not
based upon the index plus the margin for determining future rate adjustments)
were underwritten based on the payment due at the fully-indexed rate.
In addition to verifying income and assets of borrowers, the Bank
obtains independent appraisals on all residential first mortgage loans and title
insurance is required at closing. Private mortgage insurance is required on all
loans with a loan-to-value ratio in excess of 80% and the Bank requires real
estate tax escrows on such loans. Real estate tax escrows are voluntary on
residential mortgage loans with loan-to-value ratios of 80% or less.
Fixed-rate residential mortgage loans are generally originated by the
Bank for terms of 15 to 30 years. Although 30 year fixed-rate mortgage loans may
adversely affect our net interest income in periods of rising interest rates,
the Bank originates such loans to satisfy customer demand. Such loans are
generally originated at initial interest rates which exceed the fully indexed
rate on ARMs offered at the same time. Fixed-rate residential mortgage loans
originated by the Bank generally include due-on-sale clauses, which permit the
Bank to demand payment in full if the borrower sells the property without the
Bank's consent. Due-on-sale clauses are an important means of adjusting the
rates on the Bank's fixed-rate mortgage loan portfolio, and the Bank will
generally exercise its rights under these clauses if necessary to maintain
market yields.
ARMs originated in recent years have interest rates that adjust annually
based upon the movement of the one year treasury bill constant maturity index,
plus a margin of 2.00% to 2.75%. These loans generally have a maximum interest
rate adjustment of 2% per year, with a lifetime maximum interest rate
adjustment, measured from the initial interest rate, of 5.5% or 6.0%.
The Bank offers a variety of other loan products including residential
single family construction loans to persons who intend to occupy the property
upon completion of construction, home equity loans secured by junior mortgages
on one-to-four family owner-occupied residences, and short-term fixed-rate
consumer loans either unsecured or secured by monetary assets such as bank
deposits and marketable securities or personal property.
ORIGINATION OF LOANS. Loan originations can be attributed to depositors,
retail customers, phone inquiries, advertising, the efforts of the Bank's loan
officers, and referrals from other borrowers, real estate brokers and builders.
The Bank originates loans primarily through its own efforts, occasionally
obtaining loan opportunities as a result of referrals from loan brokers.
35
At December 31, 2006, the Bank's total capital, net of goodwill and loan
loss reserves, was approximately $99.17 million and thus it was generally not
permitted to make loans to one borrower in excess of approximately $14.89
million, with an additional amount of approximately $9.93 million being
permitted if secured by readily marketable collateral. The Bank was also not
permitted to make any single mortgage loan in an amount in excess of
approximately $14.89 million. At December 31, 2006, the Bank was in compliance
with these standards.
DELINQUENCY PROCEDURES. When a borrower fails to make a required payment
on a loan, the Bank attempts to cause the deficiency to be cured by contacting
the borrower. The Bank reviews past due loans on a case by case basis, taking
the action it deems appropriate in order to collect the amount owed. Litigation
may be necessary if other procedures are not successful. Judicial resolution of
a past due loan can be delayed if the borrower files a bankruptcy petition
because collection action cannot be continued unless the Bank first obtains
relief from the automatic stay provided by the Bankruptcy Code.
If a non-mortgage loan becomes delinquent and satisfactory arrangements
for payment cannot be made, the Bank seeks to realize upon any personal property
collateral to the extent feasible and collect any remaining amount owed from the
borrower through legal proceedings, if necessary.
It is the Bank's policy to discontinue accruing interest on a loan when
it is 90 days past due or if management believes that continued interest
accruals are unjustified. The Bank may continue interest accruals if a loan is
more than 90 days past due if the Bank determines that the nature of the
delinquency and the collateral are such that collection of the principal and
interest on the loan in full is reasonably assured. When the accrual of interest
is discontinued, all accrued but unpaid interest is charged against current
period income. Once the accrual of interest is discontinued, the Bank records
interest as and when received until the loan is restored to accruing status. If
the Bank determines that collection of the loan in full is in reasonable doubt,
then amounts received are recorded as a reduction of principal until the loan is
returned to accruing status.
36
The following table sets forth information concerning the Company's loan
portfolio by type of loan at the dates indicated:
DECEMBER 31,
--------------------------------------------------------------------------------------------------------
2006 2005 2004 2003 2002
------------------ ------------------ ------------------ ------------------ ------------------
% OF % OF % OF % OF % OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
--------- ----- --------- ----- --------- ----- --------- ----- --------- -----
(Dollars in thousands)
Commercial and
professional loans $ 63,331 17.0% $ 33,370 10.8% $ 16,498 5.7% $ 22,228 7.5% $ 16,704 6.0%
Secured by real estate
1 - 4 family 139,611 37.5 139,931 45.1 155,079 53.9 169,589 57.4 180,730 65.4
Multi family 4,013 1.1 2,874 0.9 4,600 1.6 6,608 2.2 8,958 3.2
Non-residential
(commercial) 160,417 43.1 132,142 42.6 109,597 38.1 94,956 32.2 65,809 23.8
Consumer 4,763 1.3 2,018 0.6 1,989 0.7 2,239 0.7 4,051 1.6
--------- ---- --------- ---- --------- --- --------- --- --------- -----
Total loans 372,135 100.0% 310,335 100.0% 287,763 100.0% 295,620 100.0% 276,252 100.0%
===== ===== ===== ===== =====
Less: Allowance
for loan losses (3,771) (3,266) (2,927) (2,593) (2,315)
Unearned fees (1,212) (1,105) (784) (864) (755)
--------- --------- --------- --------- ---------
Loans, net $ 367,152 $ 305,964 $284,052 $ 292,163 $273,182
========= ========= ========= ========= =========
37
IMPAIRED LOAN BALANCE, NONACCRUAL LOANS AND LOANS GREATER THAN 90 DAYS STILL
ACCRUING
The following table sets forth certain information regarding nonaccrual
loans, including the ratio of such loans to total assets as of the dates
indicated, and certain other related information. The Bank had no foreclosed
real estate during these periods and loans past due more than 90 days still
accruing were $0 and $74,000 at December 31, 2006 and 2005, respectively.
DECEMBER 31,
-----------------------------------------------
2006 2005 2004 2003 2002
---- ---- ---- ---- ----
(Dollars in Thousands)
Nonaccrual loans:
Commercial and $ -- $ -- $ -- $ -- $--
professional loans
Consumer -- 3 1 -- --
Secured by real estate 201 253 342 109 59
---- ---- ---- ---- ---
Total nonaccrual loans 201 256 343 109 59
---- ---- ---- ---- ---
Accruing loans delinquent
90 days or more -- 74 50 -- --
---- ---- ---- ---- ---
Total nonperforming loans $201 $330 $393 $109 $59
==== ==== ==== ==== ===
Total nonperforming loans
to total assets .02% .03% .04% .01% --
==== ==== ==== ==== ===
The following tables present information regarding the Company's total
allowance for loan losses as well as the allocation of such amounts to the
various categories of loans at the dates indicated (dollars in thousands):
DECEMBER 31, 2006
-------------------------------------------
ALLOWANCE
FOR LOAN PERCENT OF PERCENT OF
LOSSES ALLOWANCE TOTAL LOANS
--------- ---------- -----------
Commercial and
professional loans $ 852 22.6% 0.23%
Secured by real estate
1 - 4 family 634 16.8 0.17
Multi family 54 1.4 0.01
Non-residential 2,166 57.5 0.58
Consumer and other 64 1.7 0.02
General allowance (1) -- -- --
------- ------- -------
Total allowance
for loan losses $ 3,771 100.0% 1.01%
======= ======= =======
(1) The allowance for loan losses is allocated to specific loans as
necessary.
DECEMBER 31, 2005
-------------------------------------------
ALLOWANCE
FOR LOAN PERCENT OF PERCENT OF
LOSSES ALLOWANCE TOTAL LOANS
--------- ---------- -----------
Commercial and
professional loans $ 450 13.8% 0.15%
Secured by real estate
1 - 4 family 937 28.7 0.30
Multi family 39 1.2 0.01
Non-residential 1,784 54.6 0.57
Consumer and other 27 0.8 0.01
General allowance (1) 29 0.9 0.01
------- ------- -------
Total allowance
for loan losses $ 3,266 100.0% 1.05%
======= ======= =======
----------
(1) The allowance for loan losses is allocated to specific loans as
necessary.
38
DECEMBER 31, 2004
-------------------------------------------
ALLOWANCE
FOR LOAN PERCENT OF PERCENT OF
LOSSES ALLOWANCE TOTAL LOANS
--------- ---------- -----------
Commercial and
professional loans $ 223 7.6% 0.08%
Secured by real estate
1 - 4 family 775 26.5 0.27
Multi family 62 2.1 0.02
Non-residential 1,398 47.8 0.49
Consumer and other 27 0.9 0.01
General allowance (1) 442 15.1 0.15
------- ------- -------
Total allowance
for loan losses $ 2,927 100.0% 1.02%
======= ======= =======
----------
(1) The allowance for loan losses is allocated to specific loans as
necessary.
DECEMBER 31, 2003
-------------------------------------------
ALLOWANCE
FOR LOAN PERCENT OF PERCENT OF
LOSSES ALLOWANCE TOTAL LOANS
--------- ---------- -----------
Commercial and
professional loans $ 300 11.6% 0.10%
Secured by real estate
1 - 4 family 424 16.3 0.14
Multi family 89 3.4 0.03
Non-residential 1,198 46.2 0.41
Consumer and other 30 1.2 0.01
General allowance (1) 552 21.3 0.19
------- ------- -------
Total allowance
for loan losses $ 2,593 100.0% 0.88%
======= ======= =======
----------
(1) The allowance for loan losses is allocated to specific loans as
necessary.
DECEMBER 31, 2002
-------------------------------------------
ALLOWANCE
FOR LOAN PERCENT OF PERCENT OF
LOSSES ALLOWANCE TOTAL LOANS
--------- ---------- -----------
Commercial and
professional loans $ 225 9.7% 0.08%
Secured by real estate
1 - 4 family 452 19.5 0.16
Multi family 121 5.2 0.04
Non-residential 888 38.4 0.32
Consumer and other 55 2.4 0.02
General allowance (1) 574 24.8 0.21
------- ------- -------
Total allowance
for loan losses $ 2,315 100.0% 0.83%
======= ======= =======
(1) The allowance for loan losses is allocated to specific loans as
necessary.
39
The following tables set forth information regarding the aggregate
maturities of the Company's loans in the specified categories and the amount of
such loans which have fixed and variable rates.
DECEMBER 31, 2006
-----------------------------------------
WITHIN 1 TO AFTER
1 YEAR 5 YEARS 5 YEARS TOTAL
------- ------- ------- --------
(In thousands)
FIXED RATE
Commercial and professional $ 828 $32,036 $ 228 $ 33,092
Non-residential 32,325 30,405 17,482 80,212
Total fixed rate $33,153 $62,441 $17,710 $113,304
------- ------- ------- --------
ADJUSTABLE RATE
Commercial and professional 12,957 13,827 3,455 30,239
Non-residential 20,816 11,818 52,334 84,968
Total adjustable rate $33,773 $25,645 $55,789 $115,207
------- ------- ------- --------
Total $66,926 $88,086 $73,499 $228,511
======= ======= ======= ========
The following table sets forth information with respect to activity in
the Company's allowance for loan losses during the periods indicated (in
thousands, except percentages):
YEARS ENDED DECEMBER 31,
-------------------------------------------------------------
2006 2005 2004 2003 2002
-------- -------- -------- -------- ---------
Average loans outstanding $327,210 $287,178 $290,774 $291,586 $ 265,961
======== ======== ======== ======== =========
Allowance at beginning
of period 3,266 2,927 2,593 2,315 2,030
Charge-offs:
Commercial and other
loans 42 26 24 4 199
Real estate loans -- -- -- 13 --
-------- -------- -------- -------- ---------
Total loans charged-off 42 26 24 17 199
-------- -------- -------- -------- ---------
Recoveries:
Commercial and other
loans 137 185 178 55 97
Real estate loans -- -- -- -- --
-------- -------- -------- -------- ---------
Total loans recovered 137 185 178 55 97
-------- -------- -------- -------- ---------
Net recoveries
(charge-offs) 95 159 154 38 (102)
-------- -------- -------- -------- ---------
Provision for loan losses
charged to operating
expenses 410 180 180 240 387
Allowance at end of period $ 3,771 $ 3,266 $ 2,927 $ 2,593 $ 2,315
-------- -------- -------- -------- ---------
Ratio of net recoveries
(charge-offs) to average
loans outstanding .03% .06% .05% .01% (.03)%
======== ======== ======== ======== =========
Allowance as a percent
of total loans 1.01% 1.05% 1.02% 0.88% 0.83%
======== ======== ======== ======== =========
Total loans at end
of period $372,135 $310,335 $287,763 $295,620 $ 276,252
======== ======== ======== ======== =========
40
DEPOSITS
The Bank concentrates on obtaining deposits from a variety of
businesses, professionals and retail customers. The Bank offers a number of
different deposit programs, including statement savings accounts, NOW accounts,
money market deposits accounts, checking accounts and certificates of deposits
with terms from seven days to five years. Deposit account terms vary according
to the minimum balance required, the time period the funds must remain on
deposit and the interest rate, among other factors. The Bank prices its deposit
offerings competitively within the market it serves. These products are designed
to attract new customers, retain existing customers and create opportunities to
offer other bank products or services. While the market and pricing for deposit
funds are very competitive, the Bank believes that personalized, quality service
is also an important element in retaining core deposit customers.
The following table summarizes the composition of the average balances
of major deposit categories:
DECEMBER 31,
--------------------------------------------------------
2006 2005 2004
----------------- ---------------- -----------------
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
-------- ---- -------- ---- -------- ----
(Dollars in thousands)
Demand deposits $ 47,890 -- $ 44,739 -- $ 38,896 --
NOW and money market 35,141 0.61% 42,756 0.56% 47,677 0.65%
Savings deposits 171,604 2.95 221,374 1.99 224,542 1.55
Time deposits 410,729 4.21 338,834 2.82 309,968 1.94
-------- ---- -------- ---- -------- ----
Total deposits $665,364 3.39% $647,703 2.19% $621,083 1.58%
======== ==== ======== ==== ======== ====
The aggregate amount of jumbo certificates of deposit, each with a
minimum denomination of $100,000, was approximately $203.59 million, $203.72
million and $109.74 million at December 31, 2006, 2005 and 2004, respectively.
The following table summarizes the maturity distribution of time
deposits of $100,000 or more as of December 31, 2006:
(In thousands)
3 months or less $103,269
Over 3 months but within 6 months 84,426
Over 6 months but within 12 months 12,714
Over 12 months 3,181
--------
Total $203,590
========
41
SHORT-TERM BORROWINGS
Securities sold under agreements to repurchase generally mature within
30 days from the date of the transactions. Short-term borrowings consist of
Treasury Tax and Loan Note Options and various other borrowings which generally
have maturities of less than one year. The details of these categories are
presented below:
YEARS ENDED DECEMBER 31,
---------------------------------
2006 2005 2004
------- -------- --------
(Dollars in thousands)
Securities sold under repurchase
agreements and federal funds purchased
Balance at year-end $62,652 $ 73,044 $127,747
Average during the year $56,236 $108,785 $129,794
Maximum month-end balance $79,154 $145,489 $148,753
Weighted average rate during the year 3.75% 3.47% 1.87%
Rate at December 31 4.94% 3.59% 2.27%
CAPITAL RESOURCES AND LIQUIDITY
LIQUIDITY
The management of the Company's liquidity focuses on ensuring that
sufficient funds are available to meet loan funding commitments, withdrawals
from deposit accounts, the repayment of borrowed funds, and ensuring that the
Bank and the Company comply with regulatory liquidity requirements. Liquidity
needs of the Bank have historically been met by deposits, investments in federal
funds sold, principal and interest payments on loans, and maturities of
investment securities.
For the parent company, Berkshire Bancorp Inc., liquidity means having
cash available to fund operating expenses and to pay stockholder dividends, when
and if declared by the Company's Board of Directors. The Company paid cash
dividends per share of $.16, $.15 and $.11 in fiscal 2006, 2005 and 2004,
respectively. The ability to fund the Company's operations and to pay dividends
is not dependent upon the receipt of dividends from the Bank. At December 31,
2006, the Company had cash of approximately $11.5 million and investment
securities with a fair market value of $15.9 million.
CONTINGENT LIABILITIES AND COMMITMENTS
The Bank maintains financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and stand-by
letters of credit. The following table presents the Company's commitments at
December 31, 2006.
EXPIRATION BY PERIOD
-----------------------------------------------------
LESS MORE
THAN 1-3 3-5 THAN
TOTAL 1 YEAR YEARS YEARS 5 YEARS
------- ------- ------- ----- ------
(In thousands)
Lines of Credit $38,288 $11,148 $21,866 $ -- $5,274
Standby Letters
of Credit 3,423 3,423 -- -- --
Loan Commitments -- -- -- -- --
------- ------- ------- ------ ------
Total $41,711 $14,571 $21,866 $ -- $5,274
======= ======= ======= ====== ======
42
CONTRACTUAL OBLIGATIONS
The following table presents the Company's contractual obligations at
December 31, 2006.
PAYMENTS DUE BY PERIODS
-----------------------------------------------------
LESS MORE
THAN 1-3 3-5 THAN
TOTAL 1 YEAR YEARS YEARS 5 YEARS
------- ------- ------- ----- ------
(In thousands)
Long-Term Debt $75,419 $ 9,302 $29,436 $14,000 $22,681
Operating Leases 3,551 867 1,234 976 474
Time Deposits 423,712 418,413 5,297 2 --
------- ------- ------- ------ ------
Total Contractual
Obligations $502,682 $428,582 $35,967 $14,978 $23,155
======= ======= ======= ====== ======
The Company currently has two unconsolidated subsidiaries and no special
purpose entities.
CAPITAL
The capital ratios of the Bank and the Company are presently in excess
of the requirements necessary to meet the "well capitalized" capital category
established by bank regulators. See Note P to the Consolidated Financial
Statements.
INTEREST RATE RISK
Fluctuations in market interest rates can have a material effect on the
Bank's net interest income because the yields earned on loans and investments
may not adjust to market rates of interest with the same frequency, or with the
same speed, as the rates paid by the Bank on its deposits.
Most of the Bank's deposits are either interest-bearing demand deposits
or short term certificates of deposit and other interest-bearing deposits with
interest rates that fluctuate as market rates change. Management of the Bank
seeks to reduce the risk of interest rate fluctuations by concentrating on loans
and securities investments with either short terms to maturity or with
adjustable rates or other features that cause yields to adjust based upon
interest rate fluctuations. In addition, to cushion itself against the potential
adverse effects of a substantial and sustained increase in market interest
rates, the Bank has purchased off balance sheet interest rate cap contracts
which generally provide that the Bank will be entitled to receive payments from
the other party to the contract if interest rates exceed specified levels. These
contracts are entered into with major financial institutions.
The Company seeks to maximize its net interest margin within an
acceptable level of interest rate risk. Interest rate risk can be defined as the
amount of the forecasted net interest income that may be gained or lost due to
favorable or unfavorable movements in interest rates. Interest rate risk, or
sensitivity, arises when the maturity or repricing characteristics of assets
differ significantly from the maturity or repricing characteristics of
liabilities.
43
In the banking industry, a traditional measure of interest rate sensitivity is
known as "gap" analysis, which measures the cumulative differences between the
amounts of assets and liabilities maturing or repricing at various time
intervals. The following table sets forth the Company's interest rate repricing
gaps for selected maturity periods:
BERKSHIRE BANCORP INC.
INTEREST RATE SENSITIVITY GAP AT DECEMBER 31, 2006
(IN THOUSANDS, EXCEPT FOR PERCENTAGES)
----------------------------------------------------------------------------------------
3 MONTHS 3 THROUGH 1 THROUGH OVER
OR LESS 12 MONTHS 3 YEARS 3 YEARS TOTAL FAIR VALUE
------------- ------------- ------------- -------------- ------------ ----------
Federal funds sold 11,300 11,300 11,300
(Rate) 5.11%
Interest bearing deposits in banks 4,950 -- -- -- 4,950 4,950
(Rate) 4.17% 4.17%
Loans (1)(2)
Adjustable rate loans 75,884 11,281 22,208 32,804 142,177 144,075
(Rate) 8.97% 7.66% 6.65% 6.91% 8.03%
Fixed rate loans 12,680 20,502 23,523 173,253 229,958 230,977
(Rate) 8.59% 7.89% 6.90% 6.61% 6.86%
--------- --------- --------- --------- ----------
Total loans 88,564 31,783 45,731 206,057 372,135 375,052
Investments (3)(4) 144,793 82,033 103,620 190,390 520,836 515,234
(Rate) 4.28% 4.39% 4.31% 4.88% 4.52%
--------- --------- --------- --------- ----------
Total rate-sensitive assets 249,607 113,816 149,351 396,447 909,221
--------- ---------- --------- --------- ----------
Deposit accounts (5)
Savings and NOW 193,945 -- -- -- 193,945 193,945
(Rate) 3.19% 3.19%
Money market 14,413 -- -- -- 14,413 14,413
(Rate) 0.70% 0.70%
Time Deposits 198,474 219,939 5,297 2 423,712 423,161
(Rate) 4.67% 5.02% 2.78% 1.74% 4.83%
--------- --------- --------- --------- ----------
Total deposit accounts 406,832 219,939 5,297 2 632,070
Repurchase Agreements 59,652 3,000 -- -- 62,652 62,606
(Rate) 5.01% 3.52% -- -- 4.94%
Other borrowings 2,588 6,714 29,436 36,681 75,419 75,569
(Rate) 5.53% 3.46% 3.60% 7.23% 5.42%
--------- --------- --------- --------- ----------
Total rate-sensitive liabilities 469,072 229,653 34,733 36,683 770,141
--------- --------- --------- --------- ----------
Interest rate caps 20,000 (10,000) (10,000) 20
Gap (repricing differences) (239,465) (105,837) 124,618 359,764 139,080
========= ========= ========= ========= ==========
Cumulative Gap (239,465) (345,302) (220,684) 139,080
========= ========= ========= =========
Cumulative Gap to Total Rate
Sensitive Assets (26.33)% (37.98)% (24.27)% 15.30%
========= ========= ========= =========
----------
(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.
44
IMPACT OF INFLATION AND CHANGING PRICES
The Company's financial statements measure financial position and
operating results in terms of historical dollars without considering the changes
in the relative purchasing power of money over time due to inflation. The impact
of inflation is reflected in the increasing cost of the Company's operations.
The assets and liabilities of the Company are largely monetary. As a result,
interest rates have a greater impact on the Company's performance than do the
effects of general levels of inflation. In addition, interest rates do not
necessarily move in the direction, or to the same extent as the price of goods
and services. However, in general, high inflation rates are accompanied by
higher interest rates, and vice versa.
NEW ACCOUNTING PRONOUNCEMENTS
ACCOUNTING FOR FAIR VALUE MEASUREMENT
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.
ACCOUNTING FOR DEFINED BENEFIT PENSION AND OTHER POSTRETIREMENT PLANS
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) recognize 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 first 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.
ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES
On July 13, 2006, the FASB issued FASB Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes" ("FIN 48"): an interpretation of
FASB No. 109. FIN 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 48 also provides guidance on derecognition, measurement,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition. FIN 48 is effective for fiscal years beginning after
December 15, 2006.
45
We are currently assessing the impact of FIN 48 on our consolidated
financial statements and expect that the adoption of FIN 48 by the Company will
result in a decrease in our tax reserves of approximately $950,000 and a
corresponding increase to stockholders' equity as of January 1, 2007.
ACCOUNTING FOR FINANCIAL ASSETS
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.
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.
ACCOUNTING FOR PRIOR YEAR MISSTATEMENTS
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.
46
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 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.
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 previous
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 SFAS 123(R) did not have an impact on its operating
results and financial condition because the Company made no stock-based
compensation payments in fiscal 2006. The pro forma information presented in
Note B9, Stock Based Compensation, presents the estimated compensation charges
under Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation."
At December 31, 2006, the Company has one stock-based employee
compensation plan. The Company accounted for that plan under the recognition and
measurement principles of APB 25 and related interpretations. Stock-based
employee compensation costs were not reflected in net income, as all options
granted under the plan had an exercise price equal to the market value of the
underlying common stock on the date of the grant. The Company did not grant
stock options during 2006, 2005 and 2004, and we have no plans to grant
significant stock options, if any, in 2007. Therefore, we do not expect the
implementation of FAS 123(R) to affect our financial position or results of
operations in the near future.
THE MEANING OF OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS APPLICATION TO CERTAIN
INVESTMENTS
In November 2003, the Emerging Issues Task Force (the "EITF") of the
FASB issued EITF Abstract 03-1, "The Meaning of Other-Than-Temporary Impairment
and its Application to Certain Investments" (EITF Issue No. 03-1). In March
2004, the EITF reached a consensus on EITF Issue No. 03-1 and in September 2004,
the FASB issued a proposed Board-directed FASB Staff Position (an "FSP"), FSP
EITF 03-1-a, "Implementation Guidance for the Application of Paragraph 16 of
EITF Issue No. 03-1" (FSP EITF 03-1-a). The guidance in FSP EITF 03-1-a is
applicable for investments in (a) debt and equity securities that are within the
scope of SFAS Nos. 115 and 124, and (b) equity securities that are not subject
to the scope of FAS 115 and 124 and not accounted for under the equity method of
accounting, "cost-method investments."
The final FSP, retitled FSP FAS 115-1 and FAS 124-1 "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments,"
nullifies certain requirements of EITF No. 03-1 and supersedes EITF Topic No.
D-44, "Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a
Security Whose Cost Exceeds Fair Value." FSP FAS 115-1 and FAS 124-1
specifically (a) nullifies the requirements of paragraphs 10-18 of EITF No.
03-1,
47
(b) carries forward the requirements of paragraphs 8 and 9 with respect to
cost-method-investments and the disclosure requirements included in paragraphs
21 and 22 of EITF No. 03-1 and related examples, and (c) references existing
other-than-temporary impairment guidance. FSP FAS 115-1 and FAS 124-1
establishes a three-step approach for determining when an investment is
considered impaired, whether that impairment is other than temporary, and the
measurement of an impairment loss.
Application of the guidance in FSP FAS 115-1 and FAS 124-1, applicable
to reporting periods beginning after December 15, 2005, did not have a material
adverse effect on our consolidated financial statements.
INTERNAL CONTROL OVER FINANCIAL REPORTING
The current objective of the Company's Internal Control Program is to
allow the Bank and management to comply with Part 363 of the FDIC's regulations
("FDICIA") and to allow the Company to comply with Section 302 of the
Sarbanes-Oxley Act of 2002 (the "Act"). In November 2005, the FDIC amended Part
363 of its regulations by raising the asset-size threshold from $500 million to
$1 billion for internal control assessments by management and external auditors.
The final rule was effective December 28, 2005.
Section 302 of the Act requires the CEOs and CFOs of the Company to (i)
certify that the annual and quarterly reports filed with the Securities and
Exchange Commission are accurate and (ii) acknowledge that they are responsible
for establishing, maintaining and periodically evaluating the effectiveness of
the disclosure controls and procedures. Section 404 of the Act requires
management to (i) report on internal control over financial reporting, (ii)
assess the effectiveness of such internal controls, and (iii) obtain an external
auditor's report on management's assessment of its internal control. The Company
is not an accelerated filer as defined in Rule 12b-2 of the Securities Exchange
Act of 1934. Therefore, the Company is not required to comply with Section 404
until the year ending December 31, 2007.
The Committee of Sponsoring Organizations (COSO) methodology may be used
to document and test the internal controls pertaining to the accuracy of Company
issued financial statements and related disclosures. COSO requires a review of
the control environment (including anti-fraud and audit committee
effectiveness), risk assessment, control activities, information and
communication, and ongoing monitoring.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
See Item 7. Managements' Discussion and Analysis of Financial Condition
and Results of Operations - Interest Rate Risk
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
48
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
of Berkshire Bancorp Inc.
We have audited the accompanying consolidated balance sheets of Berkshire
Bancorp Inc. and subsidiaries as of December 31, 2006 and 2005, and the related
consolidated statements of income, stockholders' equity and cash flows for each
of the three years in the period ended December 31, 2006. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Berkshire Bancorp
Inc. and subsidiaries as of December 31, 2006 and 2005, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended December 31, 2006, in conformity with accounting
principles generally accepted in the United States of America.
/s/ GRANT THORNTON LLP
New York, New York
March 28, 2007
49
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
DECEMBER 31, DECEMBER 31,
2006 2005
------------ ------------
ASSETS
Cash and due from banks $ 8,061 $ 9,825
Interest bearing deposits 4,950 4,457
Federal funds sold 11,300 13,600
------------ ------------
Total cash and cash equivalents 24,311 27,882
Investment Securities:
Available-for-sale 514,798 599,410
Held-to-maturity, fair value of $436
in 2006 and $573 in 2005 433 562
------------ ------------
Total investment securities 515,231 599,972
Loans, net of unearned income 370,923 309,230
Less: allowance for loan losses (3,771) (3,266)
------------ ------------
Net loans 367,152 305,964
Accrued interest receivable 6,397 6,784
Premises and equipment, net 9,338 8,602
Goodwill, net 18,549 18,549
Other assets 7,678 9,699
------------ ------------
Total assets $ 948,656 $ 977,452
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 49,418 $ 50,269
Interest bearing 632,071 629,991
------------ ------------
Total deposits 681,489 680,260
Securities sold under agreements to repurchase 62,652 73,044
Long term borrowings 52,738 83,201
Subordinated debt 22,681 22,681
Accrued interest payable 8,110 5,731
Other liabilities 5,209 3,825
------------ ------------
Total liabilities 832,879 868,742
------------ ------------
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 qqqq -- 7,698,285 shares
Outstanding --
December 31, 2006, 6,877,881 shares
December 31, 2005, 6,890,556 shares 770 770
Additional paid-in capital 90,659 90,594
Retained earnings 37,285 33,504
Accumulated other comprehensive loss, net (4,772) (8,415)
Treasury Stock
December 31, 2006, 820,404 shares
December 31, 2005, 807,729 shares (8,165) (7,743)
------------ ------------
Total stockholders' equity 115,777 108,710
------------ ------------
Total liabilities and stockholders' equity $ 948,656 $ 977,452
============ ============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS
50
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
2006 2005 2004
-------- -------- --------
INTEREST INCOME
Federal funds sold and interest bearing deposits $ 350 $ 302 $ 63
Investment securities 24,027 25,355 21,120
Loans, including related fees 23,844 19,399 18,825
-------- -------- --------
Total interest income 48,221 45,056 40,008
-------- -------- --------
INTEREST EXPENSE
Deposits 22,559 14,191 9,833
Short-term borrowings 2,110 3,167 2,422
Long-term borrowings 4,517 5,041 3,661
-------- -------- --------
Total interest expense 29,186 22,399 15,916
-------- -------- --------
Net interest income 19,035 22,657 24,092
PROVISION FOR LOAN LOSSES 410 180 180
-------- -------- --------
Net interest income after
provision for loan losses 18,625 22,477 23,912
-------- -------- --------
NON-INTEREST INCOME
Service charges on deposit accounts 588 589 520
Investment securities gains 2,336 4 793
Other income 769 613 506
-------- -------- --------
Total non-interest income 3,693 1,206 1,819
-------- -------- --------
NON-INTEREST EXPENSE
Salaries and employee benefits 8,481 8,002 6,886
Net occupancy expense 1,961 1,728 1,538
Equipment expense 108 397 357
FDIC assessment 85 272 115
Data processing expense 366 198 157
Other 2,581 3,542 3,042
-------- -------- --------
Total non-interest expense 13,582 13,139 12,095
-------- -------- --------
Income before provision for income taxes 8,736 10,544 13,636
Provision for income taxes 3,856 5,003 6,134
-------- -------- --------
Net income $ 4,880 $ 5,541 $ 7,502
======== ======== ========
Net income per share:
Basic $ .71 $ .81 $ 1.12
======== ======== ========
Diluted $ .70 $ .80 $ 1.10
======== ======== ========
Number of shares used to compute
net income per share:
Basic 6,891 6,805 6,672
======== ======== ========
Diluted 6,976 6,939 6,848
======== ======== ========
Dividends per share $ .16 $ .15 $ .11
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS
51
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004
(IN THOUSANDS)
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TOTAL
PAR PAID-IN COMPREHENSIVE RETAINED TREASURY COMPREHENSIVE STOCKHOLDERS'
SHARES VALUE CAPITAL (LOSS) NET EARNINGS STOCK INCOME EQUITY
------ ----- ---------- ------------- -------- -------- ------------- -------------
BALANCE AT JANUARY 1, 2004 2,566 $256 $89,866 $ 775 $ 22,960 $(10,367) $103,490
Net income 7,502 7,502 7,502
Exercise of stock options (90) 1,361 1,271
Acquisition of treasury shares (69) (69)
Effect of reverse one-for-ten
stock split (2,309) (230) (233) (463)
Effect of thirty-for-one
stock dividend 7,441 744 (744)
Other comprehensive (loss) net
of reclassification adjustment
and taxes (3,377) (3,377) (3,377)
------
Comprehensive income $ 4,125
=======
Cash dividends (735) (735)
----- ---- ------- ------- -------- -------- --------
BALANCE AT DECEMBER 31, 2004 7,698 770 89,543 (2,602) 28,983 (9,075) 107,619
Net income 5,541 5,541 5,541
Exercise of stock options 354 1,332 1,686
Deferred tax benefit from exercise
of stock options 697 697
Other comprehensive (loss) net
of reclassification adjustment
and taxes (5,813) (5,813) (5,813)
------
Comprehensive loss $ (272)
======
Cash dividends (1,020) (1,020)
----- ---- ------- ------- -------- -------- --------
BALANCE AT DECEMBER 31, 2005 7,698 $770 $90,594 $(8,415) $ 33,504 $ (7,743) $108,710
Net income 4,880 4,880 4,880
Acquisition of treasury shares (790) (790)
Exercise of stock options (19) 368 349
Deferred tax benefit from exercise 84 84
of stock options
Other comprehensive income net
of reclassification adjustment
and taxes 3,643 3,643 3,643
-- -------
Comprehensive income $ 8,523
=======
Cash dividends (1,099) (1,099)
----- ---- ------- ------- -------- -------- --------
BALANCE AT DECEMBER 31, 2006 7,698 $770 $90,659 $(4,772) $ 37,285 $ (8,165) $115,777
===== ==== ======= ======= ======== ======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS
52
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
2006 2005 2004
-------- -------- ----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,880 $ 5,541 $ 7,502
Adjustments to reconcile net income
to net cash provided by operating
activities:
Realized gains on investment securities (2,336) (4) (793)
Net (accretion) amortization of premiums
of investment securities (595) (3) 2,282
Depreciation and amortization 727 650 590
Provision for loan losses 410 180 180
CHANGES IN ASSETS AND LIABILITIES:
Decrease (increase) in accrued interest 387 (770) (716)
receivable
Decrease (increase) in other assets 2,021 (3,030) (3,873)
Increase in accrued interest payable and
other liabilities 3,763 3,640 538
-------- -------- ----------
Net cash provided by operating activities 9,257 6,204 5,710
-------- -------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment securities available for sale
Purchases (489,737) (378,781) (1,740,889)
Sales, maturities and calls 580,923 404,533 1,674,188
Investment securities held to maturity
Purchases -- -- 91
Maturities 129 62 --
Net (increase) decrease in loans (61,598) (22,092) 7,931
Acquisition of premises and equipment (1,463) (575) (602)
-------- -------- ----------
Net cash provided by (used in)
investing activities 28,254 3,147 (59,281)
-------- -------- ----------
53
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
2006 2005 2004
-------- -------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (decrease) increase in non interest
bearing deposits (851) 8,078 3,769
Net increase in interest bearing deposits 2,080 52,294 11,864
(Decrease) increase in securities sold
under agreements to repurchase (10,392) (54,703) 13,356
Proceeds from long term debt 2,000 20,000 37,164
Repayment of long term debt (32,463) (32,404) (19,304)
Proceeds from issuance of
subordinated debentures, net -- 7,217 14,791
Acquisition of treasury stock (790) -- (69)
Proceeds from exercise of common
stock options 433 1,686 1,271
Cash paid for fractional shares -- -- (463)
Dividends paid (1,099) (1,020) (735)
-------- -------- ----------
Net cash (used in) provided by financing
activities (41,082) 1,148 61,644
-------- -------- ----------
Net (decrease) increase in cash and
cash equivalents (3,571) 10,499 8,073
Cash and cash equivalents at
beginning of year $ 27,882 $ 17,383 $ 9,310
-------- -------- ----------
Cash and cash equivalents at
end of year $ 24,311 $ 27,882 $ 17,383
======== ======== ==========
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash used to pay interest $ 26,807 $ 19,184 $ 15,608
Cash used to pay income taxes,
net of refunds $ 4,163 $ 6,716 $ 5,960
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS
54
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006 AND 2005
NOTE A - ORGANIZATION AND CAPITALIZATION
ORGANIZATION
Berkshire Bancorp Inc. ("Berkshire" or the "Company" or "we" and similar
pronouns), a Delaware corporation, is a bank holding company registered under
the Bank Holding Company Act of 1956. Berkshire's principal activity is the
ownership and management of its wholly owned subsidiary, The Berkshire Bank (the
"Bank"), a New York State chartered commercial bank.
The Bank was established in 1989 to provide highly personalized services
to high net worth individuals and to small and mid-sized commercial businesses
primarily from the New York City metropolitan area. In March 2001, the Company
expanded its customer base and market area with the acquisition of GSB Financial
Corporation. The Bank's main office and branch is in mid-town Manhattan. The
Bank has one other branch in lower Manhattan, four branches in Brooklyn, New
York, four branches in Orange and Sullivan Counties in New York State, and one
branch in Ridgefield, New Jersey.
The Bank competes with other banking and financial institutions in its
markets. Commercial banks, savings banks, savings and loan associations,
mortgage bankers and brokers, and credit unions actively compete for deposits
and loans. Such institutions, as well as consumer finance, mutual funds,
insurance companies, and brokerage and investment banking firms may be
considered to be competitors of the Bank with respect to one or more of the
services provided by the Bank.
The Company and the Bank are subject to the regulations of certain state
and federal agencies and, accordingly, are periodically examined by those
regulatory authorities. As a consequence of such regulation of banking
activities, the Bank's business may be affected by state and federal
legislation.
STOCK SPLIT AND STOCK DIVIDEND
At the Annual Meeting of Stockholders held on May 18, 2004, the
Company's stockholders approved an amendment to the Company's Certificate of
Incorporation effecting a one-for-ten reverse stock split of the Company's
issued and outstanding Common Stock (the "Reverse Split"). Following the
effectiveness of the Reverse Split, the Company's Board of Directors declared a
thirty-for-one forward stock split in the form of a stock dividend in Common
Stock which became effective immediately. The Company paid approximately
$463,000 to purchase fractional shares from stockholders as part of the Reverse
Split. The Company's Common Stock began trading on May 19, 2004 giving effect to
these transactions.
TRUST PREFERRED SECURITIES
As of May 18 2004, the Company established Berkshire Capital Trust I, a
Delaware statutory trust, ("BCTI"). The Company owns all the common capital
securities of BCTI. BCTI issued $15.0 million of preferred capital securities to
investors in a private transaction and invested the proceeds, combined with the
proceeds from the sale of BCTI's common capital securities, in the Company
through the purchase of $15.464 million aggregate principal amount of Floating
Rate Junior Subordinated Debentures (the "Debentures") issued by the Company.
The Debentures, the sole assets of BCTI, mature on July 23, 2034 and bear
interest at a floating rate, three month LIBOR plus 2.70%.
On April 1, 2005, the Company established Berkshire Capital Trust II, a
Delaware statutory trust, ("BCTII"). The Company owns all the common capital
securities of BCTII. BCTII issued $7.0 million of preferred capital securities
to investors in a private transaction and invested the proceeds, combined with
the proceeds from the sale of BCTII's common capital securities, in the Company
through the purchase of $7.217 million aggregate principal amount of Floating
Rate Junior Subordinated Debentures (the "2005 Debentures") issued by the
Company. The 2005 Debentures, the sole assets of BCTII, mature on May 23, 2035
and bear interest at a floating rate, three month LIBOR plus 1.95%.
55
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A - (CONTINUED)
Based on current interpretations of the banking regulators, the 2004
Debentures and 2005 Debentures (collectively, the "Debentures") qualify under
the risk-based capital guidelines of the Federal Reserve as Tier 1 capital,
subject to certain limitations. The Debentures are callable by the Company,
subject to any required regulatory approvals, at par, in whole or in part, at
any time after five years from the date of issuance. The Company's obligations
under the Debentures and related documents, taken together, constitute a full,
irrevocable and unconditional guarantee on a subordinated basis by the Company
of the obligations of BCTI and BCTII under the preferred capital securities sold
by BCTI and BCTII to investors. FIN46(R) precludes consideration of the call
option embedded in the preferred capital securities when determining if the
Company has the right to a majority of BCTI and BCTII expected residual returns.
Accordingly, BCTI and BCTII are not included in the consolidated balance sheet
of the Company.
The Federal Reserve has issued guidance on the regulatory capital
treatment for the trust-preferred securities issued by BCTI and BCTII. This rule
would retain the current maximum percentage of total capital permitted for Trust
Preferred Securities at 25%, but would enact other changes to the rules
governing Trust Preferred Securities that affect their use as part of the
collection of entities known as "restricted core capital elements." The rule
would take effect March 31, 2009; however, a five year transition period
starting March 31, 2004 and leading up to that date would allow bank holding
companies to continue to count Trust Preferred Securities as Tier 1 Capital
after applying FIN-46(R). Management has evaluated the effects of this rule and
does not anticipate a material impact on its capital ratios when the proposed
rule is finalized.
NOTE B - SUMMARY OF ACCOUNTING POLICIES
1. BASIS OF FINANCIAL STATEMENT PRESENTATION
The consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
and predominant practice within the banking industry, and include the accounts
of Berkshire Bancorp Inc. and its wholly owned subsidiaries, Greater American
Finance Group, Inc. ("GAFG"), East 39, LLC and the Bank, (collectively, the
"Company"). All significant intercompany accounts and transactions have been
eliminated.
In preparing the financial statements in conformity with accounting
principles generally accepted in the United States of America, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the balance sheets, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The principal estimates that are susceptible to significant change in
the near term relates to the allowance for loan losses, goodwill, and deferred
tax assets and liabilities. The evaluation of the adequacy of the allowance for
loan losses includes an analysis of the individual loans and overall risk
characteristics and size of the different loan portfolios, and takes into
consideration current economic and market conditions, the capability of specific
borrowers to pay specific loan obligations, as well as current loan collateral
values. However, actual losses on specific loans, which also are encompassed in
the analysis, may vary from estimated losses.
Substantially all outstanding goodwill resulted from the acquisition of
The Berkshire Bank and Goshen Savings Bank, depository institutions
concentrating in the New York City and Orange and Sullivan County communities,
respectively. As the result of the market penetration in these New York areas,
the Company had formulated its own strategy to create such a market role.
Accordingly, implicit in the purchase of these franchises was the acquisition of
that role. However, if such benefits, including new business, are not derived or
the Company changes its business plan, an impairment may be recognized.
56
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B - (CONTINUED)
The Company recognizes deferred tax assets and liabilities for the
future tax effects of temporary differences, net operating loss carryforwards
and tax credits. Deferred tax assets are subject to management's judgment based
upon available evidence that future realization is more likely than not. If
management determines that the Company may be unable to realize all or part of
net deferred tax assets in the future, a direct charge to income tax expense may
be required to reduce the recorded value of the net deferred tax asset to the
expected realizable amount.
The Company is required to provide disclosures under Statement of
Financial Accounting Standards ("SFAS") 131, "Disclosures About Segments of an
Enterprise and Related Information." Operating segments are components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and assess performance. The Company has one operating segment
and, accordingly, one reportable segment, "Community Banking." All of the
Company's activities are interrelated, and each activity is dependent and
assessed based on how each of the activities of the Company supports the others.
For example, commercial lending is dependent upon the ability of the Bank to
fund itself with retail deposits and other borrowings and to manage interest
rate and credit risk. This situation is also similar for consumer and
residential mortgage lending. Accordingly, all significant operating decisions
are based upon analysis of the Company as one operating segment or unit.
2. INVESTMENT SECURITIES
The Company accounts for its investment securities in accordance with
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities". Investments in securities are classified in one of three
categories: held to maturity, trading or available for sale. Investments for
which management has both the ability and intent to hold to maturity, are
carried at cost, adjusted for the amortization of premiums and accretion of
discounts computed by the interest method. Investments which management believes
may be sold prior to maturity due to changes in interest rates, prepayment risk
and equity, liquidity requirements or other factors, are classified as available
for sale. Available-for-sale securities are carried at fair value, with the
unrealized gains and losses, net of tax, reported as a separate component of
stockholders' equity and excluded from the determination of net income. Gains or
losses on disposition are based on the net proceeds and cost of the securities
sold, adjusted for amortization of premiums and accretion of discounts, using
the specific identification method.
THE MEANING OF OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS APPLICATION TO
CERTAIN INVESTMENTS
In November 2003, the Emerging Issues Task Force (the "EITF") of the
FASB issued EITF Abstract 03-1, "The Meaning of Other-Than-Temporary Impairment
and its Application to Certain Investments" (EITF Issue No. 03-1). In March
2004, the EITF reached a consensus on EITF Issue No. 03-1 and in September 2004,
the FASB issued a proposed Board-directed FASB Staff Position (an "FSP"), FSP
EITF 03-1-a, "Implementation Guidance for the Application of Paragraph 16 of
EITF Issue No. 03-1" (FSP EITF 03-1-a). The guidance in FSP EITF 03-1-a is
applicable for investments in (a) debt and equity securities that are within the
scope of SFAS Nos. 115 and 124, and (b) equity securities that are not subject
to the scope of FAS 115 and 124 and not accounted for under the equity method of
accounting, "cost-method investments."
The final FSP, retitled FSP FAS 115-1 and FAS 124-1 "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments,"
nullifies certain requirements of EITF No. 03-1 and supersedes EITF Topic No.
D-44, "Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a
Security Whose Cost Exceeds Fair Value." FSP FAS 115-1 and FAS 124-1
specifically (a) nullifies the requirements of
paragraphs 10-18 of EITF No. 03-1,
57
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B - (CONTINUED)
(b) carries forward the requirements of paragraphs 8 and 9 with respect to
cost-method-investments and the disclosure requirements included in paragraphs
21 and 22 of EITF No. 03-1 and related examples, and (c) references existing
other-than-temporary impairment guidance. FSP FAS 115-1 and FAS 124-1
establishes a three-step approach for determining when an investment is
considered impaired, whether that impairment is other than temporary, and the
measurement of an impairment loss.
Application of the guidance in FSP FAS 115-1 and FAS 124-1, applicable
to reporting periods beginning after December 15, 2005, did not have a material
adverse effect on our consolidated financial statements.
3. LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are stated at the amount of
unpaid principal and are net of unearned discount, unearned loan fees and an
allowance for credit losses. The allowance for loan losses is established
through a provision for loan losses charged to expense. Loan principal
considered to be uncollectible by management is charged against the allowance
for credit losses. The allowance is an amount that management believes will be
adequate to absorb losses on existing loans that may become uncollectible based
upon an evaluation of known and inherent risks in the loan portfolio. The
evaluation takes into consideration such factors as changes in the nature and
size of the loan portfolio, overall portfolio quality, specific problem or
impaired loans, and current economic conditions which may affect the borrowers'
ability to pay. The evaluation details historical losses by loan category, the
resulting loss rates for which are projected at current loan total amounts.
The Company accounts for its impaired loans in accordance with SFAS No.
114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No.
118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures." This standard requires that a creditor measure impairment based on
the present value of expected future cash flows discounted at the loan's
effective interest rate, except that as a practical expedient, a creditor may
measure impairment based on a loan's observable market price, or the fair value
of the collateral if the loan is collateral-dependent. Regardless of the
measurement method, a creditor must measure impairment based on the fair value
of the collateral when the creditor determines that foreclosure is probable.
Interest income is accrued as earned on a simple interest basis. Accrual
of interest is discontinued on a loan when management believes, after
considering economic and business conditions and collection efforts, that the
borrower's financial condition is such that collection of interest is doubtful.
When a loan is placed on such non-accrual status, all accumulated accrued
interest receivable applicable to periods prior to the current year is charged
off to the allowance for loan losses. Interest which had accrued in the current
year is reversed out of current period income. Loans 90 days or more past due
and still accruing interest must have both principal and accruing interest
adequately secured and must be in the process of collection.
The Company follows the provisions of SFAS No. 140 "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,"
SFAS No. 140 is based on consistent application of a financial-components
approach that recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has been
surrendered and derecognizes liabilities when extinguished. SFAS No. 140
provides consistent guidelines for distinguishing transfers of financial assets
from transfers that are secured borrowings. The Company adopted SFAS 140 on
April 1, 2001 and the adoption did not have a material impact upon the Company's
consolidated financial statements.
58
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B - (CONTINUED)
In October 2003, the AICPA issued SOP 03-3 Accounting for Loans or
Certain Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan with
the evidence of deterioration of credit quality since origination acquired by
completion of a transfer for which it is probable at acquisition, that the
Company will be unable to collect all contractually required payments
receivable. SOP 03-3 requires that the Company recognize the excess of all cash
flows expected at acquisition over the investor's initial investment in the loan
as interest income on a level-yield basis over the life of the loan as the
accretable yield. The loan's contractual required payments receivable in excess
of the amount of its cash flows excepted at acquisition (nonaccretable
difference) should not be recognized as an adjustment to yield, a loss accrual
or a valuation allowance for credit risk. SOP 03-3 is effective for loans
acquired in fiscal years beginning after December 31, 2004. Early adoption is
permitted. The adoption of SOP 03-3 did not have a significant impact on the
financial condition or results of operations of the Company.
LOAN COMMITMENTS ACCOUNTED FOR AS DERIVATIVE INSTRUMENTS
The SEC staff recently released Staff Accounting Bulletin (SAB) 105,
"Loan Commitments Accounted for as Derivative Instruments." SAB 105 provides
guidance about the measurement of loan commitments recognized at fair value
under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging
Activities. SAB 105 also requires companies to disclose their accounting policy
for those loan commitments including methods and assumptions used to estimate
fair value and associated hedging strategies. SAB 105 is effective for all loan
commitments accounted for as derivatives that are entered into after March 31,
2004. The adoption of SAB 105 did not have a material effect on our consolidated
financial statements.
The Company adopted SFAS No. 149 ("SFAS No. 149"), Amendment of SFAS No.
133 on Derivative Instruments and Hedging Activities, on July 1, 2003. SFAS No.
149 clarifies and amends SFAS No. 133 for implementation issues raised by
constituents or includes the conclusions reached by the FASB on certain FASB
Staff Implementation Issues. Statement No. 149 also amends SFAS No. 133 to
require a lender to account for loan commitments related to mortgage loans that
will be held for sale as derivatives. SFAS No. 149 is effective for contracts
entered into or modified after September 30, 2003. The Company periodically
enters into commitments with its customers, which it intends to sell in the
future. The adoption of SFAS No. 149 did not have a material impact on the
Company's financial position or results of operations.
The Bank has entered into interest rate cap agreements in order to hedge
its exposure to interest rate fluctuations. The Company adopted the provisions
of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities",
as amended, as of January 1, 2001. The statement requires the Company to
recognize all derivative instruments at fair value as either assets or
liabilities. Financial derivatives are reported at fair value in other assets or
other liabilities. For derivatives not designated as hedges, the gain or loss is
recognized in current earnings. Amounts reclassed into earnings, when the hedged
transaction culminates, are included in interest income.
4. BANK PREMISES AND EQUIPMENT
Bank premises and equipment, including leasehold improvements, are
stated at cost less accumulated depreciation. Depreciation expense is computed
on the straight-line method over the estimated useful lives of the assets.
Leasehold improvements are amortized over the shorter of the estimated useful
lives of the improvements or the terms of the related leases.
59
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B - (CONTINUED)
5. OTHER REAL ESTATE OWNED
Other real estate owned, representing property acquired through
foreclosure, is recorded at the lower of cost or estimated fair market value,
less costs of disposal. When property is acquired, the excess, if any, of the
loan balance over fair market value is charged to the allowance for loan losses.
Periodically thereafter, the asset is reviewed for subsequent declines in the
estimated fair market value. Subsequent declines, if any, and holding costs, as
well as gains and losses on subsequent sale, are included in the consolidated
statements of operations.
6. GOODWILL
Goodwill resulting from the acquisition of The Berkshire Bank in 1999
and GSB Financial Corporation in 2001 is accounted for under SFAS No. 142,
Goodwill and Intangible Assets. SFAS No. 142 includes requirements to test
goodwill and indefinite lived intangible assets for impairment rather than
amortize them. The Company performs such tests annually and did not identify any
impairment on its outstanding goodwill and its identifiable intangible assets
from its most recent testing, performed at September 30, 2006.
7. INCOME TAXES
The Company accounts for income taxes under the liability method of
accounting for income taxes. Deferred tax assets and liabilities are determined
based on the difference between the financial statement and tax bases of assets
and liabilities as measured by the enacted tax rates that will be in effect when
these differences reverse. Deferred tax expense is the result of changes in
deferred tax assets and liabilities. The principal types of differences between
assets and liabilities for financial statement and tax return purposes are
allowance for loan losses, deferred loan fees, deferred compensation and
securities available for sale.
8. NET INCOME PER SHARE
The Company follows the provisions of SFAS No. 128, "Earnings Per
Share." Basic earnings per share excludes dilution and is computed by dividing
income available to common shareholders by the weighted-average common shares
outstanding during the period. Diluted earnings per share takes into account the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised and converted into common stock.
9. STOCK BASED COMPENSATION
At December 31, 2006, the Company has one stock-based employee
compensation plan, which is more fully described in Note K. The Company accounts
for that plan in accordance with SFAS Statement No. 123(R), "Share Based
Payment." Previously, the Company accounted for that plan in accordance with
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees," ("APB No. 25") and related interpretations.
60
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B - (CONTINUED)
Under APB No. 25, stock-based employee compensation costs were not
reflected in net income, as all options granted under the plan had an exercise
price equal to the market value of the underlying common stock on the date of
the grant. The following table illustrates the effect on net income and earnings
per share if the Company had applied the fair value recognition provisions of
SFAS No. 123(R) to stock-based employee compensation.
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
2006 2005 2004
-------- -------- ----------
(In thousands, except per share amounts)
Net income $ 4,880 $ 5,541 $ 7,502
Less: Stock based compensation
costs determined under fair value
methods for all awards -- -- --
-------- -------- ----------
$ 4,880 $ 5,541 $ 7,502
======== ======== ==========
Basic earnings per share $ .71 $ .81 $ 1.12
.71 .81 1.12
Diluted earnings per share .70 .80 1.10
.70 .80 1.10
The fair value of each option was estimated on the date of grant using
the Black-Scholes options-pricing model using weighted-average assumptions for
expected volatility, risk-free interest and expected life of the option. The
Company did not grant stock options in fiscal 2006, 2005 and 2004. There was no
stock based compensation expense in 2006.
In December 2004, the FASB issued Statement No. 123 (revised 2004),
"Share-Based Payment" ("SFAS 123(R)") which requires the measurement and
recognition of compensation expense for all stock-based compensation payments
and supersedes the Company's previous accounting under APB 25. SFAS 123(R) is
effective for all annual periods beginning after June 15, 2005 or our fiscal
year 2006. In March 2005, the Securities and Exchange Commission (the "SEC")
issued Staff Accounting Bulletin No. 107 ("SAB 107") relating to the adoption of
SFAS 123(R). The Company adopted SFAS 123(R) in the first quarter of fiscal year
2006. The adoption of SFAS 123(R) did not have a material impact on our
financial position or results of operations.
10. CASH EQUIVALENTS
The Company considers all highly liquid debt investments purchased with
an original maturity of three months or less, and amounts due from brokers to be
cash equivalents.
11. RESTRICTIONS ON CASH AND DUE FROM BANKS
The Bank is required to maintain reserves against customer demand
deposits by keeping cash on hand or balances with the Federal Reserve Bank in a
non-interest bearing account. The amounts of those reserve and cash balances was
approximately $2,617,000 and $2,589,000 at December 31, 2006 and 2005,
respectively.
61
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B - (CONTINUED)
12. COMPREHENSIVE INCOME
The Company follows the provisions of SFAS No. 130, "Reporting
Comprehensive Income" which includes net income as well as certain other items,
which results in a change to equity during the period. (In thousands.)
YEAR ENDED DECEMBER 31, 2006
------------------------------------
Tax
Before tax (expense) Net of tax
amount benefit Amount
---------- -------- ----------
Unrealized gains (losses)
on investment securities:
Unrealized holding gains (losses)
arising during period $ 8,673 $ (3,511) $ 5,162
Less reclassification adjustment for
gains realized in net income 2,336 (934) 1,402
-------- -------- ----------
Unrealized gain on investment securities 6,337 (2,577) 3,760
Change in minimum pension liability (117) -- (117)
-------- -------- ----------
Other comprehensive income, net $ 6,220 $ (2,577) $ 3,643
======== ======== ==========
YEAR ENDED DECEMBER 31, 2005
------------------------------------
Tax
Before tax (expense) Net of tax
amount benefit Amount
-------- -------- ----------
Unrealized gains (losses)
on investment securities:
Unrealized holding gains (losses)
arising during period $ (8,834) $ 3,313 $ (5,521)
Less reclassification adjustment for
gains realized in net income 4 (1) 3
-------- -------- ----------
Unrealized (loss) on investment securities (8,838) 3,314 (5,524)
Change in minimum pension liability (289) -- (289)
-------- -------- ----------
Other comprehensive income (loss), net $ (9,127) $ 3,314 $ (5,813)
======== ======== ==========
YEAR ENDED DECEMBER 31, 2004
------------------------------------
Tax
Before tax (expense) Net of tax
amount benefit Amount
-------- -------- ----------
Unrealized gains (losses)
on investment securities:
Unrealized holding gains
arising during period $ (4,014) $ 1,711 $ (2,303)
Less reclassification adjustment for
gains realized in net income 793 (317) 476
-------- -------- ----------
Unrealized (loss) on investment securities (4,807) 2,028 (2,779)
Change in minimum pension liability (598) -- (598)
-------- -------- ----------
Other comprehensive income (loss), net $ (5,405) $ 2,028 $ (3,377)
======== ======== ==========
13. RECLASSIFICATIONS
Certain amounts in the December 31, 2005 and 2004 financial statements
have been reclassified to conform to the current period's presentation.
62
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C - INVESTMENT SECURITIES
The following is a summary of held to maturity investment securities:
DECEMBER 31, 2006
----------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
(In thousands)
Investment securities
U.S. Government Agencies $ 433 $ 4 $ (1) $ 436
===== === ==== =====
DECEMBER 31, 2005
----------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ------------- ------------ --------
(In thousands)
Investment securities
U.S. Government Agencies $ 562 $ 11 $ -- $ 573
===== ==== ==== =====
The following is a summary of available-for-sale investment securities:
DECEMBER 31, 2006
----------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- --------
(In thousands)
Investment securities
U.S. Treasury and Notes $ 5,002 $ -- $ (12) $ 4,990
U.S. Government Agencies 322,986 -- (5,822) 317,164
Mortgage-backed securities 67,472 92 (1,711) 65,853
Corporate notes 44,366 334 (662) 44,038
Municipal securities 5,698 1,489 -- 7,187
Marketable equity
securities and other 75,419 216 (69) 75,566
-------- ------- -------- --------
Totals $520,943 $ 2,131 $ (8,276) $514,798
======== ======= ======== ========
63
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C - (CONTINUED)
DECEMBER 31, 2005
----------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------- ------------- ------------ --------
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
======== ======= ======== ========
The Company has investments in certain debt and equity securities that
have unrealized losses or may be otherwise impaired, but an other-than-temporary
impairment has not been recognized in the financial statements. The following
table indicates the length of time individual securities have been in a
continuous unrealized loss position at December 31, 2006 (in thousands):
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
----------------------- ---------------------- ----------------------
FAIR VALUE UNREALIZED FAIR VALUE UNREALIZED FAIR VALUE UNREALIZED
LOSSES LOSSES LOSSES
DESCRIPTION OF SECURITIES
U.S. Treasury and Notes $ -- $ -- $ 4,990 $ 12 $ 4,990 $ 12
U.S. Government Agencies 12,061 9 305,104 5,813 317,165 5,822
Mortgage-backed securities 1,732 52 49,454 1,659 51,186 1,711
Corporate notes -- -- 10,939 662 10,939 662
Municipal securities -- -- -- -- -- --
-------- ---- -------- ------- -------- ------
Subtotal, debt securities 13,793 61 370,487 8,146 384,280 8,207
Marketable equity -- -- 13 69 13 69
-------- ---- -------- ------- -------- ------
securities and other
Total temporarily
impaired securities $ 13,793 $ 61 $370,500 $ 8,215 $384,293 $8,276
======== ==== ======== ======= ======== ======
The Company had a total of 86 debt securities with a fair market value
of $384.28 million which were temporarily impaired at December 31, 2006. The
total unrealized loss on these securities was $8.26 million, of which $8.11
million is attributable to increases in interest rates which have decreased the
market value of these securities. The remaining unrealized loss of $153,000 is
on 2 corporate notes which are currently reorganizing in U.S. bankruptcy court.
We have the ability to hold these securities to maturity, all but 7 of which are
US Government and US Government Agency securities, therefore, the unrealized
losses associated with these securities are not considered to be other than
temporary.
The Company also had 2 equity securities with an aggregated fair market
value of $13,000 which were temporarily impaired at December 31, 2006. The total
unrealized loss on these securities was $57,000. Based upon our review of the
available information, such unrealized losses are not considered to be other
than temporary.
64
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C - (CONTINUED)
The amortized cost and fair value of investment securities available for
sale and held to maturity, by contractual maturity, at December 31, 2006 are
shown below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
DECEMBER 31, 2006
---------------------------------------------------------------
AVAILABLE FOR SALE HELD TO MATURITY
--------------------------------- ---------------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
-------------- ----------------- ------------ ------------
(In thousands)
Due in one year or less $ 46,490 $ 46,359 $ -- $ --
Due after one through
five years 218,102 214,129 29 29
Due after five through
ten years 92,156 89,554 -- --
Due after ten years 88,776 89,190 404 407
Marketable equity
securities and other 75,419 75,566 -- --
-------- -------- ----- ------
Totals $520,943 $514,798 $ 433 $ 436
======== ======== ===== =====
Gross gains realized on the sales of investment securities for the years
ended December 31, 2006, 2005 and 2004 were approximately $2,342,000, $10,000
and $965,000, respectively. Gross losses were approximately $5,000, $6,000 and
$172,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
As of December 31, 2006 and 2005, securities sold under agreements to
repurchase with a book value of approximately $62.65 million and $73.04 million,
respectively, were outstanding. The book value of the securities pledged for
these repurchase agreements was $71.30 million and $77.15 million, respectively.
As of December 31, 2006 and 2005, the Company did not have any investment
securities of any one issuer where the carrying value exceeded 10% of
shareholders' equity.
65
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE D - LOANS
Major classifications of loans are as follows:
DECEMBER 31, DECEMBER 31,
2006 2005
------------ ------------
(In thousands)
Commercial and professional loans $ 63,331 $ 33,370
Secured by real estate
1 - 4 family 139,611 139,931
Multi family 4,013 2,874
Non-residential 160,417 132,142
Consumer 4,763 2,018
-------- --------
372,135 310,335
Deferred loan fees (1,212) (1,105)
Allowance for loan losses (3,771) (3,266)
-------- --------
$367,152 $305,964
======== ========
Changes in the allowance for loan losses are as follows:
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------
2006 2005 2004
-------------- -------------- --------------
(In thousands)
Balance at beginning $ 3,266 $ 2,927 $ 2,593
of year
Provision charged to 410 180 180
operations
Loans charged off (42) (26) (24)
Recoveries 137 185 178
Balance at end of year $ 3,771 $ 3,266 $ 2,927
======= ======= =======
The Bank had $201,000, $256,000 and $343,000 of non accrual loans as of
December 31, 2006, 2005 and 2004, respectively, and $0, $74,000 and $50,000 of
loans delinquent more than ninety days and still accruing interest at December
31, 2006, 2005 and 2004, respectively. The Bank classified the two non accrual
loans of $201,000 as impaired loans at December 31, 2006. However, no specific
allocation from the allowance for loan losses was made because the collateral
underlying each loan was deemed to be sufficient to cover any loss in the event
of a default.
In accordance with banking regulations, the Bank, from time to time,
enters into lending transactions in the ordinary course of business with
directors, executive officers, principal stockholders and affiliates of such
persons on the same terms as those prevailing for comparable transactions with
other borrowers. At December 31, 2006, loans to these related parties amounted
to $11.2 million, were current as to principal and interest payments, and do not
involve more than normal risk of collectibility. An analysis of activity in
loans to related parties for the year ended December 31, 2006, resulted in new
loans of $0 and repayments of approximately $1.1 million.
66
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE E - PREMISES AND EQUIPMENT
Major classifications of premises and equipment are summarized as
follows:
ESTIMATED DECEMBER 31, DECEMBER 31,
USEFUL LIVES 2006 2005
--------------- ------------- -------------
(In thousands)
Land Indefinite $ 3,572 $ 3,817
Buildings 39 years 5,190 4,059
Furniture and equipment 3 to 10 years 3,052 2,890
Leasehold improvements 2 to 10 years 1,653 1,239
------- -------
13,467 12,005
Accumulated depreciation
and amortization (4,129) (3,403)
------- -------
Total $ 9,338 $ 8,602
======= =======
Depreciation and amortization expense was approximately $727,000,
$650,000 and $590,000 for the years ended December 31, 2006, 2005 and 2004,
respectively.
NOTE F - DEPOSITS
The aggregate amount of jumbo certificates of deposits greater than
$100,000 were approximately $203.59 million and $203.72 million as of December
31, 2006 and 2005, respectively.
The scheduled maturities of all certificates of deposit are as follows:
DECEMBER 31, 2006
-----------------
(In thousands)
2007 $ 418,413
2008 5,284
2009 13
2010 2
---------
$ 423,712
=========
NOTE G - BORROWINGS
SHORT-TERM BORROWINGS Securities sold under agreements to repurchase
generally mature within 30 days from the date of the transactions. Short-term
borrowings consist of various borrowings which generally have maturities of less
than one year. The details of these categories are presented below:
YEAR ENDED DECEMBER 31,
-----------------------------------------
2006 2005 2004
------------ ----------- ------------
(Dollars in Thousands)
Securities sold under repurchase
agreements and federal funds purchased
Balance at year-end $ 62,652 $ 73,044 $127,747
Average during the year $ 56,236 $108,785 $129,794
Maximum month-end balance $ 79,154 $145,489 $148,753
Weighted average rate during the year 3.75% 3.47% 1.87%
Rate at December 31 4.94% 3.59% 2.27%
67
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE G - (CONTINUED)
LONG-TERM BORROWINGS At December 31, 2006, advances from the Federal
Home Loan Bank ("FHLB") totaling $52.74 million will mature within one to five
years and are reported as long-term borrowings. The advances are collateralized
by FHLB stock and certain first mortgage loans. The advances had a weighted
average rate of 4.38%. Unused lines of credit at the FHLB were $185.8 million at
December 31, 2006.
Outstanding long-term borrowings mature as follows (in thousands):
YEAR AMOUNT
------ ---------
2007 $ 9,302
2008 17,812
2009 11,624
2010 14,000
----- --------
Total $ 52,738
========
NOTE H - EARNINGS PER SHARE
The Company's calculation of earnings per share in accordance with SFAS
No. 128 is as follows:
YEAR ENDED DECEMBER 31, 2006
(IN THOUSANDS, EXCEPT PER SHARE DATA)
---------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
-------------- --------------- ----------
Basic earnings per share
Net income available to
common stockholders $ 4,880 6,891 $ .71
Effect of dilutive securities
Options -- 85 (.01)
------- ----- -----
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $ 4,880 6,976 $ .70
======= ===== =====
YEAR ENDED DECEMBER 31, 2005
(IN THOUSANDS, EXCEPT PER SHARE DATA)
---------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
-------------- --------------- ----------
Basic earnings per share
Net income available to
common stockholders $ 5,541 6,805 $ .81
Effect of dilutive securities
Options -- 134 (.01)
------- ----- -----
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $ 5,541 6,939 $ .80
======= ===== =====
68
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE H - (CONTINUED)
YEAR ENDED DECEMBER 31, 2004
(IN THOUSANDS, EXCEPT PER SHARE DATA)
---------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
-------------- --------------- ----------
Basic earnings per share
Net income available to
common stockholders $ 7,502 6,672 $ 1.12
Effect of dilutive securities
Options -- 176 (.02)
------- ----- -----
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $ 7,502 6,848 $ 1.10
======= == ===== ======
NOTE I - INCOME TAXES
The components of income tax expense are as follows:
YEARS ENDED DECEMBER 31,
----------------------------------------------
2006 2005 2004
---- ---- ----
Current $ 4,282,000 $ 4,985,000 $ 6,515,000
Deferred Taxes (Benefit) (426,000) 18,000 (381,000)
----------- ----------- -----------
$ 3,856,000 $ 5,003,000 $ 6,134,000
=========== =========== ===========
A reconciliation of the provision for income taxes for the years ended
December 31, 2006, 2005 and 2004 and the amount computed by applying the
statutory Federal income tax rate to income from continuing operations follows:
YEARS ENDED DECEMBER 31,
----------------------------------------------
2006 2005 2004
---- ---- ----
Effective Tax Reconciliation
Tax at statutory rate $ 2,611,000 $ 3,585,000 $ 4,636,000
State and City, net of
federal income tax benefit 1,100,000 1,344,000 1,423,000
Tax exempt income -- -- --
Other 145,000 74,000 75,000
----------- ----------- -----------
Actual provision for
income taxes $ 3,856,000 $ 5,003,000 $ 6,134,000
=========== =========== ===========
69
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE I - (CONTINUED)
The tax effect of the principal temporary differences at December 31,
2006 and 2005 are as follows:
DECEMBER 31,
--------------------------------
2006 2005
---- ----
Net deferred tax assets
Loan loss provision $1,721,000 $1,504,000
Depreciation 123,000 39,000
Other 301,000 124,000
Unrealized loss on
investment securities 2,979,000 4,841,000
---------- ----------
Net deferred tax asset
included in other assets $5,124,000 $6,508,000
========== ==========
NOTE J - STOCK PLANS
In March 1999, the stockholders of the Company approved the 1999 Stock
Incentive Plan (the "1999 Stock Incentive Plan"). The 1999 Stock Incentive Plan
permits the granting of awards in the form of nonqualified stock options,
incentive stock options, restricted stock, deferred stock, and other stock-based
incentives. Up to 600,000 shares of common stock of the Company may be issued
pursuant to the 1999 Stock Incentive Plan. Officers, directors and other key
employees of the Company or any subsidiary are eligible to receive awards under
the 1999 Stock Incentive Plan. Options outstanding under the 1999 Stock
Incentive Plan were 185,878 and 223,203 as of December 31, 2006 and 2005,
respectively. The Company did not grant options in 2006, 2005 and 2004.
A summary of activity with respect to the Stock Option Plan follows:
DECEMBER 31,
---------------------------------------------------------------------
2006 2005 2004
--------------------- ---------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
Outstanding at
beginning of year 223,203 $ 9.70 365,084 $10.65 508,419 $10.12
Granted -- $ -- -- $ -- -- $ --
Cancelled -- $ -- (3,000) $12.67 (1,500) $10.00
Exercised (37,325) $ 9.34 (138,881) $12.20 (141,835) $ 8.95
-------- -------- --------
Outstanding at
end of year 185,878 $ 9.76 223,203 $ 9.70 365,084 $10.65
======== ======== ========
Exercisable at
end of year 185,878 $ 9.76 223,203 $ 9.70 365,084 $10.65
======== ======== ========
Weighted average
fair value of
options granted
during the year $ -- $ -- $ --
====== ====== ======
70
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J - (CONTINUED)
The following table summarizes information about options outstanding and
exercisable at December 31, 2006:
OPTIONS OUTSTANDING AND EXERCISABLE
-----------------------------------------------------------------
NUMBER WEIGHTED
OUTSTANDING AVERAGE WEIGHTED
AT REMAINING AVERAGE
RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE
EXERCISE PRICES 2006 LIFE (YEARS) PRICE
--------------- ------------- ------------ ----------
$ 5.98 - 8.78 29,378 1.45 $ 8.49
10.00 - 10.00 156,500 0.69 10.00
-------
185,878
NOTE K - EMPLOYEE BENEFIT PLANS
1. RETIREMENT INCOME PLAN
The Company's Retirement Income Plan (the "Plan") covers substantially
all full-time employees. Benefits are based upon a combination of employee
compensation and years of service. The Company pays the entire cost of the Plan
and funds such costs as they accrue. The Company's funding policy is to make
annual contributions within minimum and maximum levels required by applicable
regulations. The Company's customary contributions are designed to fund normal
cost on a current basis and to fund over 30 years the estimated prior service
cost of benefit improvements (15 years of annual gains and losses). The
projected unit cost method was used to determine the annual cost.
The following table summarizes the major categories of Plan assets as of
the dates indicated:
DECEMBER 31,
------------------------------------------------------
2006 2005
-------------------------- -------------------------
FAIR VALUE % OF TOTAL FAIR VALUE % OF TOTAL
------------ ----------- ----------- -----------
(In thousands, except percentages
Mutual Funds
International Equity Fund $ 198 9.54% $ 128 7.45%
Large Cap Equity Growth Fund 504 24.28 396 23.04
International Investment
Grade Bond Fund 637 30.68 507 29.49
Small Cap Equity Growth Fund 99 4.77 114 6.63
Large Cap Equity Value Fund 487 23.46 397 23.09
Corporate Common Stocks(1) 151 7.27 165 9.60
Cash and cash equivalents -- -- 12 0.70
Total Plan Assets $ 2,076 100.00% $ 1,719 100.00%
======= ====== ======= ======
----------------
(1) Includes 4,500 shares of the Company's Common Stock with a market value of
$73,350 and $75,465 at December 31, 2006 and 2005, respectively.
71
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE K - (CONTINUED)
The assets of the Plan are primarily invested in well diversified common
stock and fixed income funds designed to minimize risk while maximizing expected
portfolio returns. To achieve the long term rate of return, Plan assets are
invested in a mixture of instruments, including but not limited to, corporate
common stock, investment grade bond funds, small and large cap equity funds and
international equity funds. The allocation of assets is determined by the
Investment Manager, and typically include 50% to 70% equities, with the
remainder invested in fixed income and a minimal amount of cash. Presently, this
diversified portfolio is expected to return approximately 8.50% in the long run.
The expected rate of return on Plan assets was determined based upon a
review of historical returns, both for our Plan and for medium to large-sized
defined benefit pension funds with similar asset allocations. This review
generated separate expected future long-term returns for each asset class listed
in the above table. These expected future returns were then blended based upon
our Plan's target asset allocation.
ASSUMPTIONS
Weighted-average assumptions used to determine benefit obligations were
as follows at the dates indicated:
DECEMBER 31,
----------------------
2006 2005
--------- --------
Discount rate 5.75% 5.50%
Rate of compensation increase 5.00% 5.00%
Weighted-average assumptions used to determine net periodic benefit cost
for the years ended December 31, 2006 and 2005 were as follows:
DECEMBER 31,
----------------------
2006 2005
----------- --------
Discount rate 5.50% 5.75%
Rate of compensation increase 5.00% 5.00%
Expected return on plan assets 8.50% 8.50%
Measurement date 1/1/2006 1/1/2005
72
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE K - (CONTINUED)
The following table sets forth the Plan's benefit obligations, fair
value of the Plan assets and the funded status of the Plan in accordance with
FAS 158 for the years ended December 31, 2006 and 2005:
DECEMBER 31,
-----------------------------------
2006 2005
-------------- -------------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year $ 2,735,177 $ 2,316,075
Service cost 353,071 304,144
Interest cost 149,594 134,275
Actuarial (gain) loss (3,660) 158,125
Benefits paid (130,339) (177,442)
----------- -----------
Benefits obligation at end of year $ 3,103,843 $ 2,735,177
=========== ===========
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year $ 1,719,290 $ 1,804,866
Actual return on plan assets 154,347 (20,484)
Employer contribution 332,700 112,350
Benefits paid (130,339) (177,442)
----------- -----------
Fair value of plan assets at end of year $ 2,075,998 $ 1,719,290
=========== ===========
AMOUNTS RECOGNIZED IN THE STATEMENT OF FINANCIAL
POSITION CONSIST OF:
Noncurrent assets $ -- N/A
Current liabilities -- N/A
Noncurrent liabilities (1,027,845) N/A
Prepaid benefit cost N/A --
Accrued benefit cost N/A (1,015,887)
Intangible asset N/A 120,874
Accumulated other comprehensive charge N/A 887,262
----------- -----------
Net amount recognized at year end $ 1,027,845 $ (7,775)
=========== ===========
AMOUNTS RECOGNIZED IN ACCUMULATED OTHER COMPREHENSIVE
INCOME CONSIST OF:
Net loss $ 820,100 $ 887,262
Transition obligation -- N/A
Prior service cost 102,504 N/A
----------- -----------
Accumulated other comprehensive charge $ 922,604 $ 887,262
ADDITIONAL YEAR-END INFORMATION FOR PENSION PLANS WITH
ACCUMULATED BENEFIT OBLIGATIONS IN EXCESS OF PLAN
ASSETS
Projected benefit obligation $ 3,103,843 $ 2,375,177
Accumulated benefit obligation 3,103,843 2,735,177
Fair value of plan assets 2,075,998 1,719,290
73
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE K - (CONTINUED)
A summary of the components of net periodic benefit cost and other amounts
recognized in other comprehensive income in accordance with FAS 158 for the
years ended December 31, 2006, 2005 and 2004 is as follows:
DECEMBER 31,
------------------------------------------------
2006 2005 2004
-------------- ------------- ------------
Service cost $ 353,071 $ 304,144 $ 243,916
Interest cost 149,594 134,275 121,005
Expected return on assets (151,131) (150,819) (150,145)
Amortization
Net transition (asset) obligation -- -- --
Prior service cost 18,370 18,370 18,370
(Gain) loss 60,286 40,091 19,058
--------- --------- ---------
Net periodic pension cost $ 430,190 $ 346,061 $ 252,204
========= ========= =========
The following table sets forth other changes in plan assets and benefit
obligations recognized in other comprehensive income in accordance with FAS 158
at December 31, 2006 and 2005:
DECEMBER 31,
-----------------------------------
2006 2005
---------------- ----------------
Net loss (gain) $ N/A $ N/A
Prior service cost N/A N/A
Increase (decrease) in minimum liability included in
other comprehensive income prior to FAS 158 application
(67,162) (289,337)
Initial OCI charge upon FAS 158 application 102,504 N/A
Amortization of prior service cost N/A N/A
Amortization of transition obligation N/A N/A
-------- --------
Total recognized in other comprehensive income 35,342 289,337
Total recognized in net periodic benefit cost and
other comprehensive income 465,532 635,398
The estimated net loss (gain), prior service cost and net transition obligation
that will be amortized from the accumulated other comprehensive income into net
periodic benefit cost over the next fiscal year are $45,148, $18,370 and $0,
respectively.
ESTIMATED FUTURE BENEFIT PAYMENTS
We estimate future benefit payments to be as follows:
BENEFIT
YEARS PAYMENTS
----- ----------
2007 $ 181,075
2008 158,350
2009 233,217
2010 158,267
2011 145,376
Years 2012-2016 1,359,610
74
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE K - (CONTINUED)
COMPANY CONTRIBUTIONS
The Company contributed $332,700 to its Retirement Plan in the fiscal
year ended December 31, 2006. During the fiscal year ending December 31, 2007,
the Company expects to contribute approximately $255,000 to its Retirement Plan.
2. FORMER GOSHEN BANK PENSION PLAN
The Bank, as successor to Goshen Bank, had a non-contributory defined
benefit pension plan covering substantially all of its employees. In the fourth
quarter of 2000, the Goshen Bank froze its defined benefit pension plan and
provided that there would be no further accruals under the plan. On October 24,
2002, the Board of Directors of the Bank approved the termination of this plan.
In 2003, we paid out approximately $600,000 to complete the termination of this
plan and purchase annuity contracts. Upon the notice of termination, all
participant benefits vest 100%.
3. POSTRETIREMENT WELFARE PLAN
The Bank, as successor to Goshen Bank provides certain health care and
life insurance benefits for retired employees and their spouses. The
postretirement health care and life insurance benefits plan was terminated for
persons retiring after December 31, 1998. Eligible employees retired on or
before that date will have benefits paid through the plan under the agreed upon
terms existing at the employee's retirement date.
DECEMBER 31,
---------------------------------
2006 2005
---------------- ---------------
(In thousands)
Change in benefit obligation
Benefit obligation at beginning of year $ 735 $ 719
Service cost -- --
Interest cost 42 43
Actual (gain) loss (27) 22
Benefits paid (52) (49)
----- ------
Benefits obligation at end of year 698 735
----- ------
Change in plan assets
Fair value of plan assets
at beginning of year -- --
Actual return on plan assets -- --
Employer contribution 49 49
Benefits paid (49) (49)
----- ------
Fair value of plan assets
at end of year -- --
----- ------
Funded status (698) (735)
Unrecognized net actuarial loss N/A 47
----- ------
Accrued benefit cost (included in
other liabilities) $ 698 $ 688
===== =====
75
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE K - (CONTINUED)
Net benefit cost included the following components:
YEAR ENDED DECEMBER 31,
----------------------------------
2006 2005
---------------- ----------------
(In thousands)
Service cost $ -- $ --
Interest cost on projected
benefit obligation 42 43
Actual return on plan assets -- --
---- ----
Net periodic benefit cost $ 42 $ 43
==== ====
The assumed discount rate used in determining the actuarial present
value of the projected benefit obligation was 6.125% and 5.875% in 2006 and
2005, respectively.
4. 401(K) PLANS
The Bank has a 401(k) plan in which employees can contribute up to 15%
of their salary. The Bank also matches 50% of the employee contribution up to a
maximum of 3% of the employee's salary. The matching expense was $124,000,
$107,000 and $89,000 for the years ended December 31, 2006, 2005 and 2004,
respectively.
5. DEFERRED COMPENSATION ARRANGEMENTS
GSB Financial and Goshen Bank established deferred compensation
arrangements for certain directors and executives. These deferred compensation
arrangements were terminated as a result of the acquisition. At December 31,
2006 and 2005, the balance accumulated under these arrangements was
approximately $245,000 and $241,000, respectively, and will be paid out when the
individual (i) ceases to be a director and/or executive of the Company; (ii)
attains the age of 75; or (iii) specifies a particular date.
In July 2006, the Bank established the Deferred Compensation Plan of The
Berkshire Bank (the "Plan") to provide for a systematic method by which key
employees of the Bank may defer payment of all or part of the compensation that
may be earned by them. The Plan is intended to be a nonqualified and unfunded
plan maintained primarily for the purpose of providing deferred compensation for
a select group of management or highly compensated employees pursuant to
Sections 201(2), 301(a)(3) and 401(a)(1) of the Employee Retirement Income
Security Act of 1974, as amended. At December 31, 2006, the balance accumulated
under the Plan was approximately $30,000.
76
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE L - COMMITMENTS AND CONTINGENCIES
1. LEASES AND OTHER COMMITMENTS
The Company leases certain of its operating facilities under
non-cancelable operating leases expiring in 2008 through 2015. The leases
require payment by the Company of the real estate taxes and insurance on the
leased properties. Approximate future minimum annual rental payments are as
follows:
Year Ending (In thousands)
December 31,
------------
2007 $ 867,000
2008 653,000
2009 581,000
2010 581,000
2011 395,000
Thereafter 603,000
----------
$3,680,000
Rental expense was approximately $1,286,000, $1,208,000 and $964,000 for
the fiscal years ended December 31, 2006, 2005 and 2004, respectively. Included
in rental expense was approximately $328,000, $359,000 and $298,000 for the
fiscal years ended December 31, 2006, 2005 and 2004, respectively, which was
paid to a company affiliated with a director of the Company.
NOTE M - FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107 requires disclosure of the estimated fair value of an
entity's assets and liabilities considered to be financial instruments. For the
Company, as for most financial institutions, the majority of its assets and
liabilities are considered financial instruments as defined in SFAS No. 107.
However, many such instruments lack an available trading market, as
characterized by a willing buyer and seller engaging in an exchange transaction.
Also, it is the Company's general practice and intent to hold its financial
instruments to maturity and not to engage in trading or sales activities, except
for certain loans. Therefore, the Company had to use significant estimations and
present value calculations to prepare this disclosure.
Changes in the assumptions or methodologies used to estimate fair values
may materially affect the estimated amounts. Also, management is concerned that
there may not be reasonable comparability between institutions due to the wide
range of permitted assumptions and methodologies in the absence of active
markets. This lack of uniformity gives rise to a high degree of subjectivity in
estimating financial instrument fair values.
Estimated fair values have been determined by the Company using the best
available data and an estimation methodology suitable for each category of
financial instruments. The estimation methodologies used, the estimated fair
values, and recorded book balances at December 31, 2006 and 2005 are outlined
below.
For cash and cash equivalents, the recorded book values of $24.31
million and $27.88 million at December 31, 2006 and 2005, respectively,
approximate fair values. The estimated fair values of investment securities are
based on quoted market prices, if available. Estimated fair values are based on
quoted market prices of comparable instruments if quoted market prices are not
available.
77
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE M - (CONTINUED)
DECEMBER 31,
------------------------------------------------------------
2006 2005
---------------------------- -------------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
------------- ------------- --------------- ---------------
(In thousands)
Investment securities $515,231 $515,234 $599,972 $599,983
Loans, net of unearned income 370,923 375,052 309,230 313,065
Time Deposits 423,712 423,161 402,585 400,407
Repurchase Agreements 62,652 62,606 73,044 72,505
Long-term Debt 75,419 75,569 105,882 105,753
The net loan portfolio at December 31, 2006 and 2005 has been valued
using a present value discounted cash flow where market prices were not
available. The discount rate used in these calculations is the estimated current
market rate adjusted for credit risk. The carrying value of accrued interest
approximates fair value.
The estimated fair values of demand deposits (i.e. interest (checking)
and non-interest bearing demand accounts, savings and certain types of money
market accounts) are, by definition, equal to the amount payable on demand at
the reporting date (i.e. their carrying amounts). The carrying amount of accrued
interest payable approximates its fair value.
The fair value of commitments to extend credit is estimated based upon
the amount of unamortized deferred loan commitment fees. The fair value of
letters of credit is based upon the amount of unearned fees plus the estimated
cost to terminate letters of credit. Fair values of unrecognized financial
instruments, including commitments to extend credit, and the fair value of
letters of credit are considered immaterial.
The fair value of interest rate caps are based upon the estimated amount
the Company would receive or pay to terminate the contracts or agreements,
taking into account current interest rates and, when appropriate, the current
creditworthiness of the counterparties. The aggregate fair value for the
interest rate caps were approximately $20,000 at December 31, 2006 and 2005.
78
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE N - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS
OF CREDIT RISK
The Bank is party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of their customers.
These financial instruments include commitments to extend credit and standby
letters of credit. Such financial instruments are recorded in the financial
statements when they become payable. Those instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
recognized in the consolidated balance sheets. The contract or notional amounts
of those instruments reflect the extent of involvement the Banks have in
particular classes of financial instruments.
The Bank's exposure to credit loss in the event of non-performance by
the other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual or notional amount
of those instruments. The Bank uses the same credit policies in making
commitments and conditional obligations as they do for on-balance-sheet
instruments.
Unless noted otherwise, the Bank does not require collateral or other
security to support financial instruments with credit risk. The approximate
contract amounts are as follows:
DECEMBER 31,
------------------------------
2006 2005
------------- -------------
(In thousands)
Unused lines of credit $ 38,288 $ 16,808
Commitments to extend credit -- 2,531
Standby letters of credit and financial
guarantees written 3,423 1,155
-------- --------
$ 41,711 $ 20,494
======== ========
Interest rate caps-notional amount $ 20,000 $ 20,000
======== ========
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Bank upon extension of credit, is based on management's
credit evaluation.
Standby letters of credit are conditional commitments issued by the Bank
to guarantee the performance of a customer to a third party. Those guarantees
are primarily issued to support public and private borrowing arrangements,
including commercial paper, bond financing and similar transactions. The credit
risk involved in issuing letters of credit is essentially the same as that
involved in extending loan facilities to customers. The Bank holds residential
or commercial real estate, accounts receivable, inventory and equipment as
collateral supporting those commitments for which collateral is deemed
necessary. The extent of collateral held for those commitments at December 31,
2006 varies up to 100%.
79
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE N - (CONTINUED)
The Company defines the initial fair value of these letters of credit as
the fee received from the customer. The maximum potential undiscounted amount of
future payments of these letters of credit as of December 31, 2006 are
$3,423,000 and they expire through 2007. Amounts due under these letters of
credit would be reduced by any proceeds the Company would be able to obtain in
liquidating the collateral for the loans, which varies depending on the
customer.
The Bank grants loans primarily to customers in New York and its
immediately adjacent suburban communities. Although the Bank has a diversified
loan portfolio, a large portion of their loans are secured by commercial or
residential real property. The Bank does not generally engage in non-recourse
lending and typically will require the principals of any commercial borrower to
obligate themselves personally on the loan. Although the Bank has diversified
loan portfolios, a substantial portion of their debtors' ability to honor their
contracts is dependent upon the economic sector. Commercial and standby letters
of credit were granted primarily to commercial borrowers.
The Bank has entered into interest rate cap agreements in order to hedge
its exposure to interest rate fluctuations. The Company adopted the provisions
of SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities",
as amended, as of January 1, 2001. The statement requires the Company to
recognize all derivative instruments at fair value as either assets or
liabilities. Financial derivatives are reported at fair value in other assets or
other liabilities. For derivatives not designated as hedges, the gain or loss is
recognized in current earnings. Amounts reclassed into earnings, when the hedged
transaction culminates, are included in interest income.
NOTE O - REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory - and possible additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Bank's consolidated financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Company must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities and certain off-balance-sheet items
as calculated under regulatory accounting practices. The Bank's capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
Quantitative measures established by regulations to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set forth in
the table below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets, and of Tier 1 capital to average assets. Management
believes that, as of December 31, 2006, the Bank meets all capital adequacy
requirements to which it is subject.
As of December 31, 2006, the Bank met all regulatory requirements for
classification as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the Bank must maintain
minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set
forth in the following table. There are no conditions or events since that date
that management believes have changed the institution's category.
80
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE O - (CONTINUED)
The following table sets forth the actual and required regulatory
capital amounts and ratios of, the Company and the Bank as of December 31, 2006
and 2005 (dollars in thousands):
TO BE WELL
CAPITALIZED
UNDER
PROMPT
FOR CAPITAL CORRECTIVE
ADEQUACY ACTION
ACTUAL PURPOSES PROVISIONS
------------- ------------- ---------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
DECEMBER 31, 2006
Total Capital (to Risk-Weighted Assets)
Company 128,452 23.9% 43,031 >8.0% -- N/A
-
Bank 99,170 19.3% 41,120 >8.0% 51,400 >10.0%
- -
Tier I Capital (to Risk-Weighted Assets)
Company 124,681 23.2% 21,516 >4.0% -- N/A
-
Bank 95,400 18.6% 20,560 >4.0% 30,840 >6.0%
- -
Tier I Capital (to Average Assets)
Company 124,681 13.4% 37,322 >4.0% -- N/A
-
Bank 95,400 10.9% 35,022 >4.0% 43,778 >5.0%
- -
TO BE WELL
CAPITALIZED
UNDER
PROMPT
FOR CAPITAL CORRECTIVE
ADEQUACY ACTION
ACTUAL PURPOSES 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%
- -
81
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE P - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY
The condensed financial information for Berkshire Bancorp Inc. (parent
company only) is as follows:
CONDENSED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31,
---------------------------------
2006 2005
--------------- ----------------
ASSETS
Cash $ 11,515 $ 11,196
Equity investment in subsidiaries 113,972 109,026
Investment in securities available for sale 15,874 11,760
Accrued interest receivable 189 481
Other assets 1,023 1,547
--------- ---------
Total assets $ 142,573 $ 134,010
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Subordinated debt $ 22,681 $ 22,681
Other liabilities 4,115 2,619
--------- ---------
Total liabilities 26,796 25,300
--------- ---------
Stockholders' equity
Common stock 770 770
Additional paid-in capital 90,659 90,594
Retained earnings 37,285 33,504
Accumulated other comprehensive
loss, net (4,772) (8,415)
Common stock in treasury, at cost (8,165) (7,743)
--------- ---------
Total stockholders' equity 115,777 108,710
--------- ---------
$ 142,573 $ 134,010
========= =========
82
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE P - (CONTINUED)
CONDENSED STATEMENTS OF INCOME
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------
2006 2005 2004
-------- -------- ------
INCOME
Interest income from the Bank $ 65 $ 53 $ 71
Interest income 1,115 1,622 1,090
Gain on sales of 1,600 10 734
investment securities
Other income (loss) 235 217 96
-------- -------- --------
Total income 3,015 1,902 1,991
EXPENSES
Salaries and employee benefits 697 605 489
Interest expense 1,780 1,268 463
Other expenses 602 580 1,058
-------- -------- --------
Total expenses 3,079 2,453 2,010
-------- -------- --------
Income (loss) before income taxes
and equity in undistributed net
income of the Bank (64) (551) (19)
Equity in undistributed
net income of the Bank 5,203 6,229 7,668
-------- -------- --------
Income before taxes 5,139 5,678 7,649
Provision for income taxes 259 137 147
-------- -------- --------
Net income $ 4,880 $ 5,541 $ 7,502
======== ======== ========
83
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE P - (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------
2006 2005 2004
-------- ----- -- ----
Operating activities:
Net income $ 4,880 $ 5,541 $ 7,502
Adjustments to reconcile net
income to net cash provided by
(used in) operating activities:
Gain on sales of investment securities (1,600) (10) (734)
Equity in undistributed net income of the Bank (5,203) (6,229) (7,668)
Dividends received from the Bank 1,730 1,291 500
Increase in other liabilities 23 1,025 798
Decrease (increase) in other assets 816 (154) 69
-------- -------- --------
Net cash provided by operating activities 646 1,464 467
-------- -------- --------
Investing activities:
Investment securities available for sale
Purchases (3,725) (4,548) (9,150)
Sales 4,854 140 3,874
Net decrease in loans -- 6,059 185
Contribution to the Bank -- (7,217) (14,791)
-------- -------- --------
Net cash provided by (used in) investing activities 1,129 (5,566) (19,882)
-------- -------- --------
Financing activities:
Proceeds from exercise of common stock options 433 1,686 1,271
Acquisition of treasury stock (790) -- (69)
Cash paid for fractional shares -- -- (463)
Issuance of subordinated debentures -- 7,217 14,791
Dividends paid (1,099) (1,020) (735)
-------- -------- --------
Net cash (used in) provided by financing activities (1,456) 7,883 14,795
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 319 3,781 (4,620)
Cash and cash equivalents at beginning of year 11,196 7,415 12,035
-------- -------- --------
Cash and cash equivalents at end of year $ 11,515 $ 11,196 $ 7,415
======== ======== ========
Supplemental disclosures of cash flow information:
Cash used to pay interest $ 1,694 $ 1,132 $ 273
Cash used to pay income taxes $ 473 $ 362 $ 419
84
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE Q - QUARTERLY FINANCIAL DATA (UNAUDITED)
The following represents summarized quarterly financial data of the
Company which, in the opinion of management, reflects all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of the Company's results of operations. (In thousands, except per
share data).
THREE MONTHS ENDED
------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
---------- ---------- ------------ -----------
2006
----
Interest income $ 11,835 $ 11,816 $ 12,141 $ 12,429
Interest expense (6,607) (6,945) (7,509) (8,125)
-------- -------- -------- --------
Net interest income 5,228 4,871 4,632 4,304
Provision for loan losses (45) (45) (45) (275)
Gains on sales of securities 741 2 -- 1,593
Non-interest income 312 304 359 382
Non-interest expenses (3,413) (3,378) (3,400) (3,391)
-------- -------- -------- --------
Income before taxes 2,823 1,754 1,546 2,613
Provision for taxes (1,327) (834) (689) (1,006)
-------- -------- -------- --------
Net income $ 1,496 $ 920 $ 857 $ 1,607
======== ======== ======== ========
Per share data
Net income per common share
Basic $ .22 $ .13 $ .12 $ .24
======== ======== ======== ========
Diluted $ .21 $ .13 $ .12 $ .24
======== ======== ======== ========
THREE MONTHS ENDED
------------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
---------- ---------- ------------ -----------
2005
----
Interest income $ 10,967 $ 11,378 $ 11,250 $ 11,461
Interest expense (4,814) (5,585) (5,879) (6,121)
-------- -------- -------- --------
Net interest income 6,153 5,793 5,371 5,340
Provision for loan losses (45) (45) (45) (45)
Gains (losses) on sales of securities 6 3 -- (5)
Non-interest income 263 282 300 357
Non-interest expenses (3,193) (3,378) (3,221) (3,347)
-------- -------- -------- --------
Income before taxes 3,184 2,655 2,405 2,300
Provision for taxes (1,486) (1,304) (1,108) (1,105)
-------- -------- -------- --------
Net income $ 1,698 $ 1,351 $ 1,297 $ 1,195
======== ======== ======== ========
Per share data
Net income per common share
Basic $ .25 $ .20 $ .19 $ .17
======== ======== ======== ========
Diluted $ .25 $ .20 $ .19 $ .16
======== ======== ======== ========
85
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.
Not Applicable.
ITEM 9A. CONTROLS AND PROCEDURES
EVALUATION OF THE COMPANY'S DISCLOSURE CONTROLS AND INTERNAL CONTROL. As of the
end of the period covered by this Annual Report on Form 10-K, the Company
evaluated the effectiveness of the design and operation of its "disclosure
controls and procedures" as defined in Rule 13a-15(e) of the Securities Exchange
Act of 1934 ("Disclosure Controls"). This evaluation ("Controls Evaluation") was
done under the supervision and with the participation of the Company's
management, including the Chief Executive Officer ("CEO") who is also the Chief
Financial Officer ("CFO").
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS. The Company's management,
including the CEO/CFO, does not expect that its Disclosure Controls and/or its
"internal control over financial reporting" as defined in Rule 13a-15(f) of the
Securities Exchange Act of 1934 ("Internal Control") will prevent all error and
all fraud. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Further, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the Company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based in
part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, control may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
CONCLUSIONS. Based upon the Controls Evaluation, the CEO/CFO has concluded that
the Disclosure Controls are effective in reaching a reasonable level of
assurance that information required to be disclosed by the Company is recorded,
processed, summarized and reported within the time period specified in the
Securities and Exchange Commission's rules and forms and that any material
information relating to the Company is accumulated and communicated with
management, including its principal executive/financial officer to allow timely
decisions regarding required disclosure. In accordance with SEC requirements,
the CEO/CFO notes that during the fiscal quarter ended December 31, 2006, no
changes in Internal Control have occurred that have materially affected or are
reasonably likely to materially affect Internal Control.
ITEM 9B. OTHER INFORMATION
On March 28, 2007, the Board of Directors of the Company, upon the
recommendation of the independent directors of the Company, approved bonuses for
fiscal year 2006 to Messrs. Steven Rosenberg, Moses Krausz and David Lukens of
$25,000, $250,000 and $25,000, respectively, and fixed salaries for Messrs.
Steven Rosenberg and David Lukens for fiscal year 2007 at $220,000 and $183,000,
respectively, effective January 1, 2007.
86
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following are the current directors and executive officers of the Company:
NAME AGE POSITION(S)
---- --- --------------------------------------------
Steven Rosenberg 58 President, Chief Executive Officer,
Chief Financial Officer and Director
William L. Cohen 65 Director
Martin A. Fischer 69 Director
Moses Marx 71 Director
Randolph B. Stockwell 60 Director
Moses Krausz 66 President of The Berkshire Bank
David Lukens 57 Executive Vice President, Chief Financial
Officer of The Berkshire Bank
Mr. Rosenberg has served as President and Chief Executive Officer of the
Company since March 1999 and as Vice President and Chief Financial Officer of
the Company from April 1990 to March 1999. He continues to serve as Chief
Financial Officer. Mr. Rosenberg was elected a director in May 1995. From
September 1987 through April 1990, he served as President and Director of Scomel
Industries, Inc., a company engaged in international marketing and consulting.
Mr. Rosenberg is a director of The Cooper Companies, Inc. (a developer and
manufacturer of healthcare products).
Mr. Cohen was elected a director in July 1993. He has served as the
Chief Executive Officer of Andover Properties, LLC, a real estate development
company specializing in self storage facilities since November 2003, and has
been a private investor for over six years. Mr. Cohen served as President, Chief
Executive Officer and Chairman of the Board of The Andover Apparel Group, Inc.,
an apparel manufacturing company, from 1980 to 2000.
Mr. Fischer was elected a director on December 6, 2006. He has been the
President and Chief Executive of Mount Carmel Cemetery Association, a New York
State not-for-profit corporation since April 2001. Mr. Fischer was counsel to
Warshaw, Burstein, Cohen, Schlesinger and Kuh, a New York City law firm, from
1987 until 2001 and served as President, Chief Operating Officer and a director
of Kinney System, Inc. and The Katz Parking System, Inc. from 1981 to 1986. Mr.
Fischer was appointed Commissioner of the New York State Insurance Fund in 1977
and served as its Chairman until January 1995.
Mr. Marx was elected a director in May 1995. Mr. Marx has been the
General Partner in United Equities Company since 1954 and General Partner in
United Equities Commodities Company since 1972. He is also President of Momar
Corp. All of these are investment companies. Mr. Marx is a director of The
Cooper Companies, Inc.
Mr. Stockwell was elected a director in July 1988. He has been a private
investor for over ten years. Since April 1999, Mr. Stockwell has served as
President of Yachting Systems of America, LLC, a small start-up company. In
addition, he served in various capacities with the Community Bank, a commercial
bank, from September 1972 to January 1987.
Mr. Krausz has held the position of President of the Bank since March
1992 and Chief Executive Officer since November 1993. Prior to joining the Bank,
Mr. Krausz was Managing Director of SFS Management Co., L.P., a mortgage banker,
from 1987 to 1992 and was President of UMB Bank and Trust Company, a New York
State chartered bank, from 1978 to 1987.
Mr. Lukens has held the position of Senior Vice President and Chief
Financial Officer of the Bank since December 1999 and Executive Vice President
since December 2003. Prior to joining the Bank, Mr. Lukens was Senior Vice
President and Chief Financial officer of First Washington State Bank, a New
Jersey commercial bank, from 1994 to 1999 and was Vice President and Controller
at the Philadelphia, PA branch of Bank Leumi Le-Israel B.M., an international
commercial bank, from 1978 to 1994.
There are no family relationships (whether by blood, marriage or
adoption) among any of the Company's current directors or executive officers.
87
ITEM 10. (CONTINUED)
At each annual meeting of stockholders, the successors to the directors
then serving are elected to serve from the time of their election and
qualification until the next annual meeting following their election or until
their successors have been duly elected and qualified, or until their earlier
death, resignation or removal. All of our current directors have been elected to
serve until the annual meeting of stockholders to be held in 2007. The Company's
officers, except for Messrs. Krausz and Lukens who have employment agreements,
serve at the discretion of the Board of Directors.
AUDIT COMMITTEE MEMBERS, FINANCIAL EXPERT AND INDEPENDENCE
Our Board of Directors has established an Audit Committee comprised of
three independent directors, Messrs. William L. Cohen, Martin A. Fischer and
Randolph B. Stockwell. All of the members of the Audit Committee meet the
independence requirements under current NASDAQ corporate governance standards
for companies whose securities are listed on NASDAQ. Based upon their education
and relevant experience, our Board has determined that Messrs. Cohen and
Stockwell each qualify as financial experts as defined by the Sarbanes-Oxley Act
of 2002 and the rules of the Securities and Exchange Commission.
CORPORATE CODE OF ETHICS
We have adopted a Corporate Code of Ethics that applies to the
directors, officers and employees, including the senior management: the chief
executive officer, chief financial officer, controller and persons performing
similar functions, of Berkshire Bancorp Inc. and its subsidiaries. Copies of our
Corporate Code of Ethics are available without charge upon written request to
the Company, Attention President, at its principal executive office.
ITEM 11. COMPENSATION DISCUSSION AND ANALYSIS
Our Board of Directors has delegated primary authority for executive
compensation to the three independent members of the Board, or Independent
Directors, who, though not a formal compensation committee of the Board, act in
such capacity.
PHILOSOPHY ON EXECUTIVE COMPENSATION
It is our philosophy to compensate executive officers in a manner that
promotes the recruitment, motivation and retention of exceptional employees who
will help us achieve our strategic business objectives and increase stockholder
value. Our executive compensation philosophy is implemented through compensation
programs based upon the following principles:
* Targeted total compensation (salary, bonus, and long-term incentives)
and benefits package for executives should be set near the median levels
of compensation for corporate executives delivered by certain peer
companies, taking into account the relative responsibilities of the
executive officers involved. Actual total compensation in any given year
may be above or below the target level based on individual and corporate
performance.
* Our total compensation package should provide an appropriate mix of
fixed and variable compensation to support a meaningful
pay-for-performance relationship for our executive officers.
* Performance-based compensation should be tied to performance measures
believed to enhance future stockholder value.
* Our long-term incentive program should be designed to encourage
executive retention and link executive compensation directly to
long-term stockholder interests.
* Compensation plans should be easy to understand and administer.
88
OVERVIEW OF COMPANY POLICY ON EXECUTIVE COMPENSATION
Our executive compensation policy and practice is established by the
Independent Directors. Specific policies and practices relating to each element
of named executive officers' compensation are described below. The objective of
our compensation policy is to provide an overall compensation opportunity that
is competitive with that offered for similar positions by similar organizations
in our industry. Executive compensation may be above or below this general level
at times for a variety of reasons, including performance, recruiting or
retention requirements and market conditions.
Actual compensation against this generally median target is designed to
be commensurate with our corporate performance and the individual performance of
our executives. We generally structure our benefits based on a review of the
typical practices within our industry and our business strategy.
Our approach to the total pay package for our executive officers is to
view the various elements of the package as a portfolio of rewards, designed to
achieve different specific purposes but to balance each other in motivating
appropriate behavior, rewarding different aspects of performance or meeting
corporate objectives for attracting and retaining the talent needed to
successfully lead our company and increase stockholder value.
THE ROLE OF THE INDEPENDENT DIRECTORS AND MANAGEMENT IN DETERMINING EXECUTIVE
COMPENSATION
For compensation purposes, our executive officers consist of the three
executive officers named in the Summary Compensation Table. The Independent
Directors approve all key elements of our executive compensation and benefit
programs for the named executive officers. In addition, they assess our
financial performance and capital position compared to our plan in determining
future awards under the plans. Finally, the Independent Directors approve all
salary increases, cash bonus amounts, equity grants, employment, severance, or
change of control agreements and all benefit programs as they apply to the named
executive officers.
COMPENSATION POLICY REGARDING NAMED EXECUTIVE OFFICERS
Each element of compensation is described below. Generally, the mix of
pay elements, including salary and annual cash bonus, long-term incentive and
equity opportunity, benefits and perquisites, are designed to address the needs
of our company and reflect the competitive marketplace. We review the mix and
allocation to individuals regularly, but maintain a flexible policy to deliver
compensation that motivates, retains and rewards our executives. In executing
this policy, the Independent Directors consider a variety of factors, applying
its collective judgment where appropriate, against a frame of reference that the
total pay opportunity should be generally competitive.
BASE SALARIES
In general, we target base salaries at competitive levels relative to
executive officers in comparable positions in our industry, taking into account
the comparable responsibilities of the executive officers involved. Where the
responsibilities of executive positions are different from those typically found
among other bank holding companies or banks, or where executives are new to
their responsibilities or play a particularly critical role, base salaries may
be targeted above or below median competitive levels. In determining salaries,
the Independent Directors also take into account individual leadership,
integrity and vision, experience and performance relative to other executive
officers in comparable positions. We believe the named executive officers'
salaries reported in the Summary Compensation Table are in keeping with this
philosophy.
ANNUAL NON-EQUITY INCENTIVE AWARDS
For 2006, the Independent Directors determined the cash awards for the
named executive officers which represent, in their view, a generally competitive
level of bonus for corporate and individual performance. This amount is set for
each individual and position so that, along with base salary, the executive's
total cash pay would be comparable to the cash compensation of executives of
similarly sized companies in our industry.
89
ANNUAL INCENTIVE PERFORMANCE GOALS AND MEASURES
At the beginning of each year, the Independent Directors review our
business plan and budgets for the coming year. Historically and in 2006, the
targets for performance are measured by the (i) management of our loan
portfolio, loan products and underwriting standards, (ii) management of our
investment activities and portfolio of investment securities, (iii) integration
of new bank branches, (iv) integration of new technologies and information
systems, (v) safety and soundness of the bank, (vi) financial performance to
budget, and (vii) growth in stockholders' equity. The annual incentive portion
of total compensation is designed to reward executives for meeting these
objectives which we believe are the important drivers for the long-term success
of our company.
At year end, the Independent Directors review performance against these
objectives and apply more judgmental factors, which reflect actual achievements
in such areas as the quality of earnings, risk positioning and strategic
positioning of our portfolio of loans and investment securities. The effect of
market and industry conditions, interest rates and the economy in general on
performance is also considered. Total payouts may be adjusted up or down based
on this assessment.
Based on their assessment of each executive officer's performance for
the year relative to our plan, their judgment on the appropriate effect of any
of the factors discussed above and any individual performance adjustments, the
Independent Directors make a decision on the actual bonus to be paid to such
executive officer for the year. The decision is based in part upon
recommendations made by the Chief Executive Officer and the named executive
officer's immediate superior, if not the Chief Executive Officer.
Further detail on individual annual bonus payments made to the named
executive officers is provided in the Summary Compensation Table and its
accompanying narrative.
LONG-TERM AND INCENTIVE AWARDS
We provide periodic, but not annual, long-term equity incentives through
our 1999 Stock Incentive Plan which was approved by our stockholders. Equity
incentives in past years provided for long-term compensation opportunities for
the named executive officers in the form of a fair market value stock option
grant.
STOCK OPTIONS
We intend that the value of any future stock options we grant be
measured by the fair value of the option at grant date under FAS 123(R). We
believe that periodic, not annual, stock option grants best link executive
compensation to the interests of our stockholders. The value realizable from
this type of award is solely dependent on the increase in our stock price over
the term of the options, after which the options expire. Our practice in regard
to stock options and other equity grants is that such grants are typically made
to existing executives on a periodic basis, with possible exceptions for new
hires, promotions or special retention awards. The Independent Directors review
management recommendations as to stock option grants to employees below the
named executive officer level.
Typically, stock option awards are approved in advance and they are
effective on a future pre-selected date. We do not select stock option grant
dates for executives in coordination with the release of material, non-public
information, or time the release of such information because of option grant
dates. Historically, we have awarded non-qualified stock options which vest in
full one year from the date of the award and expire five years thereafter.
RESTRICTED STOCK
We have not used restricted stock grants in the past, though we may do
so in the future. Restricted stock, unlike a stock option, is an outright grant
of common stock in which ownership vests over a period of time. If restricted
stock is granted, then, throughout the vesting period holders of restricted
stock would have the right to vote their restricted shares and to receive
dividends.
90
POLICY ON POST-TERMINATION BENEFITS
Our policy on executive post-termination benefits is to review each
situation as it arises. We seek to provide fair and appropriate treatment to all
of our employees depending upon the termination situation.
CHANGE OF CONTROL TERMINATION POLICIES
We have no change of control agreements with any of our employees.
RETIREMENT PLAN
Substantially all full-time employees are eligible to participate in the
Berkshire Bancorp Inc. Retirement Income Plan after one year of employment. We
believe that retirement plan benefits are an integral part of compensation of
our executive officers and other employees. We provide these benefits in order
to make an income stream available to the recipients that will assist in meeting
their post-retirement needs. Benefits are determined by compensation and years
of service. Further detail regarding the retirement plan is provided in the
Pension Benefits Table and accompanying discussion.
DEFERRED COMPENSATION
Certain named executives are eligible to participate in the Deferred
Compensation Plan of The Berkshire Bank. This plan, adopted in July 2006, is
designed to allow executives to defer base salary and annual incentives until a
future date. The interest rates at which these deferrals accrue are not
guaranteed and we believe are in line with competitive practice in our industry.
Further detail on the interest rates we pay is provided in the Nonqualified
Deferred Compensation Table and accompanying discussion.
PERQUISITES AND OTHER BENEFITS
We do not provide perquisites of any kind to our named executive
officers. However, our executives are eligible to participate in the benefit
plans available to all of our employees.
NON-EMPLOYEE DIRECTOR COMPENSATION
In 2006, the Independent Directors reviewed the components of its
non-employee director compensation program and recommended to the Board that it
remain unchanged. A further review will be undertaken in 2007 to assure that
director pay remains appropriate. Details regarding director compensation is
provided in the Director Compensation Table and accompanying discussion.
TAX CONSIDERATIONS
Section 162(m) of the Internal Revenue Code disallows a tax deduction
for compensation in excess of $1 million paid to our Chief Executive Officer or
any of our other named executive officers whose total compensation is required
to be reported. However, performance-based compensation that satisfies the
requirements of Section 162(m) is deductible. We intend to establish and
administer executive officer compensation programs that are deductible. However,
we may award compensation from time to time that is not fully tax deductible if
we determine that such awards are consistent with our philosophy and in the best
interests of our stockholders.
Section 409A of the Internal Revenue Code provides that amounts deferred
under nonqualified deferred compensation plans are included in an employee's
income when they vest unless specified requirements are met. If these
requirements are not met, employees are also subject to an additional income tax
and interest penalties. Our nonqualified deferred compensation plans are
intended to meet, and will be amended to meet, these requirements. As a result,
our employees will be taxed when the deferred compensation is actually paid to
them and we will be entitled to a tax deduction at that time.
Section 280G of the Internal Revenue Code disallows a company's tax
deduction for what are defined as "excess parachute payments," and Section 4999
imposes a 20% excise tax on any person who receives excess parachute payments.
91
None of our named executive officers are entitled to such payments upon
termination of their employment, including termination following a change of
control of our company. We do not have change of control agreements with any of
our named executive officers.
Our stock awards generally accelerate in the event of a change of
control and qualifying termination of employment. This acceleration could
contribute to potential excess parachute payments.
ACCOUNTING CONSIDERATIONS
Stock options, restricted stock, and performance shares are accounted
for based on their grant date fair value, as determined under FAS 123R. We
consider the accounting expense as well as the cash expense of all programs as
part of our design and review criteria.
EXECUTIVE COMPENSATION & BENEFITS REPORT
The independent directors have reviewed and discussed the Compensation
Discussion and Analysis set forth in this Form 10-K with our management; and
Based on such review and discussions the Independent Directors
recommended to our Board of Directors that the Compensation Discussion and
Analysis be included in this Annual Report on Form 10-K.
William L. Cohen
Martin A. Fischer
Randolph B. Stockwell
92
EXECUTIVE COMPENSATION
The following table shows the compensation paid in or with respect to
the last fiscal year to the individual who served as our Chief Executive Officer
and Chief Financial Officer for the fiscal year ended December 31, 2006, and to
each of the other executive officers of the Bank whose total compensation was
more than $100,000 during the fiscal year ended December 31, 2006 (our "named
executive officers").
SUMMARY COMPENSATION TABLE
CHANGE IN
PENSION VALUE
AND
NONQUALIFIED
DEFERRED
COMPENSATION ALL OTHER
NAME AND PRINCIPAL SALARY BONUS EARNINGS COMPENSATION TOTAL
POSITION YEAR $ $ $ $ $
Steven Rosenberg 2006 200,000 25,000 232,267 -- 457,267
President, Chief Executive
Officer and Chief Financial
Officer
Moses Krausz 2006 422,130 250,000 -- 11,424 683,554
President and Chief Executive
Officer of The Berkshire Bank
David Lukens 2006 174,000 25,000 11,996 7,658 218,654
Executive Vice President and
Chief Financial Officer of The
Berkshire Bank
NARRATIVE SUMMARY COMPENSATION TABLE
Mr. Rosenberg does not have an employment agreement with us. The amounts
reported for Change in Pension Value and Nonqualified Deferred Compensation
Earnings includes only the change in the value of his benefit payable under our
Retirement Income Plan. Mr. Rosenberg does not participate in the Bank's 401(k)
Plan or its Deferred Compensation Plan.
Mr. Krausz has an employment agreement with us. The agreement expires on April
20, 2008 unless automatically renewed for up to three additional years as
provided for in the agreement. The agreement provides for the payment to Mr.
Krausz of a specified base salary with fixed annual increases, the payment of a
discretionary bonus and participation in our employee benefit plans. There are
no change in control provisions in Mr. Krausz's employment agreement. Mr. Krausz
is a participant in the Bank's 401(k) Plan and its Deferred Compensation Plan.
The amounts reported in All Other Compensation consists of contributions we made
to Mr. Krausz's 401(k) account of $6,600, income associated with life insurance
coverage and aggregate earnings on the Deferred Compensation Plan.
Mr. Lukens has an employment agreement with us. The agreement will expire on
June 30, 2008 unless automatically renewed for up to three additional years as
provided for in the agreement. The agreement provides for the payment to Mr.
Lukens of a base salary and annual bonus, and participation in our employee
benefit plans. There are no change in control provisions Mr. Lukens' employment
agreement. The amounts reported for Change in Pension Value and Nonqualified
Deferred Compensation Earnings includes only the change in the value of Mr.
Luken's benefit payable under our Retirement Income Plan. Mr. Lukens is a
participant in the Bank's 401(k) Plan and its Deferred Compensation Plan. The
amounts reported in All Other Compensation consists of contributions we made to
Mr. Lukens' 401(k) account of $5,970, income associated with life insurance
coverage and aggregate earnings on the Deferred Compensation Plan.
93
GRANTS OF PLAN-BASED AWARDS IN FISCAL YEAR ENDED DECEMBER 31, 2006
There were no grants of awards made to any of our named executive
officers in 2006 under any non-equity or equity incentive plan.
The following table sets forth certain information regarding
equity-based awards held by each of our named executive officers as of December
31, 2006.
OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2006
--------------------------------------------------------------------------------------------------------------------
OPTION AWARDS STOCK AWARDS
--------------------------------------------------------------------------------------------------------------------
EQUITY
INCENTIVE
PLAN AWARDS:
MARKET OR
EQUITY PAYOUT
EQUITY INCENTIVE PLAN VALUE OF
INCENTIVE PLAN AWARDS: UNEARNED
NUMBER OF NUMBER OF AWARDS: NUMBER OF NUMBER OF SHARES,
SECURITIES SECURITIES NUMBER OF SHARES OR UNEARNED UNITS, OR
UNDERLYING UNDERLYING SECURITIES UNITS OF MARKET VALUE OF SHARES, UNITS, OTHER
UNEXERCISED UNEXERCISED UNDERLYING OPTION STOCK SHARES OR UNITS OR OTHER RIGHTS RIGHTS THAT
NAME OPTIONS OPTIONS UNEXERCISED EXERCISE OPTION THAT HAVE OF STOCK THAT THAT HAVE NOT HAVE NOT
(#) (#) UNEARNED OPTIONS PRICE EXPIRATION NOT VESTED HAVE NOT VESTED VESTED VESTED
EXERCISABLE UNEXERCISABLE (#) $ DATE (#) (#) (#) (#)
Steven Rosenberg 30,000 -- -- 10.00 07/31/07 -- -- -- --
Moses Krausz 60,000 -- -- 10.00 07/31/07 -- -- -- --
David Lukens 15,000 -- -- 10.00 07/31/07 -- -- -- --
OPTION EXERCISES AND STOCK VESTED IN FISCAL YEAR ENDED DECEMBER 31, 2006
The following table sets forth certain information regarding option
exercises by our named executive officers during the year ended December 31,
2006.
-----------------------------------------------------------------
OPTION AWARDS STOCK AWARDS
-----------------------------------------------------------------
NUMBER OF NUMBER OF
SHARES SHARES
ACQUIRED ON VALUE REALIZED ACQUIRED ON VALUE REALIZED
EXERCISE ON EXERCISE (1) VESTING ON VESTING
NAME (#) ($) (#) ($)
Steven Rosenberg -- -- -- --
Moses Krausz -- -- -- --
David Lukens 5,000 28,083 -- --
(1) Calculated based upon the closing sale price of our common stock on the date
of exercise less the exercise price for such shares, but excluding any tax
obligation incurred by the named executive officer in connection with the
exercise.
94
1999 STOCK INCENTIVE PLAN
Our 1999 Stock Incentive Plan permits the granting of awards in the form
of nonqualified stock options, incentive stock options, restricted stock,
deferred stock, and other stock-based incentives. Up to 600,000 shares of our
common stock may be issued pursuant to the 1999 Stock Incentive Plan (subject to
appropriate adjustment in the event of changes in our corporate structure).
Officers, directors and other key employees of us or any of our subsidiaries are
eligible to receive awards under the 1999 Stock Incentive Plan. The option
exercise price of all options which are granted under the 1999 Stock Incentive
Plan must be at least equal to 100% of the fair market value of a share of
common stock of the Company on the date of grant. At December 31, 2006, options
to acquire 557,757 shares of our common stock have been granted under this plan,
185,878 options are outstanding and exercisable, and 42,243 options are
available for future grants.
POST-EMPLOYMENT COMPENSATION
PENSION BENEFITS
NUMBER OF PRESENT VALUE PAYMENTS
YEARS CREDITED OF ACCUMULATED DURING LAST
SERVICE BENEFIT FISCAL YEAR
NAME PLAN NAME (#) ($) ($)
Steven Rosenberg Retirement Income Plan 15.7 1,063,312 --
David Lukens Retirement Income Plan 6.0 57,953 --
RETIREMENT INCOME PLAN. Our Retirement Income Plan is a noncontributory defined
benefit plan covering substantially all of our full-time, non-union United
States employees. Under the Retirement Income Plan, our benefits were based upon
a combination of employee compensation and years of service. We paid the entire
cost of the plan for our employees and funded such costs as they accrued. Our
funding policy was to make annual contributions within minimum and maximum
levels required by applicable regulations. Our customary contributions were
designed to fund normal cost on a current basis and fund over 30 years the
estimated prior service cost of benefit improvements (15 years of annual gains
and losses). The projected unit cost method was used to determine the annual
cost. Plan assets consist principally of equity and fixed income mutual funds.
Benefit accruals were frozen as of September 15, 1988, resulting in a
plan curtailment. As a result of such curtailment, we did not accrue benefits
for future services; however, we did continue to contribute as necessary for any
unfunded liabilities. In 2000, we reinstated the Retirement Income Plan to cover
substantially all of our full-time, non-union United States employees.
Except for Mr. Rosenberg whose benefit is subject to the laws governing
the Retirement Income Plan, a participant in the Retirement Income Plan
accumulates a balance in his or her retirement account by receiving: (i) an
annual retirement credit of 5% of gross wages paid during the year, but not in
excess of the applicable annual maximum compensation permitted to be taken into
account under Internal Revenue Service guidelines for each year of service; and
(ii) an annual interest credit based upon the 30-year U. S. Treasury securities
rate. We pay the entire cost of the Retirement Income Plan for our employees and
fund such costs as they accrue.
Our plan provides for a normal retirement age of 65. However, the
estimated annual unreduced benefits payable under the Retirement Income Plan
upon earlier retirement at age 62 for Messrs. Rosenberg and Lukens are
approximately $160,000 and $16,000, respectively. In accordance with the laws
currently governing the Retirement Income Plan, the estimated annual benefit
payable to Mr. Rosenberg is not expected to increase. Mr. Krausz is not a
participant in the Retirement Income Plan. (See Note K of Notes to Consolidated
Financial Statements for more information concerning the Retirement Income
Plan).
95
NONQUALIFIED DEFERRED COMPENSATION
EXECUTIVE AGGREGATE
CONTRIBUTIONS REGISTRANT AGGREGATE AGGREGATE BALANCE AT
IN FISCAL YEAR CONTRIBUTIONS IN EARNINGS IN WITHDRAWALS/ DECEMBER 31,
2006 FISCAL YEAR 2006 FISCAL YEAR 2006 DISTRIBUTIONS 2006
NAME PLAN NAME $ $ $ $ $
Moses Krausz Deferred Compensation 7,000 -- 75 -- 7,075
Plan
David Lukens Deferred Compensation 2,610 -- 28 -- 2,638
Plan
------------------
All of the amounts reported under the caption Registrant's Contributions
and Aggregate Earnings in Fiscal 2006 have also been reported in the Summary
Compensation Table for fiscal 2006. None of the amounts reported in Aggregate
Balance at December 31, 2006 were reported as compensation to the named
executive officer in our Summary Compensation Tables of previous years.
DEFERRED COMPENSATION PLAN. The Bank's deferred compensation plan was
established in July 2006 to provide for a systematic method by which key
employees of the Bank may defer payment of not less than 3% and not more than
50% of his or her compensation that would otherwise be payable during the year.
The Deferred Compensation Plan is intended to be a nonqualified and unfunded
plan maintained primarily for the purpose of providing deferred compensation for
a select group of management or highly compensated employees pursuant to
Sections 201(2), 301(a)(3) and 401(a)(1) of the Employee Retirement Income
Security Act of 1974, as amended.
On June 30 and December 31 of each year, account balances are credited
with the applicable earnings rate, the highest deposit rate paid by the Bank on
its generally available interest bearing deposit accounts (excluding time
deposits), in effect at that time. Distributions from the Deferred Compensation
Plan may be made upon (i) termination of employment, (ii) an unforeseeable
emergency, (iii) death, (iv) disability, as defined under Section 409A of the
Internal Revenue Code of 1986, as amended, (the "Code") and (v) a Change in
Control Event, to the extent such Change in Control Event constitutes
permissible payment under Section 409A of the Code.
96
COMPENSATION OF DIRECTORS
DIRECTOR COMPENSATION FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006.
CHANGE IN
PENSION
VALUE AND
FEES NONQUALIFIED
EARNED OR NON-EQUITY DEFERRED
PAID IN STOCK OPTION INCENTIVE PLAN COMPENSATION ALL OTHER
CASH AWARDS AWARDS COMPENSATION EARNINGS COMPENSATION TOTAL
NAME $ $ $ $ $ $ $
William L. Cohen 32,500 -- -- -- -- -- 32,500
Moses Marx 26,500 -- -- -- -- -- 26,500
Martin A. Fischer (a) 3,083 -- -- -- -- -- 3,083
Thomas V. Guarino (b) 28,416 -- -- -- -- -- 28,416
Randolph B. Stockwell 30,500 -- -- -- -- -- 30,500
Each director who is not also an employee receives a stipend of $25,000
per annum and $1,500 for each day during which he participates in a meeting of
the Board or a Committee of the Board. Each of these directors also receives a
fee of $1,000 for telephonic meetings of the Board or a Board Committee. In
addition, see "1999 Stock Incentive Plan" above.
-----------------
(a) Mr. Fischer was elected to the Board on December 7, 2006.
(b) Mr. Guarino resigned from the Board effective August 31, 2006.
(c) Messrs. Cohen, Marx and Stockwell each own stock options for 3,000
shares of the Company's common stock.
(d) Mr. Fischer owns stock options for 1,500 shares of our common stock.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND RELATED
STOCKHOLDER MATTERS.
The following table sets forth certain information as of March 23, 2007
with respect to the beneficial ownership of our Common Stock by (i) each person
who is known by us to own beneficially more than 5% of our Common Stock, (ii)
each of our directors and persons named in the Summary Compensation Table, and
(iii) all executive officers and directors as a group.
AMOUNT AND NATURE
NAME AND ADDRESS OF OF BENEFICIAL PERCENT
TITLE OF CLASS BENEFICIAL OWNER OWNERSHIP OF CLASS
----------------- --------------------------------- ------------------- ---------
Common Stock William L. Cohen 7,500 (1) *
160 Broadway
New York, NY 10038
Common Stock Martin A. Fischer 9,800 (2) *
160 Broadway
New York, NY 10038
Common Stock Moses Krausz 148,691 (3) 2.1%
4 East 39th Street
New York, NY 10016
Common Stock David Lukens 15,600 (4) *
4 East 39th Street
New York, NY 10016
Common Stock Moses Marx 3,538,864 (5) 51.3%
160 Broadway
New York, NY 10038
Common Stock Steven Rosenberg 62,580 (6) *
160 Broadway
New York, NY 10038
Common Stock Randolph B. Stockwell 24,000 (7) *
160 Broadway
New York, NY 10038
Common Stock All executive officers and
directors as a group (7 persons) 3,807,035 (8) 54.3%
---------------------------------
* Less than 1%
97
ITEM 12. (CONTINUED)
(1) Includes 3,000 shares issuable upon the exercise of options which have
been granted to Mr. Cohen under our 1999 Stock Incentive Plan.
(2) Includes 1,500 shares issuable upon the exercise of options which have
been granted to Mr. Fischer under our 1999 Stock Incentive Plan.
(3) Includes 60,000 shares issuable upon the exercise of options which have
been granted to Mr. Krausz under our 1999 Stock Incentive Plan and 2,100
shares owned by Mr. Krausz's spouse.
(4) Includes 15,000 shares issuable upon the exercise of options which have
been granted to Mr. Lukens under our 1999 Stock Incentive Plan.
(5) Includes 3,000 shares issuable upon the exercise of options which have
been granted to Mr. Marx under our 1999 Stock Incentive Plan, 285,000
shares owned by Momar Corporation and 386,163 shares owned by Terumah
Foundation. Does not include 37,302.32 shares representing 23.0% of the
shares owned by Eva and Esther, L.P., of which Mr. Marx has a 23.0%
limited partnership interest. Mr. Marx's daughters and their husbands
are the general partners of Eva and Esther, L.P.
(6) Includes 30,000 shares issuable upon the exercise of options which have
been granted to Mr. Rosenberg under our 1999 Stock Incentive Plan.
(7) Includes 3,000 shares issuable upon the exercise of options which have
been granted to Mr. Stockwell under our 1999 Stock Incentive Plan.
(8) Includes 115,500 shares of common stock which are issuable upon the
exercise of outstanding options.
EQUITY COMPENSATION PLANS
The following table details information regarding our existing equity
compensation plans as of December 31, 2006.
(C)
(A) NUMBER OF SECURITIES
NUMBER OF SECURITIES (B) REMAINING AVAILABLE FOR
TO BE ISSUED UPON WEIGHTED-AVERAGE FUTURE ISSUANCE UNDER
EXERCISE OF EXERCISE PRICE OF EQUITY COMPENSATION PLANS
OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, (EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (A)
------------- ---------------------- -------------------- -------------------------
Equity compensation 185,878 $ 9.76 42,243
plans approved by
security holders
Equity compensation -- -- --
plans not approved by
security holders
Total 185,878 $ 9.76 42,243
98
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
AND DIRECTOR INDEPENDENCE.
In January 2000, the Bank entered into a lease agreement with Bowling
Green Associates, LP, the principal owner of which is Mr. Marx, for commercial
space to open a bank branch. We obtained an appraisal of the market rental value
of the space from an independent appraisal firm and management believes that the
terms of the lease, including the annual rent paid, $328,000 and $359,000 in
fiscal 2006 and 2005, is comparable to the terms and annual rent that would be
paid to non-affiliated parties in a similar commercial transaction for similar
commercial space.
See Item 1. Business - Transactions With Related Parties and Item 2.
Properties for additional information.
POLICY REGARDING APPROVAL OF TRANSACTIONS BETWEEN BERKSHIRE AND RELATED PARTIES
It is the policy of the Board of Directors of the Company that the
Company, acting by its independent directors, shall on an ongoing basis conduct
an appropriate review of all related party transactions required to be disclosed
pursuant to SEC Regulation S-K Item 404 for potential conflict of interest
situations and that all such related party transactions must be approved by the
Company's Audit Committee.
INDEPENDENCE OF DIRECTORS
Our board has determined that Messrs. William L. Cohen, Martin A.
Fischer and Randolph B. Stockwell are independent under the independence
standards of the NASDAQ Stock Market LLC.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The Company's principal accountant is Grant Thornton LLP ("Grant
Thornton"). The total fees paid to Grant Thornton for the last two fiscal years
are as follows:
FISCAL YEAR ENDED FISCAL YEAR ENDED
DECEMBER 31, 2006 DECEMBER 31, 2005
------------------- -------------------
AUDIT FEES $281,540 $168,581
AUDIT RELATED FEES: Professional services -- 26,959
rendered for employee benefit plan audits,
accounting assistance in connection with
acquisitions and consultations related to
financial accounting and reporting standards
TAX FEES: Tax consulting, preparation of returns 68,200 57,160
ALL OTHER FEES: Professional services rendered -- --
for corporate support
The Audit Committee has established its pre-approval policies and
procedures, pursuant to which the Audit Committee approved the foregoing audit
and permissible non-audit services provided by Grant Thornton LLP in 2006 and
2005. Consistent with the Audit Committee's responsibility for engaging our
independent auditors, all audit and permitted non-audit services require
pre-approval by the Audit Committee. The full Audit Committee approves proposed
services and fee estimates for these services. The Audit Committee chairperson
has been designated by the Audit Committee to approve any services arising
during the year that were not pre-approved by the Audit Committee and services
that were pre-approved. Service approved by the Audit Committee chairperson are
communicated to the full Audit Committee at its next regular quarterly meeting
and the Audit Committee reviews services and fees for the fiscal year at each
such meeting. Pursuant to these procedures, the Audit Committee approved the
foregoing audit and permissible non-audit services provided by Grant Thornton
LLP.
99
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(A) DOCUMENTS FILED AS PART OF THIS REPORT:
(1) Financial Statements
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2006 and 2005
Consolidated Statements of Income for the Years Ended December 31, 2006,
2005 and 2004
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 2006, 2005 and 2004
Consolidated Statements of Cash Flows for the Years Ended December 31,
2006, 2005 and 2004
Notes to Consolidated Financial Statements
Schedule
Number DESCRIPTION
-------- -----------
None
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are not applicable and, therefore, have been omitted.
(3) Exhibits
EXHIBIT
NUMBER DESCRIPTION
------- -----------
2.1 Agreement and Plan of Reorganization, dated as of August 16, 2000, by
and between Berkshire Bancorp Inc., Greater American Finance Group,
Inc., The Berkshire Bank, GSB Financial Corporation and Goshen Savings
Bank (incorporated by reference to the Companies Registration Statement
on Form S-4 dated October 13, 2000.
3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 to the Company's Current
Report on Form 8-K dated March 30, 1999, and the Company's Quarterly
Report on Form 10-Q for the Quarterly Period Ended June 30, 2004).
3.2 Amended and Restated By-laws of the Company (incorporated by reference
to Exhibit 3.2 to the Company's Current Report on Form 8-K dated March
30, 1999).
10.1 1999 Stock Incentive Plan of the Company (incorporated by reference to
Exhibit 10.8 to the Company's Current Report on Form 8-K dated March 30,
1999).+
10.2 Employment Agreement, dated May 1, 1999, between The Berkshire Bank and
Moses Krausz (incorporated by reference to Exhibit 10.3 to the Company's
Annual Report on Form 10-K for the Fiscal Year Ended December 31,
2000).+
10.3 Employment Agreement, dated January 1, 2001, between The Berkshire Bank
and David Lukens (incorporated by reference to Exhibit 10.4 to the
Company's Annual Report on Form 10-K for the Fiscal Year Ended December
31, 2000).+
10.4 Lease Agreement, dated October 26, 1999, between Braun Management, Inc.
as agent for Bowling Green Associates, L.P., and The Berkshire Bank
(incorporated by reference to Exhibit 10.5 to the Company's Quarterly
Report on Form 10-Q for the Quarterly Period Ended March 31, 2001).
10.5 Amendment No. 2 to Employment Agreement, dated August 1, 2001, by and
between The Berkshire Bank and Moses Krausz (incorporated by reference
to Exhibit 10.8 to the Company's Quarterly Report on Form 10-Q for the
Quarterly Period Ended June 30, 2002).+
100
10.6 Amendment No. 2 to Employment Agreement, dated January 1, 2001, by and
between The Berkshire Bank and David Lukens (incorporated by reference
to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
Quarterly Period Ended June 30, 2006).+
10.7 Deferred Compensation Plan of The Berkshire Bank, dated June 27, 2005,
(incorporated by reference to Exhibit 10.2 to the Company's Quarterly
Report on Form 10-Q for the Quarterly Period Ended June 30, 2006).+
10.8 Amendment No. 1 to Deferred Compensation of The Berkshire Bank, dated
August 17, 2006 (incorporated by reference to Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the Quarterly Period Ended
September 30, 2006).+
21. Subsidiaries of the Company.
23. Consent of Independent Registered Public Accounting Firm
31. Certification of Principal Executive and Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32. Certification of Principal Executive and Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
----------------
+ Denotes a management compensation plan or arrangement.
101
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
BERKSHIRE BANCORP INC.
BY: /S/ STEVEN ROSENBERG
------------------------------------
STEVEN ROSENBERG
President, (Chief Executive Officer)
DATE: MARCH 29, 2007
------------------------------------
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934,
THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
SIGNATURE TITLE DATE
--------- ----- ----
President, (Chief
Executive Officer,
Principal Financial
Officer and Principal
Accounting Officer);
/s/ STEVEN ROSENBERG Director March 29, 2007
-------------------------
STEVEN ROSENBERG
/s/ WILLIAM L. COHEN Director March 29, 2007
-------------------------
WILLIAM L. COHEN
/s/ MARTIN A. FISCHER Director March 29, 2007
-------------------------
MARTIN A. FISCHER
/s/ MOSES MARX Director March 29, 2007
-------------------------
MOSES MARX
/s/ RANDOLPH B. STOCKWELL Director March 29, 2007
--------------------------
RANDOLPH B. STOCKWELL
102