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, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 0-13649
Berkshire Bancorp Inc.
(Exact name of registrant as specified in its charter)
Delaware 94-2563513
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
160 Broadway, New York, New York 10038
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 791-5362
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.10 per share
(Title of Class)
Indicate by check mark 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 an accelerated filer (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, 2004: $57,816,584.
Number of shares of Common Stock outstanding as of March 24, 2005: 6,759,675.
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 our wholly-owned banking subsidiary,
The Berkshire Bank (the "Bank"), a New York State chartered commercial bank.
We file annual, quarterly and current reports, proxy statements and
other information with the Securities and Exchange Commission (the "SEC"). You
may read and copy our reports or other filings made with the SEC at the SEC's
Public Reference Room, located at 450 Fifth Street, N.W., Washington, DC 20549.
You can also access information that we file electronically on the SEC's website
at WWW.SEC.GOV.
We do not presently have a website. However, as soon as practicable
after filing with or furnishing to the SEC, we will provide at no cost, paper or
electronic copies of our Annual Reports on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K and amendments to those reports. Requests
should be directed to:
Berkshire Bancorp Inc.
Investor Relations
160 Broadway
New York, NY 10038
2
Stock Split and Stock Dividend. At the Annual Meeting of Stockholders
held on May 18, 2004, the Company's stockholders approved an amendment to the
Company's Certificate of Incorporation effecting a one-for-ten reverse stock
split of the Company's issued and outstanding Common Stock (the "Reverse
Split"). Following the effectiveness of the Reverse Split, the Company's Board
of Directors declared a thirty-for-one forward stock split in the form of a
stock dividend in Common Stock (the "Stock Dividend) which became effective
immediately. The Company paid approximately $463,000 to purchase fractional
shares from stockholders as part of the Reverse Split. The Company's Common
Stock began trading on May 19, 2004 giving effect to these transactions.
Trust Preferred Securities. As of May 18 2004, the Company established
Berkshire Capital Trust I, a Delaware statutory trust, ("BCTI"). The Company
owns all the common capital securities of BCTI. BCTI issued $15.0 million of
preferred capital securities to investors in a private transaction and invested
the proceeds, combined with the proceeds from the sale of BCTI's common capital
securities, in the Company through the purchase of $15.464 million aggregate
principal amount of Floating Rate Junior Subordinated Debentures (the
"Debentures") issued by the Company. The Debentures, the sole assets of BCTI,
mature on July 23, 2034 and bear interest at a floating rate, three month LIBOR
plus 2.70%.
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, its
agencies, and business corporations, and mortgage-backed securities. The Bank
currently operates from five deposit-taking offices in New York City and four
deposit- taking offices in Orange and Sullivan Counties, New York. In July 1995,
the Bank opened a branch in Brooklyn, in January 2001, the Bank opened a branch
in downtown Manhattan and in March 2001, as a result of the merger with Goshen
Bank, the Bank acquired two branches in Goshen, NY, a branch in Harriman, NY and
a branch in Bloomingburg, NY. These branches provide the Bank with customary
retail banking offices. On March 22, 2001, the Company purchased a parcel of
land and building located in mid-town Manhattan for a total purchase price of
$3.49 million in cash. In January 2003, the Bank relocated its main office to
and opened a branch at this mid-town Manhattan location. The Bank opened two
additional branches in Brooklyn, New York during 2003.
The Bank's principal loan types are residential and commercial mortgage
loans and commercial non-mortgage loans, both unsecured and secured by personal
property. The Bank's revenues come principally from interest on loans and
investment securities. The Bank's primary sources of funds are deposits and
proceeds from principal and interest payments on loans and investment
securities.
Operating Plan. The Bank's operating plan concentrates on obtaining
deposits from a variety of businesses, professionals and retail customers and
investing those funds in conservatively underwritten loans. Due to the Bank's
underwriting criteria, its deposits have significantly exceeded the level of
satisfactory loans available for investment in recent years. Hence, the Bank
has, in recent years, invested a portion of its available funds in investment
and mortgage-backed securities.
Market Area. The Bank draws its customers principally from the New York
City metropolitan area and, since the merger with Goshen Bank in 2001, the
Villages of Goshen and Harriman, New York and their surrounding communities,
representing most of Orange County, NY. The Bank also has a branch in
Bloomingburg, New York, just over the border between Orange and Sullivan
Counties. Predominantly rural with numerous small towns, many residents of
Orange and Sullivan Counties work in New York City. Consequently, the health of
the economy in the New York City metropolitan area has, and will continue to
have a direct effect on the economic well being of residents and businesses in
these counties. 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
3
which are substantially larger in size than the Company. The Bank's competition
for loans comes principally from commercial banks, savings banks, savings and
loan associations, mortgage bankers, finance companies and other institutional
lenders. Many of the institutions which compete with the Bank have much greater
financial and marketing resources than the Bank. The Bank's principal methods of
competition include loan and deposit pricing, maintaining close ties with its
local communities, the quality of the personal service it provides, the types of
business services it provides, and other marketing programs.
Operations of the Bank. Reference is made to the information set forth
in Item 7 herein ("Management's Discussion and Analysis of Financial Condition
and Results of Operations") for information as to various aspects of the Bank's
operations, activities and conditions.
In March, 2001, pursuant to the terms of an Agreement and Plan of
Reorganization dated August 16, 2000 (the "Agreement"), we completed the merger
with GSB Financial Corporation, a Delaware corporation, a savings and loan
holding company ("GSB Financial"), and its wholly-owned subsidiary, Goshen
Savings Bank, a federal savings bank, chartered and existing under the laws of
the United States ("Goshen Bank"). GSB Financial was merged with and into
Berkshire and Goshen Bank was merged with and into The Berkshire Bank. Holders
of the common stock of GSB Financial received $20.75 in cash for each share of
common stock of GSB Financial held by them, or, in the alternative, at their
election, 0.6027 shares of Berkshire's common stock. As a result of this
transaction, 978,032 shares of GSB Financial common stock were converted into
589,460 shares of Berkshire common stock, and 974,338 shares of GSB Financial
common stock were purchased for $20.75 per share, totaling approximately $20.2
million.
This transaction was accounted for under the purchase method of
accounting. Goodwill of $7.5 million was recorded in the transaction. Effective
January 1, 2002, we adopted Statement of Financial Accounting Standard No. 142,
Goodwill and Intangible Assets which eliminates the amortization of goodwill and
requires an annual impairment test. As of December 31, 2004, we have completed
the impairment testing of our intangible assets, including goodwill. We did not
identify any impairment on our outstanding goodwill.
On November 7, 2002, we sold our 24.9% interest in a merchant credit
card processing company for $285,000, which was the initial purchase price we
paid for our interest in December 1999. We accounted for our interest in this
company under the equity method of accounting and have recorded approximately
$200,000 in net losses since December 1999. The final installment payment of
$25,000 was received during 2003.
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 one subsidiary, Berkshire Agency, Inc., a company engaged in the
title insurance agency business.
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 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.
4
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.
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, 2004 and 2003, 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.
5
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
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
ration of 4.0% to 5.0% or more. As of December 31, 2004 and 2003, the Bank's
Tier I leverage capital ratio was 8.6% and 7.0%, 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, 2004 and 2003, the Bank maintained a 23.3% and
18.3% Tier I risk-based capital ratio and a 24.1% and 19.1% total risk-based
capital ratio, respectively.
In addition to the foregoing regulatory capital requirements, the FDIC
Improvements Act of 1991 created a "prompt corrective action" framework, under
which decreases in a depository institution's capital category trigger various
supervisory actions. Pursuant to implementing regulations adopted by the FDIC,
for purposes of the prompt corrective action provisions, a state-chartered,
6
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, 2004 and 2003, 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 2003 and 2004 calendar years totaled approximately $14.38
million. However, the ability of Berkshire to pay future dividends and meet its
other financial obligations is not presently dependent upon the receipt of
dividends from the Bank.
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 shareholders who control the
Company are affiliates, within the meaning of the Federal Reserve Act, of the
Bank and its subsidiaries. The Bank's authority to engage in transactions with
its "affiliates" is limited by Sections 23A and 23B of the Federal Reserve Act.
Section 23A limits the aggregate amount of transactions with any individual
affiliate to 10% of the capital and surplus of the Bank and also limits the
aggregate amount of transactions with all affiliates to 20% of the Bank's
capital and surplus. Extensions of credit to affiliates must be secured by
certain specified collateral, and the purchase of low quality assets from
affiliates is generally prohibited. Section 23B provides that certain
transactions with affiliates, including loans and asset purchases, must be on
terms and under circumstances, including credit standards, that are at least as
favorable to the Bank as those prevailing at the time for comparable
transactions with non-affiliated companies. In the absence of comparable
transactions, such transactions may only occur under terms and circumstances,
including credit standards, that in good faith would be offered to or would
apply to non-affiliated companies.
The Bank may make loans to its and the Company's directors, executive
officers, and 10% stockholders, as well as to entities controlled by them,
subject to specific federal and state limits. Among other things, these loans
must (a) be made on terms that are substantially the same as, and follow credit
underwriting procedures that are not less stringent than, those prevailing for
comparable transactions with unaffiliated persons and that do not involve more
than the normal risk of repayment or present other unfavorable features and (b)
not exceed certain limitations on the amount of credit extended to such persons,
individually and in the aggregate, which limits are based, in part, on the
amount of the Bank's capital. In addition, extensions of credit in excess of
certain limits must be approved by the Bank's Board of Directors. However, the
Bank may make loans to executive officers, directors and principal stockholders
on preferential terms, provided the extension of credit is made pursuant to a
benefit or compensation program of the Bank that is widely available to
employees
7
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 (see Item. 2 - Properties for additional information).
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.
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 2004 and 2003 was equal to 0.0154% and 0.0168%, respectively,
of its insured deposits and which is recorded as a deposit insurance premium
expense for financial statement purposes. Beginning in 2005, the assessment was
revised to 0.0444% 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
8
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, 2004, 2003 and 2002, 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 2004, 2003 and 2002. (See Dividends in Item 5).
Employees. On March 24, 2005, Berkshire had one full time employee and
the Bank employed approximately 100 full time and 6 part time employees. The
Bank's employees are not represented by a collective bargaining unit, and the
Bank considers its relationship with its employees to be good.
ITEM 2. Properties.
The following are Berkshire's and the Bank's principal facilities as of
March 24, 2005:
Approximate Approximate
Floor Area Annual Lease
Location Operations (Sq. Ft.) Rent Expiration
------------ ----------------- --------- --------- ----------
New York, NY Executive Offices 1,500 $ 18,000 (1)(3)
New York, NY Main Bank Office
and Bank Branch 9,700 Owned Feb 2008
Brooklyn, NY Bank Branch 4,500 $ 167,100 March 2008
Brooklyn, NY Bank Branch 1,433 $ 35,925 March 2008
Brooklyn, NY Bank Branch 2,592 $ 105,060 December 2012
New York, NY Bank Branch 9,924 $ 275,000 June 2010 (2)(3)
Goshen, NY Bank Branch 10,680 Owned
Harriman, NY Bank Branch 1,623 Owned
Bloomingburg, NY Bank Branch 1,530 $ 20,360 June 2005
-------------
(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 the Bank or
its assets is 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 operations of the Bank.
ITEM 4. Submission of Matters to a Vote of Security Holders.
Not Applicable.
9
PART II
ITEM 5. Market for Registrant's Common Equity, Issuer Purchases of Equity
Securities and Related Stockholder Matters.
The Company's Common Stock trades on the Nasdaq National Market System
under the symbol BERK. The following table sets forth, for the periods
indicated, the high and low sales prices for the Company's Common Stock,
restated to reflect the one-for-ten reverse stock split and thirty-for-one
forward stock split which occurred on May 18, 2004, as reported by NASDAQ.
Fiscal Year Ended December 31, 2004 High Low
----------------------------------- ------ ----
January 1, 2004 to March 31, 2004 19.67 16.33
April 1, 2004 to June 30, 2004 19.33 15.00
July 1, 2004 to September 30, 2004 17.40 15.02
October 1, 2004 to December 31, 2004 20.50 16.10
Fiscal Year Ended December 31, 2003 High Low
----------------------------------- ------ ----
January 1, 2003 to March 31, 2003 11.48 10.62
April 1, 2003 to June 30, 2003 13.17 10.83
July 1, 2003 to September 30, 2003 14.83 11.67
October 1, 2003 to December 31, 2003 17.00 13.83
As of the close of business on March 24, 2005, there were approximately
1,740 holders of record of the Company's Common Stock.
Dividends
For the fiscal years ended December 31, 2004, 2003 and 2002, 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 2004, 2003 and 2002.
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
one-for-ten reverse stock split and thirty-for-one forward stock split which
occurred on May 18, 2004, as follows:
Per Share
Declaration Date Record Date Payment Date Amount
----------------------------- ------------------------- ------------------------ ---------------
April 8, 2002 April 23, 2002 April 30, 2002 $ .03
October 4, 2002 October 21, 2002 October 29, 2002 $ .04
April 8, 2003 April 23, 2003 April 30, 2003 $ .04
October 3, 2003 October 21, 2003 October 29, 2003 $ .05
April 1, 2004 April 19, 2004 April 28, 2004 $ .05
October 5, 2004 October 22, 2004 October 29, 2004 $ .06
The declaration, payment and amount of such dividends in the future are
within the discretion of the Board of Directors and will depend upon our
earnings, capital requirements, financial condition and other relevant factors.
Equity Compensation Plans
See Part III, Item 12 for information concerning the Company's equity
compensation plans.
10
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, 2004,
2003, 2002, 2001 and 2000. 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,
-----------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
(Dollars in thousands,except per share data)
Balance Sheet Data:
Total Assets $972,649 $905,669 $683,738 $536,365 $244,023
Loans, net 284,052 292,163 273,182 250,010 74,515
Investment securities 631,592 569,848 371,458 242,579 117,060
Goodwill, net 18,549 18,549 18,549 18,438 11,543
Deposits 619,888 604,255 473,818 338,776 137,647
Stockholders' equity 107,619 103,490 98,525 95,992 79,107
Statement of Operations Data:
Interest income 40,008 34,426 32,242 24,941 14,019
Interest expense 15,916 13,647 13,416 11,877 5,184
-------- -------- -------- -------- --------
Net interest income before
provision for loan losses 24,092 20,779 18,826 13,064 8,835
Provision for loan losses 180 240 387 287 55
-------- -------- -------- -------- --------
Net interest income 23,912 20,539 18,439 12,777 8,780
Investment securities gains 793 2,746 1,539 637 13,288
Other income 1,026 1,237 748 786 1,330
Other expenses 12,095 11,463 10,780 7,838 3,829
Amortization of goodwill -- -- -- 935 635
-------- -------- -------- -------- --------
Income before income taxes 13,636 13,059 9,946 5,427 18,934
Provision for income taxes 6,134 5,644 4,349 2,128 6,868
-------- -------- -------- -------- --------
Net income $ 7,502 $ 7,415 $ 5,597 $ 3,299 $ 12,066
======== ======== ======== ======== ========
Net income per share:
Basic $ 1.12 $ 1.12 $ .81 $ .47 $ 1.92
======== ======== ======== ======== ========
Diluted $ 1.10 $ 1.10 $ .81 $ .47 $ 1.92
======== ======== ======== ======== ========
Cash dividends per
common share $ .11 $ .09 $ .07 $ .08 $ .21
======== ======== ======== ======== ========
Selected Operating Ratios
Return on average assets 0.8% 0.9% 0.9% 0.8% 5.8%
Return on average equity 7.2% 7.2% 5.9% 3.5% 14.9%
Net interest margin 2.6% 2.7% 3.3% 3.6% 4.7%
Average equity/average assets 11.0% 12.7% 15.6% 23.8% 39.1%
Allowance for loan
losses/total loans 1.0% 0.9% 0.8% 0.8% 1.5%
(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.
11
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, 2004, 2003 and 2002. All references to earnings per share, unless stated
otherwise, refer to earnings per diluted share. References to per share amounts
for the fiscal years ended December 31, 2003 and 2002 have been revised to
reflect the one-for-ten reverse stock split and thirty-for-one forward stock
split in the form of a 3000% stock dividend which occurred on May 18, 2004. The
discussion should be read in conjunction with the consolidated financial
statements and related notes (Notes located in Item 8 herein). Reference is also
made to Part I, Item 1 "Business" herein.
Segments
Management has determined that the Company through its wholly owned
bank subsidiary, the Bank, operates in one business segment, community banking.
The Bank's principal business activity consists of gathering deposits from the
general public and investing those deposits in residential and commercial
mortgage loans and commercial non-mortgage loans, both unsecured and secured by
personal property. In addition, the Bank invests those deposits in debt
obligations issued by the U.S. Government, its agencies, business corporations
and mortgage-backed securities.
General
Stock Split and Stock Dividend. At the Annual Meeting of Stockholders held on
May 18, 2004, the Company's stockholders approved an amendment to the Company's
Certificate of Incorporation effecting a one-for-ten reverse stock split of the
Company's issued and outstanding Common Stock (the "Reverse Split"). Following
the effectiveness of the Reverse Split, the Company's Board of Directors
declared a thirty-for-one forward stock split in the form of a stock dividend in
Common Stock (the "Stock Dividend) which became effective immediately. The
Company paid approximately $463,000 to purchase fractional shares from
stockholders as part of the Reverse Split. The Company's Common Stock began
trading on May 19, 2004 giving effect to these transactions.
Trust Preferred Securities. As of May 18 2004, the Company established Berkshire
Capital Trust I, a Delaware statutory trust, ("BCTI"). The Company owns all the
common capital securities of BCTI. BCTI issued $15.0 million of preferred
capital securities to investors in a private transaction and invested the
proceeds, combined with the proceeds from the sale of BCTI's common capital
securities, in the Company through the purchase of $15.464 million aggregate
principal amount of Floating Rate Junior Subordinated Debentures (the
"Debentures") issued by the Company. The Debentures, the sole assets of BCTI,
mature on July 23, 2034 and bear interest at a floating rate, three month LIBOR
plus 2.70%.
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
12
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 each defined reporting unit. A fair value is
determined for each reporting unit based on at least one of three various market
valuation methodologies. If the fair values of the reporting units exceed their
book values, no write-down of recorded goodwill is necessary. If the fair value
of the reporting unit is less, an expense may be required on the Company's books
to write down the related goodwill to the proper carrying value. As of December
31, 2004, the Company completed its annual impairment testing, which determined
that no impairment write-offs were necessary.
The Company recognizes deferred tax assets and liabilities for the
future tax effects of temporary differences, net operating loss carryforwards
and tax credits. Deferred tax assets are subject to management's judgment based
upon available evidence that future realization is more likely than not. If
management determines that the Company may be unable to realize all or part of
net deferred tax assets in the future, a direct charge to income tax expense may
be required to reduce the recorded value of the net deferred tax asset to the
expected realizable amount.
Discussion of Financial Condition and Results of Operations
Overview
Fiscal Year Ended December 31, 2004 Compared to Fiscal Year Ended
December 31, 2003. Net income was $7.50 million, or $1.10 per diluted share, for
the fiscal year ended December 31, 2004, compared to $7.42 million, or $1.10 per
diluted share, for the fiscal year ended December 31, 2003, an increase of
$87,000 or 1.17%. Investment securities and total assets increased by 10.84% and
7.40%, respectively, and loans decreased by 2.78%.
Fiscal Year Ended December 31,
------------------------------------------------
2004 2003 %
Inc/(Dec)
(In millions, except per share data)
Total Assets $972.6 $905.7 7%
Loans, net 284.1 292.2 (3)%
Investment Securities 631.6 569.8 11%
Total Liabilities 865.0 802.2 8%
Deposits 619.9 604.3 3%
Borrowings 238.8 192.1 24%
Stockholders' Equity 107.6 103.5 4%
Total Income 41.8 38.4 9%
Interest Income 40.0 34.4 16%
Total Expense 28.0 25.4 10%
Interest Expense 15.9 13.6 17%
Net Interest Income 24.1 20.8 16%
Net Income 7.5 7.4 1%
Diluted Income Per Share 1.10 1.10 0%
Bank Branches 9 9 -
13
Fiscal Year Ended December 31, 2003 Compared to Fiscal Year Ended
December 31, 2002. Net income was $7.42 million, or $1.10 per diluted share, for
the fiscal year ended December 31, 2003, compared to $5.60 million, or $.81 per
diluted share, for the fiscal year ended December 31, 2002, an increase of
32.48%. Investment securities, loans and total assets increased by 53.38%, 6.95%
and 32.46%, respectively. Two new branches were opened in Brooklyn, New York
during 2003 making a total of nine bank branches in operation at years' end.
Fiscal Year Ended December 31,
----------------------------------------------
2003 2002 % Inc.
(In millions, except per share data)
Total Assets $905.7 $683.7 32%
Loans, net 292.2 273.2 7%
Investment Securities 569.8 371.5 53%
Total Liabilities 802.2 585.2 37%
Deposits 604.3 473.8 28%
Borrowings 192.1 104.4 84%
Stockholders' Equity 103.5 98.5 5%
Total Income 38.4 34.5 11%
Interest Income 34.4 32.2 7%
Total Expense 25.4 24.6 3%
Interest Expense 13.6 13.4 1%
Net Interest Income 20.8 18.8 11%
Net Income 7.4 5.6 32%
Diluted Income Per Share 1.10 0.81 36%
Bank Branches 9 7 -
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.
14
The Company's average balances, interest, and average yields are set forth on
the following table (in thousands, except percentages):
Twelve Months Ended Twelve Months Ended
December 31, 2004 December 31, 2003
---------------------------------------- -------------------------------------------
Interest Interest
Average and Average Average and Average
Balance Dividends Yield/Rate Balance Dividends Yield/Rate
------- --------- ---------- ------- --------- ----------
INTEREST-EARNING ASSETS:
Loans (1) $ 290,774 $ 18,825 6.47% $ 291,586 $ 19,061 6.54%
Investment securities 620,511 21,120 3.40 470,412 15,321 3.26
Other (2)(5) 4,376 63 1.44 3,946 44 1.12
--------- -------- ---- --------- -------- ----
Total interest-earning assets 915,661 40,008 4.37 765,944 34,426 4.49
---- ----
Noninterest-earning assets 40,592 37,844
--------- ---------
Total Assets $ 956,253 $ 803,788
========= =========
INTEREST-BEARING LIABILITIES:
Interest bearing deposits 272,219 3,809 1.39 201,817 2,593 1.28
Time deposits 309,968 6,024 1.94 333,112 7,537 2.26
Other borrowings 223,208 6,083 2.73 125,609 3,517 2.80
--------- -------- ---- --------- -------- ----
Total interest-bearing
liabilities 805,395 15,916 1.98 660,538 13,647 2.07
-------- ---- -------- ----
Demand deposits 38,896 32,592
Noninterest-bearing liabilities 7,163 8,318
Stockholders' equity (5) 104,799 102,340
--------- ---------
Total liabilities and
stockholders' equity $ 956,253 $ 803,788
========= =========
Net interest income $ 24,092 $ 20,779
======== ========
Interest-rate spread (3) 2.39% 2.42%
==== ====
Net interest margin (4) 2.63% 2.71%
==== ====
Ratio of average interest-
earning assets to average
interest bearing liabilities 1.14 1.16
========= =========
Twelve Months Ended
December 31, 2002
------------------------------------------
Interest
Average and Average
Balance Dividends Yield/Rate
------- --------- ----------
INTEREST-EARNING ASSETS:
Loans (1) $ 265,961 $ 18,723 7.04%
Investment securities 298,008 13,383 4.49
Other (2)(5) 8,479 136 1.60
--------- -------- ----
Total interest-earning assets 572,448 32,242 5.63
----
Noninterest-earning assets 36,541
---------
Total Assets $ 608,989
=========
INTEREST-BEARING LIABILITIES:
Interest bearing deposits 116,331 1,644 1.41
Time deposits 273,452 8,766 3.21
Other borrowings 86,210 3,006 3.49
--------- -------- ----
Total interest-bearing
liabilities 475,993 13,416 2.82
-------- ----
Demand deposits 30,102
Noninterest-bearing liabilities 7,586
Stockholders' equity (5) 95,308
---------
Total liabilities and
stockholders' equity $ 608,989
=========
Net interest income $ 18,826
========
Interest-rate spread (3) 2.81%
====
Net interest margin (4) 3.29%
====
Ratio of average interest-
earning assets to average
interest bearing liabilities 1.20
=========
----------------------
(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.
15
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, 2004
Versus
Twelve Months Ended December 31, 2003
Increase (Decrease) Due To
-------------------------------------------
Rate Volume Total
---- ------ -----
Interest-earning assets:
Loans $ (204) $ (32) $ (236)
Investment securities 659 5,140 5,799
Other 13 6 19
------- ------- -------
Total 468 5,114 5,582
------- ------- -------
Interest-bearing
liabilities:
Deposit accounts:
Interest bearing deposits 222 994 1,216
Time deposits (1,066) (447) (1,513)
Other borrowings (88) 2,654 2,566
------- ------- -------
Total (932) 3,201 2,269
------- ------- -------
Net interest income $ 1,400 $ 1,913 $ 3,313
======= ======= =======
Twelve Months Ended December 31, 2003
Versus
Twelve Months Ended December 31, 2002
Increase (Decrease) Due To
-------------------------------------------
Rate Volume Total
---- ------ -----
Interest-earning assets:
Loans $(1,330) $ 1,668 $ 338
Investment securities (3,278) 5,216 1,938
Other (41) (51) (92)
------- ------- -------
Total (4,649) 6,833 2,184
------- ------- -------
Interest-bearing
liabilities:
Deposit accounts:
Interest bearing deposits (151) 1,100 949
Time deposits (2,598) 1,369 (1,229)
Other borrowings (595) 1,106 511
------- ------- -------
Total (3,344) 3,575 231
------- ------- -------
Net interest income $(1,305) $ 3,891 $ 1,953
======= ======= =======
16
Interest Rate Risk
Fluctuations in market interest rates can have a material effect on the
Company's net interest income because the yields earned on loans and investments
may not adjust to market rates of interest with the same frequency, or with the
same speed, as the rates paid by the Bank on its deposits.
Most of the Bank's deposits are either interest-bearing demand deposits
or short term certificates of deposit and other interest-bearing deposits with
interest rates that fluctuate as market rates change. Management of the Bank
seeks to reduce the risk of interest rate fluctuations by concentrating on loans
and securities investments with either short terms to maturity or with
adjustable rates or other features that cause yields to adjust based upon
interest rate fluctuations. In addition, to cushion itself against the potential
adverse effects of a substantial and sustained increase in market interest
rates, the Bank has purchased off balance sheet interest rate cap contracts
which generally provide that the Bank will be entitled to receive payments from
the other party to the contract if interest rates exceed specified levels. These
contracts are entered into with major financial institutions.
We seek to maximize our net interest margin within an acceptable level
of interest rate risk. Interest rate risk can be defined as the amount of the
forecasted net interest income that may be gained or lost due to favorable or
unfavorable movements in interest rates. Interest rate risk, or sensitivity,
arises when the maturity or repricing characteristics of assets differ
significantly from the maturity or repricing characteristics of liabilities.
Provision for Loan Losses
The Company maintains an allowance for loan losses at a level deemed
sufficient to absorb losses, which are inherent in the loan portfolio at each
balance sheet date. Management reviews the adequacy of the allowance on at least
a quarterly basis to ensure that the provision for loan losses has been charged
against earnings in an amount necessary to maintain the allowance at a level
that is appropriate based on management's assessment of estimated losses. The
Company's methodology for assessing the appropriateness of the allowance for
loan losses consists of several key elements. These elements include a specific
allowance for loan watch list classified loans, an allowance based on historical
trends, an additional allowance for special circumstances, and an unallocated
portion. The Company consistently applies the following comprehensive
methodology.
The allowance for loan watch list classified loans addresses those
loans maintained on the Company's loan watch list which are assigned a rating of
substandard, doubtful, or loss. Substandard loans are those with a well-defined
weakness or a weakness, which jeopardizes the repayment of the debt. A loan may
be classified as substandard as a result of impairment of the borrower's
financial condition and repayment capacity. Loans for which repayment plans have
not been met or collateral equity margins do not protect the Company may also be
classified as substandard. Doubtful loans have the characteristics of
substandard loans with the added characteristic that collection or liquidation
in full, on the basis of presently existing facts and conditions, is highly
improbable. Although the possibility of loss is extremely high for doubtful
loans, the classification of loss is deferred until pending factors, which might
improve the loan, have been determined. Loans rated as doubtful in whole or in
part are placed in nonaccrual status. Loans which are classified as loss are
considered uncollectible and are charged to the allowance for loan losses. There
were $343,000, $109,000 and $59,000 of classified loans at December 31, 2004,
2003 and 2002, respectively.
Loans on the loan watch list may also be impaired loans, which are
defined as nonaccrual loans or troubled debt restructurings, which are not in
compliance with their restructured terms. Each of the classified loans on the
loan watch list is individually analyzed to determine the level of the potential
loss in the loan under the current circumstances. The specific reserve
established for these criticized and impaired loans is based on careful analysis
of the loan's performance, the related collateral value, cash flow
considerations and the financial capability of any guarantor. The allowance for
loan watch list classified loans is equal to the total amount of potential
unconfirmed losses for
17
the individual classified loans on the watch list. Loan watch list loans are
managed and monitored by assigned Senior Management.
The allowance based on historical trends uses charge-off experience of
the Company to estimate potential unconfirmed losses in the balances of the loan
and lease portfolios. The historical loss experience percentage is based on the
charge-off history. Historical loss experience percentages are applied to all
non-classified loans to obtain the portion of the allowance for loan losses
which is based on historical trends. Before applying the historical loss
experience percentages, loan balances are reduced by the portion of the loan
balances which are subject to guarantee by a government agency. Loan balances
are also adjusted for unearned discount on installment loans.
The Company also maintains an unallocated allowance. The unallocated
allowance is used to cover any factors or conditions which may cause a potential
loan loss but are not specifically identifiable. It is prudent to maintain an
unallocated portion of the allowance because no matter how detailed an analysis
of potential loan losses is performed these estimates by definition lack
precision. Management must make estimates using assumptions and information,
which is often subjective and changing rapidly.
Since all identified losses are immediately charged off, no portion of
the allowance for loan losses is restricted to any individual loan or groups of
loans, and the entire allowance is available to absorb any and all loan losses.
A loan is placed in a nonaccrual status at the time when ultimate
collectibility of principal or interest, wholly or partially, is in doubt. Past
due loans are those loans which were contractually past due 90 days or more as
to interest or principal payments but are well secured and in the process of
collection. Renegotiated loans are those loans which terms have been
renegotiated to provide a reduction or deferral of principal or interest as a
result of the deteriorating financial position of the borrower.
Results of Operations Fiscal Year Ended December 31, 2004 Compared to Fiscal
Year Ended December 31, 2003.
General.
References to per share amounts below, unless stated otherwise, refer to diluted
shares. References to per share amounts for the fiscal years ended December 31,
2003 have been revised to reflect the one-for-ten reverse stock split and
thirty-for-one forward stock split in the form of a stock dividend which
occurred on May 18, 2004.
Net Income. Net income for the fiscal year ended December 31, 2004 was $7.50
million, or $1.10 per share, as compared to $7.42 million, or $1.10 per share,
for the fiscal year ended December 31, 2003.
The Company's net income is largely dependent on interest rate levels,
the demand for the Company's loan and deposit products and the strategies
employed to manage the interest rate and other risks inherent in the banking
business. From June 2003 through June 30, 2004, interest rates, as measured by
the prime rate, remained constant at 4.00%. On July 1, 2004, inflation fighting
actions taken by the Federal Reserve Board resulted in a 25 basis point increase
in the prime rate to 4.25%, the first such increase in more than four years.
Similar 25 basis point moves taken by the Federal Reserve Board in August,
September, November and December of 2004, and February 2005 have moved the prime
rate to its present level of 5.50%.
Net Interest Income. The Company's primary source of revenue is net interest
income, or the difference between interest income on earning assets, such as
loans and investment securities, and interest expense on interest-bearing
liabilities such as deposits and borrowings.
For the fiscal year ended December 31, 2004, net interest income
increased by $3.31 million, or 15.94%, to $24.09 million from $20.78 million for
the fiscal year ended December 31, 2003. The increase in net interest income was
the result of a 19.55% growth in the average amount of interest-earning assets
to $915.66 million at the end of 2004 from $765.94 million at the end of 2003,
partially
18
offset by the 21.93% growth in the average amount of interest-bearing
liabilities to $805.40 million from $660.54 million at December 31, 2004 and
2003, respectively, as well as the interest-rate spread or the difference
between the average yield on interest-earning assets and the average cost of
interest-bearing liabilities.
During fiscal 2004, the average yield on interest-earning assets fell
to 4.37% from 4.49% in fiscal 2003, a decline of 2.67%, while the average cost
of interest-bearing liabilities fell to 1.98% from 2.07%, a decline of 4.35% The
interest-rate spread decreased to 2.39% during fiscal 2004 from 2.42% during
fiscal 2003.
If interest rates remain at current levels or increase slowly over
time, we expect to see only moderate pressure on the Company's interest-rate
spread and net interest income. Investment securities in our portfolio that have
been sold, matured or called by the issuer during fiscal 2003 and 2004 have been
replaced with securities carrying somewhat lower yields and, by design, shorter
maturities to hedge against a rising interest rate environment. Rates paid on
deposit accounts are likely to increase in a rising rate environment due to
competition for deposits in the market place. The cost of borrowed funds with
floating rather than fixed interest rates will increase as well.
Net Interest Margin. Net interest margin, or annualized net interest income as a
percentage of average interest-earning assets, declined to 2.63% in fiscal 2004
from 2.71% in fiscal 2003. We seek to secure and retain customer deposits with
competitive products and rates, while making strategic use of the prevailing
interest rate environment to borrow funds at what we believe to be attractive
rates. We invest such deposits and borrowed funds in a prudent mix of fixed rate
and adjustable rate loans, investment securities and short-term interest-earning
assets which provided an aggregate average yield of 4.37% and 4.49% in fiscal
2004 and 2003, respectively.
The average amount of loans decreased slightly to $290.77 million in
fiscal 2004 from $291.59 million in fiscal 2003, as did the average yield on the
loan portfolio which declined to 6.47% in fiscal 2004 from 6.54% in fiscal 2003.
During periods of low and stable interest rates, as was the case during 2003,
borrowers gravitate towards fixed-rate loans to lock in a low interest rate,
whereas adjustable rate loans are generally preferred when interest rates are
trending higher. One-to-four family mortgage loans, approximately 54% and 57% of
our loan portfolio at December 31, 2004 and 2003, respectively, are particularly
sensitive to changes in interest rates.
The average amount of investment securities increased by $150.10
million to $620.51 million in fiscal 2004 from $470.41 million in fiscal 2003.
The average yield on investment securities improved by 14 basis points, to 3.40%
in 2004 from 3.26% in 2003 and are likely to continue to increase in a rising
interest rate environment.
Interest Income. Total interest income for the fiscal year ended December 31,
2004 increased by $5.58 million, or 16.21%, to $40.01 million from $34.43
million for the fiscal year ended December 31, 2003. The increase in interest
income was primarily due to the growth in the average amount of total
interest-earning assets. Loans contributed $18.83 million of interest income in
fiscal 2004, a decline of $236,000 from the $19.06 million of interest income
contributed in fiscal 2003. Investment securities contributed $21.12 million of
interest income in fiscal 2004, an increase of 37.85% over the $15.32 million of
interest income earned on loans in fiscal 2003.
Fiscal 2004 Fiscal 2003
----------------------- -----------------------
Interest % of Interest % of
Income Total Income Total
(In thousands, except percentages)
Loans $18,825 47.05% $19,061 55.37%
Investment Securities 21,120 52.79 15,321 44.50
Other 63 0.16 44 0.13
------- ------ ------- ------
Total Interest Income $40,008 100.00% $34,426 100.00%
19
Loans, which are inherently risky and therefore command a higher return
than our conservative portfolio of investment securities, declined to 31.76% of
our total average interest-earning assets in fiscal 2004 from 38.07% in fiscal
2003. While we actively seek to originate new loans with qualified borrowers who
meet the Bank's underwriting standards, our strategy has been to maintain those
standards, sacrificing some current income to avoid possible large future losses
in the loan portfolio.
Fiscal 2004 Fiscal 2003
------------------- --------------------
Average % of Average % of
Amount Total Amount Total
(In thousands, except percentages)
Loans $290,774 31.76% $291,586 38.07%
Investment Securities 620,511 67.77 470,412 61.42
Other 4,376 0.47 3,946 0.51
-------- ------ -------- ------
Total Interest-Earning Assets $915,661 100.00% $765,944 100.00%
Interest Expense. Total interest expense for the fiscal year ended December 31,
2004 increased by $2.27 million, or 16.63%, to $15.92 million from $13.65
million for the fiscal year ended December 31, 2003. The increase in interest
expense was due primarily to the growth in the average amount of
interest-bearing liabilities, partially offset by the decline in the average
rate paid on such liabilities, 1.98% and 2.07% in fiscal years 2004 and 2003,
respectively. As rates move higher, interest expense will increase as we price
our deposit products to meet the competition and the adjustable rates paid on
other borrowings increase as well. In May 2004, we sold $15.46 million of
floating rate junior subordinated debentures which mature in 2034 and used the
net proceeds to augment the Bank's capital. The additional interest expense on
these debentures, which are included in other borrowings, was $463,000 during
fiscal 2004.
Fiscal 2004 Fiscal 2003
----------------------- -----------------------
Interest % of Interest % of
Income Total Income Total
(In thousands, except percentages)
Interest-Bearing Deposits $ 3,809 23.93% $ 2,593 19.00%
Time Deposits 6,024 37.85 7,537 55.23
Other Borrowings 6,083 38.22 3,517 25.77
------- ------ ------- ------
Total Interest Expense $15,916 100.00% $13,647 100.00%
Fiscal 2004 Fiscal 2003
------------------- -------------------
Average % of Average % of
Amount Total Amount Total
(In thousands, except percentages)
Interest-Bearing Deposits $272,219 33.80% $201,817 30.55%
Time Deposits 309,968 38.49 333,112 50.43
Other Borrowings 223,208 27.71 125,609 19.02
-------- ------ -------- ------
Total Interest-Bearing Liabilities $805,395 100.00% $660,538 100.00%
Non-Interest Income. Non-interest income consists primarily of realized gains on
sales of marketable securities and service fee income. For the fiscal year ended
December 31, 2004, total non-interest income decrease by $2.16 million to $1.82
million from $3.98 million for the fiscal year ended December 31, 2003. In 2003,
we recorded gains of $2.75 million on the sales and issuer redemptions of
investment securities. In 2004, such gains amounted to $793,000. Service charges
on deposit accounts decreased by $120,000 to $520,000 in fiscal 2004 from
$640,000 in fiscal 2003. The decline is primarily due to marketing efforts
introducing new deposit products, which includes the waiver of such fees for a
period of time to attract new customers.
20
Fiscal 2004 Fiscal 2003
------------------------- -------------------------
Non-Interest % of Non-Interest % of
Income Total Income Total
(In thousands, except percentages)
Service Charges on Deposits $ 520 28.59% $ 640 16.07%
Investment Securities gains 793 43.60 2,746 68.94
Other 506 27.81 597 14.99
------ ------ ------ ------
Total Non-Interest Income $1,819 100.00% $3,983 100.00%
Non-Interest Expense. Non-interest expense includes salaries and employee
benefits, occupancy and equipment expenses, legal and professional fees and
other operating expenses associated with the day-to-day operations of the
Company. Total non-interest expense for the year ended December 31, 2004
increased by $632,000, or 5.51%, to $12.10 million from $11.46 million for the
year ended December 31, 2003. The largest component of non-interest expense are
salaries and employee benefits which increased by $1.01 million, or 17.25%, to
$6.89 million in fiscal 2004 from $5.87 million in fiscal 2003. The increase is
due to the additional staffing of our two new Brooklyn branches which opened in
April and June of 2003 and the addition of personnel in our internal control and
compliance departments.
Fiscal 2004 Fiscal 2003
---------------------- ---------------------
Non-Interest % of Non-Interest % of
Expense Total Expense Total
(In thousands, except percentages)
Salaries and Employee Benefits $ 6,886 56.93% $ 5,873 51.24%
Net Occupancy Expense 1,538 12.72 1,611 14.05
Equipment Expense 357 2.95 397 3.46
FDIC Assessment 115 0.95 80 0.70
Data Processing Expense 157 1.30 183 1.60
Other 3,042 25.15 3,319 28.95
------- ------ ------- ------
Total Non-Interest Expense $12,095 100.00% $11,463 100.00%
Provision for Income Tax. During the years ended December 31, 2004 and 2003, we
recorded recorded income tax expense of $6.13 million and $5.64 million,
respectively. The tax provisions for federal, state and local taxes recorded for
2004 and 2003 represent effective tax rates of 44.98% and 43.22%, respectively.
Common Stock Repurchases
On May 15, 2003, The Company's Board of Directors authorized the
purchase of up to an additional 450,000 shares of its Common Stock in the open
market, from time to time, depending upon prevailing market conditions, thereby
increasing the maximum number of shares which may be purchased by the Company
from 1,950,000 shares of Common Stock to 2,400,000 shares of Common Stock. Since
1990 through December 31, 2003, the Company has purchased a total of 1,844,646
shares of its Common Stock. During fiscal year 2004, we purchased a total of
4,263 shares and at December 31, 2004, there were 551,091 shares of Common Stock
which may yet be purchased under our stock repurchase plan. The following table
sets forth information with respect to such purchases during the periods
indicated.
Fiscal Year 2004
Number of Average Price
Shares Paid Per
Purchased Share
--------------- --------------------
January 4,263 $ 16.33
February - March -- --
April - June -- --
July - September -- --
October - December -- --
21
Results of Operations Fiscal Year Ended December 31, 2003 Compared to Fiscal
Year Ended December 31, 2002.
General.
References to per share amounts below, unless stated otherwise, refer to diluted
shares. References to per share amounts for the fiscal years ended December 31,
2003 and 2002 have been revised to reflect the one-for-ten reverse stock split
and thirty-for-one forward stock split in the form of a 3000% stock dividend
which occurred on May 18, 2004.
Net Income. Net income for the fiscal year ended December 31, 2003 was $7.42
million, or $1.10 per share, as compared to $5.60 million, or $.81 per share,
for the fiscal year ended December 31, 2002.
Interest rates, as measured by the prime rate, began the year at 4.25%,
declined by 25 basis points in late June to 4.00% and remained at that level
through December 31, 2003. We have operated in a consistently declining interest
rate environment since May 2000 when the prime rate peaked at 9.50%, which has
also been a period of low inflation, stock market uncertainties, recession and
the aftermath of September 11, 2001.
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, 2003, net interest income
increased by $1.95 million, or 10.37%, to $20.78 million from $18.83 million for
the fiscal year ended December 31, 2002. The increase in net interest income was
the result of a 33.80% growth in the average amount of interest-earning assets
to $765.94 million at the end of 2003 from $572.45 million at the end of 2002,
partially offset by the 38.77% growth in the average amount of interest-bearing
liabilities to $660.54 million from $475.99 million at December 31, 2003 and
2002, respectively, as well as the difference between the yield on assets
compared to the cost of liabilities.
During fiscal 2003, the average yield on interest-earning assets fell
to 4.49% from 5.63% in fiscal 2002, a decline of 20.25%, while the average cost
of interest-bearing liabilities fell to 2.07% from 2.82%, a decline of 26.60%
The interest-rate spread, the difference between the average yield on interest-
earning assets and the average cost of interest bearing liabilities, eased by 39
basis points to 2.42% during fiscal 2003 from 2.81% during fiscal 2002.
Net Interest Margin. Net interest margin, or annualized net interest income as a
percentage of average interest-earning assets, declined to 2.71% in fiscal 2003
from 3.29% in fiscal 2002. 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, and to invest such funds in a prudent mix of loans and investment
securities. The average amounts of loans and investment securities increased by
$25.63 million and $172.40 million, respectively, to $291.59 million and $470.41
million, respectively, in the year ended December 31, 2003, from $265.96 million
and $298.01 million, respectively, in the year ended December 31, 2002.
The average yield on loans declined to 6.54% in 2003 from 7.04% in 2002
as older loans with higher rates, commercial and residential mortgage loans,
were paid off, matured, and/or refinanced at lower rates. During periods of low
and stable interest rates, as was the case during 2003, borrowers gravitate
towards fixed-rate loans to lock in a low interest rate, whereas adjustable rate
loans are generally preferred when interest rates are high. One-to-four family
mortgage loans, approximately 57% of our loan portfolio at December 31, 2003,
are particularly sensitive to changes in interest rates.
The average amounts of interest-bearing deposits and time deposits
increased by $85.49 million and $59.66 million, respectively, to $201.82 million
and $333.11 million, respectively, in fiscal year 2003, from $116.33 million and
$273.45 million, respectively, in fiscal year 2002. Borrowed funds increased by
22
$39.40 million to $125.61 million in 2003 from $86.21 million in the 2002.
During fiscal year 2003, the average rates paid on interest-bearing deposits,
time deposits and borrowed funds declined to 1.28%, 2.26% and 2.80%,
respectively, from 1.41%, 3.21% and 3.49%, respectively in fiscal year 2002.
Interest Income. Total interest income for the fiscal year ended December 31,
2003 increased by $2.18 million, or 6.77%, to $34.43 million from $32.24 million
for the fiscal year ended December 31, 2002. The increase was the result of the
33.80% increase in the average amount of total interest-earning assets to
$765.94 million in fiscal year 2003 from $572.45 million in fiscal 2002.
Interest income on loans and investment securities increased to $19.06 million
and $15.32 million, respectively, in fiscal year 2003, from $18.72 million and
$13.38 million, respectively in fiscal year 2003.
Interest Expense. Total interest expense for the fiscal year ended December 31,
2003 increased by $231,000, or 1.72%, to $13.65 million from $13.42 million for
the fiscal year ended December 31, 2002. The increase in interest expense was
due primarily to the 38.77% increase in the average amount of total
interest-bearing liabilities, all but offset by the 26.60% decline in the
average rate paid on such balances. Interest expense increased to $2.59 million
on interest-bearing deposits and decreased to $7.54 million on time deposits
during fiscal year 2003, from $1.64 million and $8.77 million, respectively,
during fiscal year 2002. Interest expense on borrowings, which are generally
invested in earning assets of similar maturities, increased to $3.52 million in
fiscal year 2003 from $3.01 million in fiscal year 2002.
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, 2003, total non-interest income increase by $1.70 million, or
74.16%, to $3.98 million from $2.29 million for the fiscal year ended December
31, 2002. Investment securities gains increased to $2.75 million in fiscal year
2003 from $1.54 million in fiscal 2002, as we sold securities during 2003,
realizing gains, and purchased new securities with shorter maturities. Service
charges on deposit accounts increased by $92,000 to $640,000 in fiscal year 2003
from $548,000 in fiscal year 2002.
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, 2003
increased by $683,000, or 6.34%, to $11.46 million from $10.78 million for the
year ended December 31, 2002. The increase was largely due to the $690,000
increase in salaries and employee benefits resulting from the additional
personnel required to operate our expanding business.
Provision for Income Tax. During the years ended December 31, 2003 and 2002, we
recorded income tax expense of $5.64 million and $4.35 million, respectively.
The tax provisions for federal, state and local taxes recorded for 2003 and 2002
represent effective tax rates of 43.22% and 43.73%, 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 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.
23
As required by the Statement of Financial Accounting Standard No. 115
("SFAS No. 115"), securities are classified into three categories: trading,
held-to-maturity and available-for-sale. Securities that are bought and held
principally for the purpose of selling them in the near term are classified as
trading securities and are reported at fair value with unrealized gains and
losses included in trading account activities in the statement of income.
Securities that the Bank has the positive intent and ability to hold to maturity
are classified as held-to-maturity and reported at amortized cost. All other
securities are classified as available-for-sale. Available-for-sale securities
are reported at fair value with unrealized gains and losses included, on an
after-tax basis, as a separate component of net worth. The Bank does not have a
trading securities portfolio and has no current plans to maintain such a
portfolio in the future. The Bank generally classifies all newly purchased debt
securities as available for sale in order to maintain the flexibility to sell
those securities if the need arises. The Bank has a limited portfolio of
securities classified as held to maturity, represented principally by securities
purchased a number of years ago.
Federal Home Loan Bank Stock. The Bank owns stock of the Federal Home
Loan Bank of New York (the "FHLBNY") which is necessary for it to be a member of
the FHLBNY. Membership requires the purchase of stock equal to 1% of the Bank's
residential mortgage loans. If the Bank borrows from the FHLBNY, the Bank must
own stock at least equal to 5% of its borrowings.
The following table sets forth the cost and fair value of
available-for- sale and held-to-maturity securities as of the dates indicated:
December 31,
---------------------------------------------------------------------------------------
2004 2003 2002
---------------------------- ---------------------------- --------------------------
Cost Fair Cost Fair Cost Fair
Value Value Value
------------- ------------ ------------ ------------- ------------ -----------
(In thousands)
Available-For-Sale
U.S. Treasury Notes $ 24,896 $ 24,722 $ 39,941 $ 39,847 $ 20,110 $ 20,213
U.S. Government Agencies 471,018 467,271 419,175 416,753 301,224 303,597
Mortgage-backed 109,822 109,330 93,875 97,448 6,256 6,262
securities
Corporate notes 21,089 21,627 1,570 1,662 3,878 4,076
Municipal securities 1,307 1,441 991 1,061
Marketable equity
securities and other 6,363 6,577 12,305 12,366 36,383 36,447
-------- -------- -------- -------- -------- --------
Total $634,495 $630,968 $567,857 $569,137 $367,851 $370,625
======== ======== ======== ======== ======== ========
Held-To-Maturity
U.S. Government Agencies $ 624 $ 633 $ 711 $ 715 $ 833 $ 835
-------- -------- -------- -------- -------- --------
Total $ 624 $ 633 $ 711 $ 715 $ 833 $ 835
======== ======== ======== ======== ======== ========
24
The following tables summarize the Company's available-for-sale and
held- to-maturity securities:
December 31, 2004
---------------------------------------------------
Weighted
Average
Yield Cost Fair Value
----------- ------------ -----------
(Dollars in thousands)
Available-For-Sale
U.S. Treasury Notes
Due within one year 1.63% $ 9,968 $ 9,926
Due after one year through five years 1.76 14,928 $ 14,796
-------- --------
24,896 24,722
-------- --------
U.S. Government Agencies Obligations
Due within one year 2.36 14,973 14,936
Due after one year through five years 3.25 170,493 169,620
Due after five years through ten years 4.26 184,348 182,567
Due after ten years 3.71 101,204 100,148
-------- --------
471,018 467,271
-------- --------
Municipal Obligations
Due after ten years 9.32 1,307 1,441
-------- --------
1,307 1,441
-------- --------
Mortgage-backed securities
Due after five years through ten years 4.16 22,571 22,298
Due after ten years 4.10 87,251 87,032
-------- --------
109,822 109,330
-------- --------
Corporate Notes
Due after one year through five years 7.18 3,036 3,135
Due after five years through ten years 6.54 6,210 6,151
Due after ten years 7.61 11,842 12,341
21,088 21,627
-------- --------
Common Stocks 2.43 329 470
Preferred Stocks 9.45 454 527
Money market funds 1.78 800 800
Federal Home Loan Bank Stock 0.00 4,780 4,780
-------- --------
6,363 6,577
-------- --------
$634,494 $630,968
======== ========
Held-To-Maturity
U.S. Government Agencies Obligations
Due after one year through five years 3.11 58 59
Due after five years through ten years 2.41 93 93
Due after ten years 6.18 473 481
-------- --------
$ 624 $ 633
======== ========
25
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, 2004, 2003 and 2002, the Company had total loans, net of
unearned income of $286.98 million, $294.76 million and $275.50 million,
respectively, and an allowance for loan losses of $2.93 million, $2.59 million,
and $2.32 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
26
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, 2004 and 2003,
approximately $151.20 million and $169.59 million, respectively, or 52.69% and
57.4%, 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, 2004 and 2003,
approximately 13% and 12%, respectively, of the Bank's residential one-to-four
family owner-occupied first mortgage portfolio were ARMs and approximately 87%
and 88%, 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.
27
At December 31, 2004, the Bank's total capital, net of goodwill and
loan loss reserves, was approximately $82.97 million and thus it was generally
not permitted to make loans to one borrower in excess of approximately $12.4
million, with an additional amount of approximately $8.3 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 $12.4
million. At December 31, 2004, 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.
The following tables set forth information concerning the Company's
loan portfolio by type of loan at the dates indicated:
December 31,
-------------------------------------------------------------------------------------
2004 2003 2002
-------------------------- ------------------------ -----------------------------
% of % of % of
Amount Total Amount Total Amount Total
------------- ---------- ----------- --------- ----------------- ---------
(Dollars in thousands)
Commercial and
professional loans $ 16,498 5.7 % $ 22,228 7.5 % $ 16,704 6.0 %
Secured by real estate
1 - 4 family 155,079 53.9 169,589 57.4 180,730 65.4
Multi family 4,600 1.6 6,608 2.2 8,958 3.2
Non-residential
(commercial) 109,597 38.1 94,956 32.2 65,809 23.8
Consumer 1,989 0.7 2,239 0.7 4,051 1.6
------- ----- ------- ----- ------- -----
Total loans 287,763 100.0 % 295,620 100.0 % 276,252 100.0 %
===== ===== =====
Less:
Allowance for
loan losses (2,927) (2,593) (2,315)
Unearned fees (784) (864) (755)
-------- -------- --------
Loans, net $284,052 $292,163 $273,182
======== ======== ========
28
December 31, 2001 December 31, 2000
----------------------- -------------------------
% of % of
Amount Total Amount Total
------ ----- ------ -----
(Dollars in thousands)
Commercial and
professional loans $ 19,130 7.6% $ 9,419 12.5%
Secured by real estate
1 - 4 family 165,195 65.5 25,677 34.0
Multi family 11,186 4.4 4,765 6.3
Non-residential (commercial) 51,893 20.6 34,968 46.2
Consumer 4,689 1.8 229 0.3
Other 140 0.1 565 0.7
-------- ----- --------
Total loans 252,233 100.0% 75,623 100.0%
===== =====
Less:
Allowance for loan losses (2,030) (1,108)
Unearned fees (193) (275)
-------- --------
Loans, net $250,010 $ 74,240
======== ========
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 $50,000 and $0 at December 31, 2004 and 2003, respectively.
December 31,
----------------------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ----
(Dollars in Thousands)
Nonaccrual loans:
Commercial and $ -- $ -- $ -- $ 9 $ --
professional loans
Consumer 1 -- -- -- --
Secured by real estate 342 109 59 -- --
------ ------ ------ ------ ------
Total nonaccrual loans 343 109 59 9 --
------ ------ ------ ------ ------
Accruing loans delinquent
90 days or more 50 -- -- -- --
Total nonperforming loans $ 393 $ 109 $ 59 $ 9 $ --
====== ====== ====== ====== ======
Total nonperforming loans
to total assets .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, 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.
29
December 31, 2003
--------------------------------------------------------
Allowance
for Loan Percent of Percent of
Losses Allowance Total Loans
--------------- ---------------- -----------------
Commercial and
professional loans $ 300 11.6% 0.10%
Secured by real estate
1 - 4 family 424 16.3 0.14
Multi family 89 3.4 0.03
Non-residential 1,198 46.2 0.41
Consumer and other 30 1.2 0.01
General allowance (1) 552 21.3 0.19
------- ----- ----
Total allowance
for loan losses $ 2,593 100.0% 0.88%
======= ===== ====
----------
(1) The allowance for loan losses is allocated to specific loans as necessary.
December 31, 2002
--------------------------------------------------------
Allowance
for Loan Percent of Percent of
Losses Allowance Total Loans
--------------- ---------------- -----------------
Commercial and
professional loans $ 225 9.7% 0.08%
Secured by real estate
1 - 4 family 452 19.5 0.16
Multi family 121 5.2 0.04
Non-residential 888 38.4 0.32
Consumer and other 55 2.4 0.02
General allowance (1) 574 24.8 0.21
------- ----- ----
Total allowance
for loan losses $ 2,315 100.0% 0.83%
======= ===== ====
----------
(1) The allowance for loan losses is allocated to specific loans as necessary.
December 31, 2002
--------------------------------------------------------
Allowance
for Loan Percent of Percent of
Losses Allowance Total Loans
--------------- ---------------- -----------------
Commercial and
professional loans $ 188 9.3% 0.07%
Secured by real estate
1 - 4 family 804 39.6 0.32
Multi family 84 4.1 0.03
Non-residential 790 38.9 0.32
Consumer and other 24 1.2 0.06
General allowance (1) 140 6.9 0.06
------- ----- ----
Total allowance
for loan losses $ 2,030 100.0% 0.79%
======= ===== ====
----------
(1) The allowance for loan losses is allocated to specific loans as necessary.
30
December 31, 2002
--------------------------------------------------------
Allowance
for Loan Percent of Percent of
Losses Allowance Total Loans
--------------- ---------------- -----------------
Commercial and
professional loans $ 89 8.0% 0.12%
Secured by real estate 654 59.0 0.86
Personal and other 13 1.2 0.02
General allowance (1) 352 31.8 0.47%
------- ----- ----
Total allowance
for loan losses $ 1,108 100.0% 1.47%
======= ===== ====
----------
(1) The allowance for loan losses is allocated to specific loans as necessary.
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, 2002
--------------------------------------------------------
Within 1 to After
1 Year 5 Years 5 Years Total
-------- --------- --------- ------
(In thousands)
Fixed Rate
Commercial and professional $ 657 $ 3,961 $ 128,193 $ 132,811
Non-residential 5,453 31,755 30,885 68,093
--------- --------- --------- ---------
Total fixed rate $ 6,110 $ 35,716 $ 159,078 $ 200,904
--------- --------- --------- ---------
Adjustable Rate
Commercial and professional 1,407 10,459 15,002 26,868
Non-residential 25,396 11,298 23,297 59,991
--------- --------- --------- ---------
Total adjustable rate $ 26,803 $ 21,757 $ 38,299 $ 86,859
--------- --------- --------- ---------
Total $ 32,913 $ 57,473 $ 197,377 $ 287,763
========= ========= ========= =========
31
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,
--------------------------------------------------------------------
2004 2003 2002 2001 2000
---- ---- ---- ---- ----
Average loans outstanding $290,774 $291,586 $265,961 $195,296 $ 70,357
======== ======== ======== ======== ========
Allowance at beginning
of period 2,593 2,315 2,030 1,108 923
Charge-offs:
Commercial and other
loans 24 4 199 97 --
Real estate loans -- 13 -- -- --
-------- -------- -------- -------- --------
Total loans charged-off 24 17 199 97 --
-------- -------- -------- -------- --------
Recoveries:
Commercial and other
loans 178 55 97 41 130
Real estate loans -- -- -- -- --
-------- -------- -------- -------- --------
Total loans recovered 178 55 97 41 130
-------- -------- -------- -------- --------
Net recoveries
(charge-offs) 154 38 (102) (56) 130
-------- -------- -------- -------- --------
Provision for loan losses
charged to operating
expenses 180 240 387 287 55
Acquisition of GSB -- -- -- 691 --
-------- -------- -------- -------- --------
Allowance at end of period $ 2,927 $ 2,593 $ 2,315 $ 2,030 $ 1,108
-------- -------- -------- -------- --------
Ratio of net recoveries
(charge-offs) to average
loans outstanding .05% 0.01% (.03)% (.02)% .18%
======== ======== ======== ======== ========
Allowance as a percent
of total loans 1.02% 0.88% 0.83% 0.80% 1.47%
======== ======== ======== ======== ========
Total loans at end
of period $287,763 $295,620 $276,252 $252,233 $ 75,623
======== ======== ======== ======== ========
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.
32
The following table summarizes the composition of the average balances
of major deposit categories:
December 31,
--------------------------------------------------------------------------------
2004 2003 2002
---- ---- ----
Average Average Average Average Average Average
Amount Yield Amount Yield Amount Yield
------ ----- ------ ----- ------ -----
(Dollars in thousands)
Demand deposits $ 38,896 -- $ 32,592 -- $ 30,102 --
NOW and money market 47,677 0.65% 58,723 1.02% 60,114 1.28%
Savings deposits 224,542 1.55 143,094 1.95 56,217 1.56
Time deposits 309,968 1.94 333,112 2.26 273,452 3.21
-------- ---- -------- ---- -------- ----
Total deposits $621,083 1.58% $567,521 1.78% $419,885 2.48%
======== ==== ======== ==== ======== ====
The aggregate amount of jumbo certificates of deposit, each with a
minimum denomination of $100,000, was approximately $109.74 million, $110.08
million and $108.72 million December 31, 2004, 2003 and 2002, respectively.
The following table summarizes the maturity distribution of time
deposits of $100,000 or more as of December 31, 2004:
(In thousands)
3 months or less $ 48,987
Over 3 months but within 6 months 25,160
Over 6 months but within 12 months 10,375
Over 12 months 25,219
--------
Total $109,741
========
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,
--------------------------------------------------
2004 2003 2002
-------------- --------------- --------------
(Dollars in thousands)
Securities sold under repurchase
agreements and federal funds purchased
Balance at year-end $127,747 $114,391 $ 46,673
Average during the year $129,794 $ 57,554 $ 38,443
Maximum month-end balance $148,753 $114,391 $ 47,407
Weighted average rate during the year 1.87% 1.68% 1.79%
Rate at December 31 2.27% 1.73% 1.46%
33
Capital Resources and Liquidity
Liquidity
The management of the Company's liquidity focuses on ensuring that
sufficient funds are available to meet loan funding commitments, withdrawals
from deposit accounts, the repayment of borrowed funds, and ensuring that the
Bank and the Company comply with regulatory liquidity requirements. Liquidity
needs of The Berkshire Bank have historically been met by deposits, investments
in federal funds sold, principal and interest payments on loans, and maturities
of investment securities.
For the parent company, Berkshire Bancorp Inc., liquidity means having
cash available to fund operating expenses and to pay shareholder dividends, when
and if declared by our Board of Directors. We paid cash dividends per share of
$.11, $.08 and $.07 in fiscal 2004, 2003 and 2002, respectively. The ability to
fund our operations and to pay dividends is not dependent upon the receipt of
dividends from The Berkshire Bank. At December 31, 2004, we had cash of
approximately $7.4 million and investment securities with a fair market value of
$9.0 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, 2004.
Expiration By Period
----------------------------------------------------------------------------------------
Less More
Than 1-3 3-5 Than
Total 1 Year Years Years 5 Years
----- ------ ----- ----- -------
(In thousands)
Lines of Credit $ 15,859 $ 9,555 $ 3,730 $ 958 $ 1,616
Standby Letters
of Credit 750 706 44 -- --
Loan Commitments -- -- -- -- --
Total $ 16,609 $ 10,261 $ 3,774 $ 958 $ 1,616
======== ======== ======== ======== ========
Contractual Obligations
The following table presents the Company's contractual obligations at
December 31, 2004.
Payments Due By Periods
----------------------------------------------------------------------------------------
Less More
Than 1-3 3-5 Than
Total 1 Year Years Years 5 Years
----- ------ ----- ----- -------
(In thousands)
Long-Term Debt $ 95,605 $ 2,638 $ 43,296 $ 35,671 $ 14,000
Operating Leases 3,695 712 1,440 1,012 531
Time Deposits 274,309 218,691 53,538 2,080 --
-------- -------- -------- -------- --------
Total Contractual
Obligations $373,609 $222,041 $ 98,274 $ 38,763 $ 14,531
======== ======== ======== ======== ========
The Company currently has one unconsolidated subsidiary and no special
purpose entities.
34
Capital
The capital ratios of the Bank and Berkshire are presently in excess of
the requirements necessary to meet the "well capitalized" capital category
established by bank regulators. See Note P to the Consolidated Financial
Statements.
Interest Rate Risk
Fluctuations in market interest rates can have a material effect on the
Bank's net interest income because the yields earned on loans and investments
may not adjust to market rates of interest with the same frequency, or with the
same speed, as the rates paid by the Bank on its deposits.
Most of the Bank's deposits are either interest-bearing demand deposits
or short term certificates of deposit and other interest-bearing deposits with
interest rates that fluctuate as market rates change. Management of the Bank
seeks to reduce the risk of interest rate fluctuations by concentrating on loans
and securities investments with either short terms to maturity or with
adjustable rates or other features that cause yields to adjust based upon
interest rate fluctuations. In addition, to cushion itself against the potential
adverse effects of a substantial and sustained increase in market interest
rates, the Bank has purchased off balance sheet interest rate cap contracts
which generally provide that the Bank will be entitled to receive payments from
the other party to the contract if interest rates exceed specified levels. These
contracts are entered into with major financial institutions.
The Company seeks to maximize its net interest margin within an
acceptable level of interest rate risk. Interest rate risk can be defined as the
amount of the forecasted net interest income that may be gained or lost due to
favorable or unfavorable movements in interest rates. Interest rate risk, or
sensitivity, arises when the maturity or repricing characteristics of assets
differ significantly from the maturity or repricing characteristics of
liabilities.
35
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, 2004
(in thousands, except for percentages)
-------------------------------------------------------
3 Months 3 Through 1 Through
or Less 12 Months 3 Years
---------------- ----------------- ----------------
Federal funds sold 7,500
(Rate) 2.25%
Interest bearing deposits in banks 372 -- --
(Rate) 1.40%
Loans (1)(2)
Adjustable rate loans 46,352 16,394 7,989
(Rate) 6.35% 5.06% 7.56%
Fixed rate loans 546 5,564 16,732
(Rate) 7.35% 7.37% 6.84%
--------- --------- ---------
Total loans 46,898 21,958 24,721
Investments (3)(4) 25,587 34,963 187,503
(Rate) 4.64% 2.11% 2.95%
--------- --------- ---------
Total rate-sensitive assets 72,857 56,921 212,224
--------- --------- ---------
Deposit accounts (5)
Savings and NOW 277,616 -- --
(Rate) 1.59%
Money market 25,772 -- --
(Rate) 0.73%
Time Deposits 113,377 105,314 53,538
(Rate) 1.83% 1.92% 2.78%
--------- --------- ---------
Total deposit accounts 416,765 105,314 53,538
Repurchase Agreements 57,297 37,450 33,000
(Rate) 1.92% 2.49% 2.92%
Other borrowings 2,638 43,296
(Rate) % 3.34% 3.61%
--------- --------- ---------
Total rate-sensitive liabilities 474,062 145,402 129,834
--------- --------- ---------
Interest rate caps 20,000 (10,000)
Gap (repricing differences) (421,205) (88,481) 92,390
========= ========= =========
Cumulative Gap (421,205) (509,686) (417,296)
========= ========= =========
Cumulative Gap to Total Rate
Sensitive Assets (45.84)% (55.47)% (45.42)%
========= ========= =========
Berkshire Bancorp Inc.
Interest Rate Sensitivity Gap at December 31, 2004
(in thousands, except for percentages)
-------------------------------------------------------
Over
3 Years Total Fair Value
---------------- ----------------- ----------------
Federal funds sold 7,500 7,500
(Rate)
Interest bearing deposits in banks -- 372 372
(Rate) 1.40%
Loans (1)(2)
Adjustable rate loans 16,124 86,859 91,219
(Rate) 6.41% 6.13%
Fixed rate loans 178,062 200,904 200,241
(Rate) 6.29% 6.82%
--------- ----------
Total loans 194,186 287,763 291,460
Investments (3)(4) 382,620 630,673 631,601
(Rate) 4.39% 3.85%
--------- ----------
Total rate-sensitive assets 576,806 918,808
--------- ----------
Deposit accounts (5)
Savings and NOW -- 277,616 277,616
(Rate) 1.59%
Money market -- 25,772 28,882
(Rate) 0.73%
Time Deposits 2,080 274,309 273,397
(Rate) 1.97% 2.05%
--------- ----------
Total deposit accounts 2,080 577,697
Repurchase Agreements -- 127,747 127,422
(Rate) -- 2.35%
Other borrowings 65,135 111,069 112,598
(Rate) 4.17% 3.94%
--------- ----------
Total rate-sensitive liabilities 67,215 816,513
--------- ----------
Interest rate caps (10,000) 26
Gap (repricing differences) 519,591 102,295
========= ==========
Cumulative Gap 102,295
=========
Cumulative Gap to Total Rate
Sensitive Assets 11.13%
=========
----------
(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.
36
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
Loan Commitments
In March 2004, the Securities and Exchange Commission (the "SEC") staff
issued Staff Accounting Bulletin ("SAB") 105 ("SAB 105"), "Application of
Accounting Principles to Loan Commitments." The SEC staff does not believe an
asset results from the expected future cash flows of servicing a committed loan
until the servicing assets have been contractually separated from the underlying
loan by sale or securitization of the loan with the servicing retained. SAB 105
is effective for all new loan commitments entered into beginning April 1, 2004.
We have followed an accounting methodology consistent with the guidance in SAB
105; accordingly, the adoption of SAB 105 has not had a material effect on our
consolidated financial statements.
Stock-Based Compensation
In December 2004, the Financial Accounting Standards Board (the "FASB")
issued Statement No. 123 (Revised), Share-based Payment, ("FAS 123(R)"). FAS
123(R) requires that the compensation cost relating to share-based payment
transactions be recognized in financial statements. That cost will be measured
based on the fair value of the equity or liability instruments issued. We will
be required to apply FAS 123(R) in the third quarter of 2005. The scope of FAS
123(R) includes a wide range of share-based compensation arrangements including
share options, restricted share plans, performance-based awards, share
appreciation rights and employee share purchase plans. FAS 123(R) replaces FASB
Statement 123, Accounting for Stock-Based Compensation ("FAS 123"), and
supersedes the Accounting Principles Board (the "APB") Opinion No. 25,
Accounting for Stock Issued to Employees ("APB Opinion No. 25"). FAS 123, as
originally issued in 1995, established as preferable a fair-value-based method
of accounting for share-based payment transactions with employees. However, FAS
123 permitted entities the option of continuing to apply the guidance in APB
Opinion No. 25, as long as the footnotes to financial statements disclosed what
net income would have been had the had the preferable fair-value-based method
been used.
FAS 123(R) provides three methods for companies to transition to the
new standard requiring the expensing of options. Companies may elect to (i)
restate results for prior quarters in the fiscal year of adoption of FAS 123(R)
to reflect the FAS 123 proforma compensation costs, or (ii) restate results for
prior periods, whether annual or quarterly, to reflect the FAS 123 proforma
compensation costs. We are in the process of determining which transition
approach to use and the effect, if any, such transition approach will have on
our financial statements.
Accounting for Loans or Certain Debt Securities Acquired in a Transfer
In October 2003, the American Institute of Cetified Public Accountants
(the "AICPA") issued SOP 03-3, Accounting for Loans or Certain Debt Securities
Acquired in a Transfer. SOP 03-3 applies to a loan with the evidence of
deterioration of credit quality since origination acquired by completion of a
transfer for which it is probable at acquisition, that the Company will be
unable to collect all contractually required payments receivable. SOP 03-3
requires that the Company recognize the excess of all cash flows expected at
acquisition over the investor's initial investment in the loan as interest
income on a level-yield basis over the life of the loan as the accretable yield.
The loan's
37
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. Management is
currently evaluating the provisions of SOP 03-3.
Variable Interest Entities
In January 2003, the FASB released Interpretation No. 46, Consolidation
of Variable Interest Entities ("FIN 46"). Fin 46 requires that all primary
beneficiaries of Variable Interest Entities ("VIE") consolidate that entity. FIN
46 is effective immediately for VIEs created after January 31, 2003 and to VIEs
to which an enterprise obtains an interest after that date. It applies in the
first fiscal year or interim period beginning after June 15, 2003, to VIEs in
which an enterprise holds a variable interest it acquired before February 1,
2003. In December 2003, the FASB published a revision to FIN 46 ("FIN 46R") to
clarify some of the provisions of the interpretation and to defer the effective
date of implementation for certain entities. Under the guidance of FIN 46R,
entities that do not have interests in structures that are commonly referred to
as special purpose entities are required to apply the provisions of the
interpretation in financial statements for periods ending after March 14, 2004.
We do not have interests in special purpose entities and, accordingly, applied
the provisions of FIN 46R with our first quarter 2004 financial statements.
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 03-1). The quantitative and
qualitative disclosure provisions of EITF 03-1 are effective for years ending
after December 15, 2003 and were included in the Company's 2003 Form 10-K. In
March 2004, the EITF issued a Consensus on Issue 03-1 requiring that the
provisions of EITF 03-1 be applied for reporting periods beginning after June
15, 2004 to investments accounted for under SFAS Nos. 115 and 124. EITF 03-1
establishes a three-step approach for determining whether an investment is
considered impaired, whether that impairment is other-than-temporary, and the
measurement of an impairment loss. In September 2004, the FASB issued a proposed
Board-directed FASB Staff Position, FSP EITF Issue 03-1-a, "Implementation
Guidance for the Application of Paragraph 16 of EITF 03-1." The proposed FSP
would provide implementation guidance with respect to debt securities that are
impaired solely due to interest rates and/or sector spreads and analyzed for
other-than-temporary impairment under paragraph 16 of EITF 03-1. The Board has
directed the FASB staff to delay the effective date for the measurement and
recognition guidance contained in paragraphs 10-20 of EITF Issue No. 03-1,
including steps two and three of the three-step approach for determining whether
an investment is other-than-temporarily impaired. However, step one of that
approach must still be initially applied for impairment evaluations in reporting
periods beginning after June 15, 2004. The delay of the effective date for
paragraphs 10-20 of EITF Issue 03-1 will be superseded with the final issuance
of proposed FSP EITF Issue 03-1-a, "Implementation Guidance for the Application
of Paragraph 16 of EITF Issue No. 03-1." The Company is in the process of
determining the impact that this EITF will have on its financial statements.
Internal Control Over Financial Reporting
The current objective of the Bank's Internal Control Program is to
allow management to comply with FDICIA requirements and with Section 302 of the
Sarbanes-Oxley Act of 2002 (the "Act"). Section 302 of the Act requires the 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 report on internal
control over financial reporting. The SEC requires us to comply with Section 404
by the year ending December 31, 2006.
38
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.
39
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
of Berkshire Bancorp Inc.
We have audited the accompanying consolidated statements of financial position
of Berkshire Bancorp Inc. and subsidiaries as of December 31, 2004 and 2003, and
the related consolidated statements of operations, changes in stockholders'
equity and cash flows for each of the three years in the period ended December
31, 2004. 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. An audit 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, 2004 and 2003, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended December 31, 2004, in conformity with accounting
principles generally accepted in the United States of America.
We have also audited, in accordance with the interim standards adopted by the
Public Company Accounting Oversight Board (United States), the effectiveness of
The Berkshire Bank's (a subsidiary of Berkshire Bancorp Inc.) internal control
over financial reporting as of December 31, 2004, based on criteria established
in Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) and our report dated March 29,
2005 expressed an unqualified opinion on management's assertion that The
Berkshire Bank maintained effective internal control over financial reporting.
/s/ GRANT THORNTON LLP
Philadelphia, Pennsylvania
March 29, 2005
40
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
December 31, December 31,
2004 2003
----------------------------
ASSETS
Cash and due from banks $ 9,511 $ 7,478
Interest bearing deposits 372 1,832
Federal funds sold 7,500 --
--------- ---------
Total cash and cash equivalents 17,383 9,310
Investment Securities:
Available-for-sale 630,968 569,137
Held-to-maturity, fair value of $633
in 2004 and $715 in 2003 624 711
--------- ---------
Total investment securities 631,592 569,848
Loans, net of unearned income 286,979 294,756
Less: allowance for loan losses (2,927) (2,593)
--------- ---------
Net loans 284,052 292,163
Accrued interest receivable 6,014 5,298
Premises and equipment, net 8,677 8,665
Goodwill, net 18,549 18,549
Other assets 6,382 1,836
--------- ---------
Total assets $ 972,649 $ 905,669
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 42,191 $ 38,422
Interest bearing 577,697 565,833
--------- ---------
Total deposits 619,888 604,255
Securities sold under agreements to repurchase 127,747 114,391
Long term borrowings 95,605 77,745
Subordinated debt 15,464 --
Accrued interest payable 2,516 2,208
Other liabilities 3,810 3,580
--------- ---------
Total liabilities 865,030 802,179
--------- ---------
Stockholders' equity
Preferred stock - $.10 Par value: -- --
2,000,000 shares authorized - none issued
Common stock - $.10 par value
Authorized -- 10,000,000 shares
Issued -- 7,698,285 shares
Outstanding --
December 31, 2004, 6,748,675 shares
December 31, 2003, 6,614,094 shares 770 256
Additional paid-in capital 89,543 89,866
Retained earnings 28,983 22,960
Accumulated other comprehensive (loss) income, net (2,602) 775
Treasury Stock
December 31, 2004, 949,610 shares
December 31, 2003, 1,084,191 shares (9,075) (10,367)
--------- ---------
Total stockholders' equity 107,619 103,490
--------- ---------
$ 972,649 $ 905,669
========= =========
The accompanying notes are an integral part of these statements
41
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Data)
For The Years Ended December 31,
----------------------------------------------
2004 2003 2002
-------- -------- --------
INTEREST INCOME
Federal funds sold and interest bearing deposits $ 63 $ 44 $ 136
Investments securities 21,120 15,321 13,383
Loans, including related fees 18,825 19,061 18,723
-------- -------- --------
Total interest income 40,008 34,426 32,242
-------- -------- --------
INTEREST EXPENSE
Deposits 9,833 10,130 10,410
Short-term borrowings 2,422 794 687
Long-term borrowings 3,661 2,723 2,319
-------- -------- --------
Total interest expense 15,916 13,647 13,416
-------- -------- --------
Net interest income 24,092 20,779 18,826
PROVISION FOR LOAN LOSSES 180 240 387
-------- -------- --------
Net interest income after
provision for loan losses 23,912 20,539 18,439
-------- -------- --------
NON-INTEREST INCOME
Service charges on deposit accounts 520 640 548
Investment securities gains 793 2,746 1,539
Other income 506 597 200
-------- -------- --------
Total non-interest income 1,819 3,983 2,287
-------- -------- --------
NON-INTEREST EXPENSE
Salaries and employee benefits 6,886 5,873 5,183
Net occupancy expense 1,538 1,611 1,625
Equipment expense 357 397 312
FDIC assessment 115 80 66
Data processing expense 157 183 193
Other 3,042 3,319 3,401
-------- -------- --------
Total non-interest expense 12,095 11,463 10,780
-------- -------- --------
Income before provision for taxes 13,636 13,059 9,946
Provision for income taxes 6,134 5,644 4,349
-------- -------- --------
Net income $ 7,502 $ 7,415 $ 5,597
======== ======== ========
Net income per share:
Basic $ 1.12 $ 1.12 $ .81
======== ======== ========
Diluted $ 1.10 $ 1.10 $ .81
======== ======== ========
Dividends per share $ .11 $ .09 $ .07
The accompanying notes are an integral part of these statements
42
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For The Years Ended December 31, 2004, 2003 and 2002
(In Thousands)
Accumulated
Common Stock Additional other
Par paid-in comprehensive
Shares value capital (loss) net
------ ----- --------- -----------
Balance at January 1, 2002 2,566 $256 $89,914 $ (281)
Net income
Acquisition of treasury shares
Exercise of stock options (24)
Other comprehensive income net
of reclassification adjustment
and taxes 1,761
Comprehensive income
Cash dividends
------ ---- ------- ------
Balance at December 31, 2002 2,566 $256 $89,890 $1,480
Net income
Acquisition of treasury shares
Exercise of stock options (24)
Other comprehensive (loss) net
of reclassification adjustment
and taxes (705)
Comprehensive income
Cash dividends
------ ---- ------- ------
Balance at December 31, 2003 2,566 $256 $89,866 $ 775
Net income
Exercise of stock options (90)
Acquisition of treasury shares
Effect of reverse one-for-ten
stock split (2,309) (230) (233)
Effect of thirty-for-one
stock dividend 7,441 744
Other comprehensive (loss) net
of reclassification adjustment
and taxes (3,377)
Comprehensive income
Cash dividends
Balance at December 31, 2004 7,698 $770 $89,543 $(2,602)
==== ======= =======
Total
Retained Treasury Comprehensive stockholders'
earnings stock income equity
-------- ------- -------- -------
Balance at January 1, 2002 $ 11,053 $(4,950) $ 95,992
Net income 5,597 5,597 5,597
Acquisition of treasury shares (4,422) (4,422)
Exercise of stock options 126 102
Other comprehensive income net
of reclassification adjustment
and taxes 1,761 1,761
-------
Comprehensive income $ 7,358
=======
Cash dividends (505) (505)
-------- ------- --------
Balance at December 31, 2002 $ 16,145 $(9,246) $ 98,525
Net income 7,415 7,415 7,415
Acquisition of treasury shares (1,350) (1,350)
Exercise of stock options 229 205
Other comprehensive (loss) net
of reclassification adjustment
and taxes (705) (705)
-------
Comprehensive income $ 6,710
=======
Cash dividends (600) (600)
-------- -------- --------
Balance at December 31, 2003 $ 22,960 $(10,367) $103,490
Net income 7,502 7,502 7,502
Exercise of stock options 1,361 1,271
Acquisition of treasury shares (69) (69)
Effect of reverse one-for-ten
stock split (463)
Effect of thirty-for-one
stock dividend (744)
Other comprehensive (loss) net
of reclassification adjustment
and taxes (3,377) (3,377)
-------
Comprehensive income $ 4,125
=======
Cash dividends (735) (735)
Balance at December 31, 2004 $ 28,983 $ (9,075) $107,619
======== ======== ========
The accompanying notes are an integral part of these statements
43
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For The Years Ended December 31,
-------------------------------------------------------
2004 2003 2002
------ ------ -----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 7,502 $ 7,415 $ 5,597
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Realized gains on investment securities (793) (4,151) (1,729)
Net amortization of premiums of
investment securities 2,282 1,405 190
Depreciation and amortization 590 605 414
Provision for loan losses 180 240 387
Increase in deferred taxes -- 204 (133)
CHANGES IN ASSETS AND LIABILITIES:
(Increase) in accrued interest receivable (716) (1,192) (707)
(Increase) decrease in other assets (3,873) (1,064) 3,026
Increase (decrease) in accrued interest
payable and other liabilities 538 (1,054) 1,316
----------- ----------- -----------
Net cash provided by operating activities 5,710 2,408 8,361
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment securities available for sale
Purchases (1,740,889) (1,837,653) (1,729,416)
Sales, maturities and calls 1,674,188 1,641,186 1,603,261
Investment securities held to maturity
Purchases 91 -- --
Maturities -- 118 780
Net decrease (increase) in loans 7,931 (19,221) (23,559)
Acquisition of premises and equipment (602) (294) (2,055)
----------- ----------- -----------
Net cash (used in) investing activities (59,281) (215,864) (150,989)
----------- ----------- -----------
44
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For The Years Ended December 31,
-------------------------------------------------------
2004 2003 2002
------ ------ -----
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in non interest
bearing deposits 3,769 7,102 1,157
Net increase in interest bearing deposits 11,864 123,335 133,885
Increase (decrease) in securities sold
under agreements to repurchase 13,356 67,718 (7,083)
Proceeds from long term debt 37,164 20,046 34,923
Repayment of long term debt (19,304) -- (19,502)
Proceeds from issuance of
subordinated debentures, net 14,791 -- --
Acquisition of treasury stock (69) (1,350) (4,422)
Proceeds from exercise of common
stock options 1,271 205 102
Cash paid for fractional shares (463) -- --
Dividends paid (735) (600) (505)
----------- ----------- -----------
Net cash provided by financing activities 61,644 216,456 138,555
----------- ----------- -----------
Net increase (decrease) in cash
and cash equivalents 8,073 3,000 (4,073)
Cash and cash equivalents at
beginning of year $ 9,310 $ 6,310 $ 10,383
----------- ----------- -----------
Cash and cash equivalents at
end of year $ 17,383 $ 9,310 $ 6,310
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash used to pay interest $ 15,608 $ 14,787 $ 12,474
Cash used to pay income taxes,
net of refunds $ 5,960 $ 2,015 $ 5,692
The accompanying notes are an integral part of these statements
45
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2004 and 2003
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, three branches in
Brooklyn, New York, and four branches in Orange and Sullivan Counties in New
York State.
The Bank competes with other banking and financial institutions in its
markets. Commercial banks, savings banks, savings and loan associations,
mortgage bankers and brokers, and credit unions actively compete for deposits
and loans. Such institutions, as well as consumer finance, mutual funds,
insurance companies, and brokerage and investment banking firms may be
considered to be competitors of the Bank with respect to one or more of the
services provided by the Bank.
The Company and the Bank are subject to the regulations of certain
state and federal agencies and, accordingly, are periodically examined by those
regulatory authorities. As a consequence of such regulation of banking
activities, the Bank's business may be affected by state and federal
legislation.
Stock Split and Stock Dividend
At the Annual Meeting of Stockholders held on May 18, 2004, the
Company's stockholders approved an amendment to the Company's Certificate of
Incorporation effecting a one-for-ten reverse stock split of the Company's
issued and outstanding Common Stock (the "Reverse Split"). Following the
effectiveness of the Reverse Split, the Company's Board of Directors declared a
thirty-for-one forward stock split in the form of a stock dividend in Common
Stock (the "Stock Dividend) which became effective immediately. The Company paid
approximately $463,000 to purchase fractional shares from stockholders as part
of the Reverse Split. The Company's Common Stock began trading on May 19, 2004
giving effect to these transactions.
Trust Preferred Securities
As of May 18 2004, the Company established Berkshire Capital Trust I, a
Delaware statutory trust, ("BCTI"). The Company owns all the common capital
securities of BCTI. BCTI issued $15.0 million of preferred capital securities to
investors in a private transaction and invested the proceeds, combined with the
proceeds from the sale of BCTI's common capital securities, in the Company
through the purchase of $15.464 million aggregate principal amount of Floating
Rate Junior Subordinated Debentures (the "Debentures") issued by the Company.
The Debentures, the sole assets of BCTI, mature on July 23, 2034 and bear
interest at a floating rate, three month LIBOR plus 2.70%.
Based on current interpretations of the banking regulators, 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 under the preferred
capital securities sold by BCTI to investors. FIN46(R) precludes consideration
of the
46
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note A - (continued)
call option embedded in the preferred capital securities when determining if the
Company has the right to a majority of BCTI expected residual returns.
Accordingly, BCTI is 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 as a result of the
adoption of FIN 46(R). 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 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 estimate that is susceptible to significant change in the
near term relates to the allowance for loan losses and goodwill. 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.
47
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note B - (continued)
The Company provides 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.
In November 2003, the Financial Accounting Standards Board ("FASB")
Emerging Issues Task Force ("EITF") reached consensus opinion on EITF Issue
03-1, "The Meaning of Other Than Temporary Impairment and Its Application to
Certain Investments. The Company adopted EITF 03-1 as of December 31, 2003. EITF
03-1 includes certain disclosures regarding quantitative and qualitative
disclosures for investment securities accounted for under SFAS No. 115 that are
impaired at the balance sheet date, but an other-than-temporary impairment has
not been recognized. The disclosures under EITF 03-1 are required for financial
statements for years ending after December 15, 2003 and are included in these
financial statements.
Other-Than-Temporary Impairment - EITF 03-1
In November 2003, the Emerging Issues Task Force (EITF) of the FASB
issued EITF Abstract 03-1, "The Meaning of Other-Than-Temporary Impairment and
its Application to Certain Investments" (EITF 03-1). The quantitative and
qualitative disclosure provisions of EITF 03-1 are effective for years ending
after December 15, 2003 and were included in the Company's 2003 Form 10-K. In
March 2004, the EITF issued a Consensus on Issue 03-1 requiring that the
provisions of EITF 03-1 be applied for reporting periods beginning after June
15, 2004 to investments accounted for under SFAS Nos. 115 and 124. EITF 03-1
establishes a three-step approach for determining whether an investment is
considered impaired, whether that impairment is other-than-temporary, and the
measurement of an impairment loss. In September 2004, the FASB issued a proposed
Board-directed FASB Staff Position, FSP EITF Issue 03-1-a, "Implementation
Guidance for the Application of Paragraph 16 of EITF 03-1." The proposed FSP
would provide implementation guidance with respect to debt securities that are
impaired solely due to interest rates and/or sector spreads and analyzed for
other-than-temporary impairment under paragraph 16 of EITF 03-1. The Board has
directed the FASB staff to delay the effective date for the measurement and
recognition guidance contained in paragraphs 10-20 of EITF Issue No. 03-1,
48
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note B - (continued)
including steps two and three of the three-step approach for determining whether
an investment is other-than-temporarily impaired. However, step one of that
approach must still be initially applied for impairment evaluations in reporting
periods beginning after June 15, 2004. The delay of the effective date for
paragraphs 10-20 of EITF Issue 03-1 will be superseded with the final issuance
of proposed FSP EITF Issue 03-1-a, "Implementation Guidance for the Application
of Paragraph 16 of EITF Issue No. 03-1." The Company is in the process of
determining the impact that this EITF will have on its 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 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.
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 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.
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.
49
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note B - (continued)
Staff Accounting Bulletin (SAB) No. 102, "Selected Loan Loss Allowance
Methodology and Documentation Issues" (SAB No. 102), codified in SAB No. 103,
provides guidance on the development, documentation, and application of a
systematic methodology for determining the allowance for loans and leases in
accordance with US GAAP. The adoption of SAB No. 102 is not expected to have a
material impact on the Company's financial position or results of operations.
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. Management is currently evaluating the provisions of SOP 03-3.
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.
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.
On January 1, 2002 the Company adopted SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 retains the
existing requirements to recognize and measure the impairment of long-lived
assets to be held and used or to be disposed of by sale. However, SFAS No. 144
makes changes to the scope and certain measurement requirements of existing
accounting guidance. The adoption of this statement did not have a significant
impact on the financial condition or results of operations of the Company.
50
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 resulted from the acquisition of The Berkshire Bank in 1999
and GSB Financial Corporation in 2001. The Company adopted SFAS No. 142,
Goodwill and Intangible Assets, on January 1, 2002. SFAS No. 142 includes
requirements to test goodwill and indefinite lived intangible assets for
impairment rather than amortize them. The Company did not identify any
impairment on its outstanding goodwill and its identifiable intangible assets
from its most recent testing, performed at December 31, 2004.
7. Income Taxes
The Company accounts for income taxes under the liability method of
accounting for income taxes. Deferred tax assets and liabilities are determined
based on the difference between the financial statement and tax bases of assets
and liabilities as measured by the enacted tax rates that will be in effect when
these differences reverse. Deferred tax expense is the result of changes in
deferred tax assets and liabilities. The principal types of differences between
assets and liabilities for financial statement and tax return purposes are
allowance for loan losses, deferred loan fees, deferred compensation and
securities available for sale.
8. Net Income Per Share
The Company follows the provisions of SFAS No. 128, "Earnings Per
Share." Basic earnings per share excludes dilution and is computed by dividing
income available to common shareholders by the weighted-average common shares
outstanding during the period. Diluted earnings per share takes into account the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised and converted into common stock. All weighted
average share and per share information in 2003 and 2002 have been retroactively
restated to reflect the stock split and stock dividend discussed in Note A.
9. Stock Based Compensation
In December 2004, the Financial Accounting Standards Board (the "FASB")
issued Statement No. 123 (Revised), Share-based Payment, ("FAS 123(R)"). FAS
123(R) requires that the compensation cost relating to share-based payment
transactions be recognized in financial statements. That cost will be measured
based on the fair value of the equity or liability instruments issued. We will
be required to apply FAS 123(R) in the third quarter of 2005. The scope of FAS
123(R) includes a wide range of share-based compensation arrangements including
share options, restricted share plans, performance-based awards, share
appreciation rights and employee share purchase plans. FAS 123(R) replaces FASB
Statement 123, Accounting for Stock-Based Compensation ("FAS 123"), and
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. FAS
123, as originally issued in 1995, established as preferable a fair-value-based
method of accounting for share-based payment transactions with employees.
However, FAS 123 permitted entities the option of continuing to apply the
guidance in APB Opinion No. 25, as long as the footnotes to financial statements
disclosed what net income would have been had the had the preferable fair-value-
based method been used.
51
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note B - (continued)
The Company follows the disclosure provisions of FAS 123 which
introduced a method of accounting for employee stock-based compensation plans
based upon the fair value of the awards on the date they are granted. Under this
fair-value- based method, public companies estimate the fair value of stock
options using a pricing model, such as the Black-Scholes model, which requires
inputs such as the expected volatility of the stock price and an estimate of the
dividend yield over the option's expected life. The FASB, however, does not
require the use of this method until the first quarter of our 2006 fiscal year.
Entities that continue to account for stock option plans under the existing
method (APB No. 25) are required to disclose proforma net income and earnings
per share, as if the fair value method had been used.
At December 31, 2004, the Company has one stock-based employee
compensation plan, which is more fully described in Note K. The Company accounts
for that plan under the recognition and measurement principles of APB No. 25,
"Accounting for Stock Issued to Employees," and related interpretations.
Stock-based employee compensation costs are not reflected in net income, as all
options granted under the plan had an exercise price equal to the market value
of the underlying common stock on the date of the grant. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation," to stock-based employee compensation.
For The Years Ended December 31,
--------------------------------------
2004 2003 2002
---- ---- ----
(In thousands, except per share amounts)
Net income As Reported: $ 7,502 $ 7,415 $ 5,597
Less: Stock based compensation
costs determined under fair
value methods for all awards -- 32 680
------- ------- -------
Pro Forma: $ 7,502 $ 7,383 $ 4,917
======= ======= =======
Basic earnings per share As Reported: $ 1.12 $ 1.12 $ .81
Pro Forma: 1.12 1.11 .72
Diluted earnings per share As Reported: 1.10 1.10 .81
Pro Forma: 1.10 1.09 .71
The fair value of each option is estimated on the date of grant using
the Black-Scholes options-pricing model using weighted-average assumptions for
expected volatility, risk-free interest and expected life of the option. The
Company did not grant stock options in 2004, 2003 and 2002.
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 $2,763,000, $1,032,000 and $1,155,000 at December 31, 2004, 2003
and 2002, respectively.
52
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, 2004
---------------------------------------------------
Tax
Before tax (expense) Net of tax
amount benefit Amount
---------------- ------------- --------------
Unrealized gains (losses)
on investment securities:
Unrealized holding gains
arising during period $ (4,014) $ 1,711 $ (2,303)
Less reclassification adjustment for
gains realized in net income 793 (317) 476
-------- ------- --------
Unrealized (loss) on investment securities (4,807) 2,028 (2,779)
Change in minimum pension liability (598) (598)
-------- ------- --------
Other comprehensive income (loss), net $ (5,405) $ 2,028 $ (3,377)
======== ======= ========
Year Ended December 31, 2003
-------------------------------------------------
Tax
Before tax (expense) Net of tax
amount benefit Amount
------------- -------------- --------------
Unrealized gains (losses)
on investment securities:
Unrealized holding gains
arising during period $ 1,231 $ (491) $ 740
Less reclassification adjustment for
gains realized in net income 2,746 (1,097) 1,649
-------- -------- ---------
Unrealized (loss) on investment securities (1,515) 606 (909)
Change in minimum pension liability 340 (136) 204
-------- -------- ---------
Other comprehensive income (loss), net $ (1,175) $ 470 $ (705)
======== ======== =========
Year Ended December 31, 2002
-----------------------------------------------
Tax
Before tax (expense) Net of tax
amount benefit Amount
------------- -------------- --------------
Unrealized gains on investment securities:
Unrealized holding gains
arising during period $ 4,760 $ (1,872) $ 2,888
Less reclassification adjustment for
gains realized in net income 1,539 (616) 923
------- -------- --------
Unrealized gain on investment securities 3,221 (1,256) 1,965
Minimum pension liability (340) 136 (204)
------- -------- --------
Other comprehensive income, net $ 2,881 $ (1,120) $ 1,761
======= ======== ========
13. Reclassifications
Certain amounts in the December 31, 2003 and 2002 financial statements
have been reclassified to conform to the current period's presentation.
53
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, 2004
---------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
------------- ---------------- --------------- --------------
(In thousands)
Investment securities
U.S. Government Agencies $ 624 $ 10 $ (1) $ 633
------- ------- -------- --------
Totals $ 624 $ 10 $ (1) $ 633
======= ======= ======= ========
December 31, 2004
---------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
------------- ---------------- --------------- --------------
(In thousands)
Investment securities
U.S. Government Agencies $ 711 $ 4 $ -- $ 715
------- ------- -------- --------
Totals $ 711 $ 4 $ -- $ 715
======= ======= ======= ========
The following is a summary of available-for-sale investment securities:
December 31, 2004
---------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
------------- ---------------- --------------- --------------
(In thousands)
Investment securities
U.S. Treasury and Notes $ 24,896 $ -- $ (174) $ 24,722
U.S. Government Agencies 471,018 97 (3,844) 467,271
Mortgage-backed securities 109,822 504 (996) 109,330
Corporate notes 21,089 692 (154) 21,627
Municipal securities 1,307 134 -- 1,441
Marketable equity
securities and other 6,363 279 (65) 6,577
-------- ------- ------- --------
Totals $634,495 $ 1,706 $(5,233) $630,968
======== ======= ======= ========
54
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note C - (continued)
December 31, 2004
---------------------------------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
------------- ---------------- --------------- --------------
(In thousands)
Investment securities
U.S. Treasury and Notes $ 39,941 $ -- $ (94) $ 39,847
U.S. Government Agencies 419,175 637 (3,059) 416,753
Mortgage-backed securities 93,875 3,838 (265) 97,448
Corporate notes 1,570 214 (122) 1,662
Municipal securities 991 70 -- 1,061
Marketable equity
securities and other 12,305 177 (116) 12,366
-------- ------- ------- --------
Totals $567,857 $ 4,936 $(3,656) $569,137
======== ======= ======= ========
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, 2004 (in thousands):
Less than 12 months 12 months or longer Total
------------------------------ ----------------------------- -----------------------------
Description of Securities Fair Value Unrealized Fair Value Unrealized Fair Value Unrealized
Losses Losses Losses
U.S. Treasury and Notes $ 14,796 $ 132 $ 9,926 $ 42 $ 24,722 $ 174
U.S. Government Agencies 253,526 1,586 192,661 2,259 446,187 3,845
Mortgage-backed securities 73,271 897 8,924 99 82,195 996
Corporate notes 4,941 58 -- 96 4,941 154
Municipal securities -- -- -- -- -- --
-------- ------- -------- ------- -------- -------
Subtotal, debt securities 346,534 2,673 211,511 2,496 558,045 5,169
Marketable equity -- -- 78 65 78 65
-------- ------- -------- ------- -------- -------
securities and other
Total temporarily
impaired securities $346,534 $ 2,673 $211,589 $ 2,561 $558,123 $ 5,234
======== ======= ======== ======= ======== =======
The Company had a total of 97 debt securities with a fair market value
of $558.05 million which were temporarily impaired at December 31, 2004. The
total unrealized loss on these securities was $5.17 million, all but $96,000 of
such unrealized loss being attributable to interest rate movements. We have the
ability to hold these securities, all but 2 of which are US Government and US
Government Agency securities to maturity, therefore, the unrealized losses
associated with these securities are not considered to be other than temporary.
We also had 4 equity securities with an aggregated fair market value of
$78,000 which were temporarily impaired at December 31, 2004. The total
unrealized loss on these securities was $65,000. Based upon our review of the
available information, such unrealized losses are not considered to be other
than temporary.
55
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, 2004 and
2003 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, 2004
------------------------------------------------------------------------
Available for Sale Held to Maturity
------------------------------------ ----------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- ---- --------- ----
(In thousands)
Due in one year or less $ 24,941 $ 24,862 $ -- $ --
Due after one through
five years 185,421 184,416 58 59
Due after five through
ten years 211,919 209,806 93 93
Due after ten years 198,440 197,192 473 481
Marketable equity
securities and other 13,774 14,692 -- --
-------- -------- -------- --------
Totals $634,495 $630,968 $ 624 $ 633
======== ======== ======== ========
December 31, 2003
------------------------------------------------------------------------
Available for Sale Held to Maturity
------------------------------------ ----------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- ---- --------- ----
(In thousands)
Due in one year or less $ -- $ -- $ -- $ --
Due after one through
five years 102,626 102,654 74 74
Due after five through
ten years 196,934 195,168 70 70
Due after ten years 255,992 258,949 567 571
Marketable equity
securities and other 12,305 12,366 -- --
-------- -------- -------- --------
Totals $567,857 $569,137 $ 711 $ 715
======== ======== ======== ========
Gross gains realized on the sales of investment securities for the
years ended December 31, 2004, 2003 and 2002 were $965,000, $2.91 million and
$1.54 million, respectively. Gross losses were $172,000 and $163,000 for the
years ended December 31, 2004 and 2003. Gross losses were not material for the
year ended December 31, 2002.
As of December 31, 2004 and 2003, securities sold under agreements to
repurchase with a book value of approximately $127.75 million and $114.39
million, respectively, were outstanding. As of December 31, 2004 and 2003, the
Company did not have any investment securities of any one issuer where the
carrying value exceeded 10% of shareholders' equity.
On November 7, 2002, we sold our 24.9% interest in a merchant credit
card processing company for $285,000, which represents our initial purchase
price in December 1999. We accounted for our interest in this company under the
equity method of accounting and have recorded approximately $200,000 in net
losses since December 1999. In addition, the Bank had loans outstanding totaling
$295,000 to this company which are being repaid as a result of this transaction.
At December 31, 2003, the purchase price to Berkshire had been paid in full.
56
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,
2004 2003
---------------- ----------------
(In thousands)
Commercial and professional loans $ 16,498 $ 22,228
Secured by real estate
1 - 4 family 155,079 169,589
Multi family 4,600 6,608
Non-residential 109,597 94,956
Consumer 1,989 2,239
-------- --------
287,763 295,620
Deferred loan fees (784) (864)
Allowance for loan losses (2,927) (2,593)
-------- --------
$284,052 $292,163
======== ========
Changes in the allowance for loan losses are as follows:
For The Years Ended December 31,
---------------------------------------------------------
2004 2003 2002
----------------- ---------------- -----------------
(In thousands)
Balance at beginning $ 2,593 $ 2,315 $ 2,030
of year
Provision charged to 180 240 387
operations
Loans charged off 24 17 199
Recoveries 178 55 97
------- ------- -------
Balance at end of year $ 2,927 $ 2,593 $ 2,315
======= ======= =======
The Company had $343,000, $109,000 and $59,000 non accrual loans as of
December 31, 2004, 2003 and 2002, respectively, and $50,000 of loans delinquent
more than ninety days and still accruing interest at December 31, 2004. The
Company did not have any impaired loans or loans past due more than 90 days and
still accruing interest as of December 31, 2003 and 2002.
The Company, from time to time, enters into lending transactions in the
ordinary course of business with directors, executive officers, principal
stockholders and affiliates of such persons on the same terms as those
prevailing for comparable transactions with other borrowers. At December 31,
2004, loans to these related parties amounted to $10.4 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 at December
31, 2004, resulted in new loans of $5.7 million and repayments of approximately
$5.7 million.
57
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 2004 2003
-------------------- ------------------- -------------------
(In thousands)
Land Indefinite $ 3,817 $ 3,817
Buildings 39 years 4,059 4,059
Furniture and equipment 3 to 10 years 2,573 2,318
Leasehold improvements 2 to 10 years 968 620
------- -------
11,417 10,814
Accumulated depreciation
and amortization (2,740) (2,149)
------- -------
Total $ 8,677 $ 8,665
======= =======
Depreciation and amortization expense was approximately $591,000,
$605,000 and $279,000 for the years ended December 31, 2004, 2003 and 2002,
respectively.
NOTE F - DEPOSITS
The aggregate amount of jumbo certificates of deposits greater than
$100,000 were approximately $109.74 million and $110.08 million as of December
31, 2004 and 2003, respectively.
The scheduled maturities of all certificates of deposit are as follows:
December 31, 2004
-----------------
(In thousands)
2005 $218,680
2006 51,673
2007 1,877
2008 2,026
2009 53
---------
$ 274,309
=========
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,
--------------------------------------------------
2004 2003 2002
--------------- -------------- --------------
(Dollars in Thousands)
Securities sold under repurchase
agreements and federal funds purchased
Balance at year-end $127,747 $114,391 $ 46,673
Average during the year $129,794 $ 57,554 $ 38,433
Maximum month-end balance $148,753 $114,391 $ 47,407
Weighted average rate during the year 1.87% 1.68% 1.79%
Rate at December 31 2.27% 1.73% 1.46%
58
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note G - (continued)
Long-Term Borrowings At December 31, 2004, advances from the Federal
Home Loan Bank ("FHLB") totaling $95.6 million will mature within one to ten
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 3.83%. Unused lines of credit at the FHLB were $46.5 million at
December 31, 2004.
Outstanding long-term borrowings mature as follows (in thousands):
Year Amount
------ ---------
2005 $ 2,638
2006 8,719
2007 34,578
2008 19,976
2009 15,694
Thereafter 14,000
---------
Total $ 95,605
=========
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, 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
======= ======= ======
Year Ended December 31, 2003
(In thousands, except per share data)
-----------------------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
----------------- ------------------- -----------------
Basic earnings per share
Net income available to
common stockholders $ 7,415 6,636 $ 1.12
Effect of dilutive securities
Options -- 111 (.02)
------- ------- ------
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $ 7,415 6,747 $ 1.10
======= ======= ======
59
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE H - (continued)
Year Ended December 31, 2002
(In thousands, except per share data)
--------------------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
----------------- ------------------- --------------
Basic earnings per share
Net income available to
common stockholders $ 5,597 6,876 $ .81
Effect of dilutive securities
Options -- 33 .--
------- ------- -----
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $ 5,597 6,909 $ .81
======= ======= ======
Options to purchase 115,375 shares of common stock for $30.00 to $38.00
per share were outstanding during the year ended December 31, 2002. These
options were not included in the computation of diluted earnings per share
because the option exercise price was greater than the average market price for
the Company's common stock during this period.
NOTE I - INCOME TAXES
The components of income tax expense are as follows:
Years Ended December 31,
---------------------------------------------------------------
2004 2003 2002
---- ---- ----
Current $ 6,515,000 $ 5,848,000 $ 4,216,000
Deferred Taxes (Benefit) (381,000) (204,000) 133,000
----------- ----------- -----------
$ 6,134,000 $ 5,644,000 $ 4,349,000
=========== =========== ===========
A reconciliation of the provision for income taxes for the years ended
December 31, 2004, 2003 and 2002 and the amount computed by applying the
statutory Federal income tax rate to income from continuing operations follows:
Years Ended December 31,
---------------------------------------------------------------
2004 2003 2002
---- ---- ----
Effective Tax Reconciliation
Tax at statutory rate $ 4,636,000 $ 4,439,000 $ 3,381,000
State and City, net of federal
income tax benefit 1,423,000 1,211,000 940,000
Tax exempt income -- (76,000) (53,000)
Other 75,000 70,000 81,000
----------- ----------- -----------
Actual provision for
income taxes $ 6,134,000 $ 5,644,000 $ 4,349,000
=========== =========== ===========
60
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,
2004 and 2003 are as follows:
December 31,
------------------------------------
2004 2003
---- ----
Net deferred tax assets
Loan loss provision $1,359,000 1,215,000
Depreciation 92,000 9,000
Other 234,000 80,000
Unrealized (gain) loss on
investment securities 1,528,000 (500,000)
---------- -----------
Net deferred tax asset
included in other assets $3,213,000 $ 804,000
========== ===========
NOTE J - STOCK PLANS
In March 1999, the stockholder's of the Company approved the 1999 Stock
Incentive Plan (the "1999 Stock Incentive Plan"). The 1999 Stock Incentive Plan
permits the granting of awards in the form of nonqualified stock options,
incentive stock options, restricted stock, deferred stock, and other stock-based
incentives. Up to 600,000 shares of common stock of the Company may be issued
pursuant to the 1999 Stock Incentive Plan. Officers, directors and other key
employees of the Company or any subsidiary are eligible to receive awards under
the 1999 Stock Incentive Plan. Options outstanding under the 1999 Stock
Incentive Plan were 314,250 and 337,125 as of December 31, 2004 and 2003,
respectively. As of December 31, 2004 and 2003, 50,834 options and 171,294
options, respectively, were also outstanding as a result of the GSB acquisition.
The Company did not grant options in 2004, 2003 and 2002.
A summary of activity with respect to the Stock Option Plan follows:
December 31,
--------------------------------------------------------------------------------------
2004 2003 2002
--------------------------- ---------------------------- ---------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ ----- ------ ----- ------ -----
Outstanding at
beginning of 508,419 $10.12 532,503 $10.10 574,788 $ 9.91
year
Granted -- $ -- -- $ -- -- $ --
Cancelled (1,500) $10.00 -- $ -- (19,527) $ 9.04
Exercised (141,835) $ 8.95 (24,084) $ 8.61 (22,758) $ 7.25
-------- -------- --------
Outstanding at
end of year 365,084 $10.65 508,419 $10.12 532,503 $10.10
======== ======== ========
Exercisable at
end of year 365,084 $10.65 497,394 $10.16 502,500 $11.03
======== ======== ========
Weighted average
fair value of
options granted
during the year $ -- $ -- $ --
====== ====== ======
61
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note J - (continued)
The following table summarizes information about options outstanding at
December 31, 2004:
Options Outstanding Options Exercisable
--------------------------------------------------------------------------- ----------------------------
Number Weighted Number
outstanding average Weighted outstanding Weighted
at remaining average at average
Range of December 31, contractual exercise December 31, exercise
exercise prices 2004 life (years) price 2004 price
--------------- ------ ------------ ------- ------ ------
$ 5.98 - 8.78 50,834 3.21 $ 8.53 50,834 $ 8.53
10.00 - 12.67 314,250 1.53 10.99 314,250 10.99
-------- --------
365,084 365,084
======== ========
NOTE K - EMPLOYEE BENEFIT PLANS
1. Retirement Income Plan
The Company has a Retirement Income Plan (the "Retirement Plan"), a
noncontributory plan covering substantially all full-time, non-union United
States employees of the Company. Benefits were based upon a combination of
employee compensation and years of service. The Company paid the entire cost of
the plan for its employees and funded such costs as they accrued. The Company's
funding policy was to make annual contributions within minimum and maximum
levels required by applicable regulations. The Company's customary contributions
were designed to fund normal cost on a current basis and fund over 30 years the
estimated prior service cost of benefit improvements (15 years of annual gains
and losses). The projected unit cost method was used to determine the annual
cost.
Benefit accruals were frozen as of September 15, 1988, resulting in a
plan curtailment. As a result of such curtailment, the Company did not accrue
benefits for future services; however, the Company did continue to contribute as
necessary for any unfunded liabilities. In 2000, the Company reinstated the
Retirement Plan to cover substantially all full-time, non-union United States
employees of the Company.
The following table summarizes the major categories of Plan assets as
of the dates indicated:
December 31,
-------------------------------------------------------------------
2004 2003
-------------------------------- --------------------------------
Fair Value % of Total Fair Value % of Total
-------------- --------------- -------------- --------------
(In thousands, except percentages
Mutual Funds
International Equity Fund $ 120 6.64% $ 127 6.99%
Large Cap Equity Growth Fund 793 43.94 831 45.76
International Investment
Grade Bond Fund 550 30.47 570 31.39
Small Cap Equity Growth Fund 118 6.54 122 6.72
Corporate Common Stocks(1) 216 11.97 157 8.65
Cash and cash equivalents 8 0.44 9 0.49
------- ------ ------- ------
Total Plan Assets $ 1,805 100.00% $ 1,816 100.00%
----------
(1) Includes 4,500 shares of the Company's Common Stock with a market value
of $92,250 and $75,000 at December 31, 2004 and 2003, respectively.
62
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
will be 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 will be
determined by the Investment Manager, and will 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 Retirement 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,
-----------------------------
2004 2003
------------- -------------
Discount rate 5.75% 6.60%
Rate of compensation increase 5.00% 5.00%
Weighted-average assumptions used to determine net periodic benefit
cost for the years ended December 31, 2004 and 2003 were as follows:
December 31,
-----------------------------
2004 2003
------------- -------------
Discount rate 6.60% 7.25%
Rate of compensation increase 5.00% 5.00%
Expected return on plan assets 8.50% 8.50%
Measurement date 1/1/2004 1/1/2003
A summary of the components of net periodic pension cost for the years
ended December 31, 2004, 2003 and 2002 is as follows:
December 31,
---------------------------------------
2004 2003 2002
---------- ------------ --------
Service cost-benefits earned
during the period $ 243,916 $ 195,162 $ 48,883
Interest cost on projected
benefit obligation 121,005 107,211 98,897
Expected return on plan assets (150,145) (123,482) (148,973)
Net amortization and deferral 37,428 43,208 18,370
--------- --------- ---------
Net pension cost of defined
benefit plan $ 252,204 $ 222,099 $ 17,177
========= ========= =========
63
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE K - (continued)
The following table sets forth the funded status and amounts recognized
in the Company's balance sheet for its defined benefit plan at December 31, 2004
and 2003:
December 31,
------------------------------------------
2004 2003
-------------------- --------------------
Actuarial present value of vested
accumulated benefit obligations $ 2,316,075 $ 1,807,366
Actuarial present value of
accumulated benefit obligations 2,316,075 1,814,032
----------- -----------
Projected benefit obligations $(2,316,075) $(1,814,032)
Fair value of plan assets 1,804,866 1,815,905
----------- -----------
Excess of projected benefit
obligation over fair value
of plan assets (511,209) 1,873
Unrecognized prior service cost 139,244 157,614
Unrecognized net loss 597,925 318,677
----------- -----------
Prepaid pension cost, included
in other assets $ 225,960 $ 478,164
=========== ===========
Estimated Future Benefit Payments
We estimate future benefit payments to be as follows:
Benefit
Years Payments
----- --------
2005 139,230
2006 144,405
2007 176,105
2008 161,432
2009 263,881
Years 2010-2014 1,042,795
Company Contributions
During the fiscal year ending December 31, 2005, the Company expects to
contribute approximately $58,000 to its Retirement Plan.
64
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE K - (continued)
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%.
December 31, 2002
---------------------
Change in benefit obligation (In thousands)
Benefit obligation at beginning of year $ 1,193
Service cost --
Interest cost 84
Actual loss 85
Benefits paid (91)
--------
Benefits obligations at end of year 1,271
Change in plan assets
Fair value of plan assets
at beginning of year 1,309
Actual return on plan assets (917)
Employer contribution --
Benefits paid (91)
--------
Fair value of plan assets
at end of year 1,127
Funded status (144)
Unrecognized net actuarial loss 340
--------
Prepaid benefit cost (included in
other assets) $ 196
========
Net pension cost included the following components:
Year Ended December 31,
---------------------------------------------
2004 2003 2002
------------ ------------- --------------
(In thousands)
Service cost $ -- $ -- $ --
Interest cost on projected
benefit obligation -- -- 84
Expected return on plan -- -- (88)
assets
Purchase accounting change -- -- --
------- ------- -------
Net periodic benefit cost $ -- $ -- $ 4
======= ======= =======
The assumed discount rate and rate of increase in future compensation
levels used in determining the actuarial present value of the projected benefit
obligation was 7.25% in 2002.
65
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE K - (continued)
3. Postretirement Welfare Plan
In addition to pension benefits, 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,
-------------------------------
2004 2003
----------- --------------
(In thousands)
Change in benefit obligation
Benefit obligation at beginning of year $ 715 $ 718
Service cost -- --
Interest cost 43 47
Actual loss 10 2
Benefits paid (49) (52)
-------- --------
Benefits obligation at end of year 719 715
-------- --------
Change in plan assets
Fair value of plan assets
at beginning of year -- --
Actual return on plan assets -- --
Employer contribution 49 52
Benefits paid (49) (52)
-------- --------
Fair value of plan assets
at end of year -- --
-------- --------
Funded status (719) (715)
Unrecognized net actuarial loss 25 15
-------- --------
Accrued benefit cost (included in
other liabilities) $ 694 $ 700
======== ========
Net benefit cost included the following components:
Year Ended December 31,
----------------------------------------
2004 2003
------------------- ------------------
(In thousands)
Service cost $ -- $ --
Interest cost on projected
benefit obligation 43 47
Actual return on plan assets -- --
-------- --------
Net periodic benefit cost $ 43 $ 47
======== ========
The assumed discount rate used in determining the actuarial present
value of the projected benefit obligation was 6.125% and 6.75% in 2004 and 2003,
respectively.
66
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE K - (continued)
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 $89,000,
$76,000 and $105,000 for the years ended December 31, 2004, 2003 and 2002,
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,
2004 and 2003, the balance accumulated under these arrangements was
approximately $241,000 and will be paid out when the individual (i) ceases to be
a director and/or executive of the Company; (ii) attains the age of 75; or (iii)
specifies a particular date.
NOTE L - COMMITMENTS AND CONTINGENCIES
1. Leases and Other Commitments
The Company leases certain of its operating facilities under
non-cancelable operating leases expiring in 2005 through 2012. 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,
--------------------
2005 $ 712
2006 713
2007 727
2008 537
2009 475
Thereafter 531
-------
$ 3,695
=======
Rental expense was approximately $964,000, $699,000 and $811,000 for
the fiscal years ended December 31, 2004, 2003 and 2002, respectively. Included
in rental expense was approximately $298,000, $270,000 and $255,000 for the
fiscal years ended December 31, 2004, 2003 and 2002, 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.
67
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note M - (continued)
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, 2004 and 2003 are outlined
below.
For cash and cash equivalents, the recorded book values of $17.38
million and $9.31 million at December 31, 2004 and 2003, respectively,
approximate fair values. The estimated fair values of investment securities are
based on quoted market prices, if available. Estimated fair values are based on
quoted market prices of comparable instruments if quoted market prices are not
available.
December 31,
-----------------------------------------------------------------------
2004 2003
-------------------------------- ------------------------------------
Carrying Estimated Carrying Estimated
amount fair value amount fair value
-------------- --------------- ----------------- ----------------
(In thousands)
Investment securities $631,592 $631,601 $569,848 $569,852
Loans, net of unearned income 286,979 291,460 294,756 301,647
Time Deposits 274,309 273,397 317,480 318,450
Repurchase Agreements 127,747 127,442 114,391 114,462
Long-term Debt 111,069 112,598 77,745 81,053
The net loan portfolio at December 31, 2004 and 2003 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 $132,000 and $180,000 at December 31,
2004 and 2003, respectively.
68
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,
-------------------------------------
2004 2003
--------------- ----------------
(In thousands)
Unused lines of credit $ 15,859 $ 11,243
Commitments to extend credit -- 2,011
Standby letters of credit and financial
guarantees written 750 775
------- --------
$ 16,609 $ 14,029
======== ========
Interest rate caps-notional amount $ 25,000 $ 30,000
======== ========
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, 2004 varies up to 100%.
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, 2004 are
$750,000 and they expire through 2006. Amounts due under these letters of credit
would be reduced by any proceeds that the Company would be able to obtain in
liquidating the collateral for the loans, which varies depending on the
customer.
69
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE N - (continued)
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" ("SFAS No. 133"), 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, 2004, the Bank meets all capital adequacy
requirements to which it is subject.
As of December 31, 2004, 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.
70
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, 2004
and 2003 (dollars in thousands):
To be well
capitalized under
For capital prompt corrective
Actual adequacy purposes action provisions
------ ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
December 31, 2004
Total Capital (to Risk-Weighted Assets)
Company 110,063 30.1% 29,234 >=8.0% -- N/A
Bank 82,970 24.1% 27,533 >=8.0% 34,416 >=10.0%
Tier I Capital (to Risk-Weighted Assets)
Company 107,136 29.3% 14,617 >=4.0% -- N/A
Bank 80,042 23.3% 13,766 >=4.0% 20,649 >=6.0%
Tier I Capital (to Average Assets)
Company 107,136 11.2% 38,250 >=4.0% -- N/A
Bank 80,042 8.6% 37,240 >=4.0% 46,550 >=5.0%
To be well
capitalized under
For capital prompt corrective
Actual adequacy purposes action provisions
------ ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
December 31, 2003
Total Capital (to Risk-Weighted Assets)
Company 86,759 26.1% 26,630 >=8.0% -- N/A
Bank 60,675 19.1% 25,417 >=8.0% 31,772 >=10.0%
Tier I Capital (to Risk-Weighted Assets)
Company 84,166 25.3% 13,315 >=4.0% -- N/A
Bank 58,082 18.3% 12,709 >=4.0% 19,063 >=6.0%
Tier I Capital (to Average Assets)
Company 84,166 10.7% 31,410 >=4.0% -- N/A
Bank 58,082 7.0% 33,391 >=4.0% 41,739 >=5.0%
71
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,
--------------------------------
2004 2003
------------ ------------
ASSETS
Cash $ 7,415 $ 12,035
Equity investment in subsidiaries 101,004 82,532
Investment in securities available for sale 9,022 2,901
Loans 6,059 6,244
Accrued interest receivable 284 74
Other assets 892 499
--------- ---------
Total assets $ 124,676 $ 104,285
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Subordinated debt $ 15,464 $ --
Other liabilities 1,593 795
--------- ---------
Total liabilities 17,057 795
--------- ---------
Stockholders' equity
Common stock 770 256
Additional paid-in capital 89,543 89,866
Retained earnings 28,983 22,960
Accumulated other comprehensive
income, net (2,602) 775
Common stock in treasury, at cost (9,075) (10,367)
--------- ---------
Total stockholders' equity 107,619 103,490
--------- ---------
$ 124,676 $ 104,285
========= =========
72
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,
---------------------------------------
2004 2003 2002
-------- -------- --------
INCOME
Interest income from the Bank $ 71 $ 106 $ 207
Interest income 1,090 795 1,149
Gain on sales of 734 1,131 7
investment securities
Other income (loss) 96 407 (73)
-------- -------- --------
Total income 1,991 2,439 1,290
EXPENSES
Salaries and employee benefits 489 442 243
Interest expense 463 -- --
Other expenses 1,058 759 505
-------- -------- --------
Total expenses 2,010 1,201 748
-------- -------- --------
Income (loss) before income taxes
and equity in undistributed net
income of the Bank (19) 1,238 542
Equity in undistributed
net income of the Bank 7,668 6,710 5,405
-------- -------- --------
Income before taxes 7,649 7,948 5,947
Provision for income taxes 147 533 350
-------- -------- --------
Net income $ 7,502 $ 7,415 $ 5,597
======== ======== ========
73
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,
--------------------------------------------
2004 2003 2002
------ ------ -----
Operating activities:
Net income $ 7,502 $ 7,415 $ 5,597
Adjustments to reconcile net
income to net cash provided by
(used in) operating activities:
Gain on sales of investment securities (734) (1,131) (7)
Equity in undistributed net income of the Bank (7,668) (6,843) (5,405)
Dividends received from the Bank 500 -- --
Increase in other liabilities 798 294 214
Decrease in other assets 69 151 840
-------- -------- --------
Net cash provided by (used in) operating activities 467 (114) 1,239
-------- -------- --------
Investing activities:
Investment securities available for sale
Purchases (9,150) (5,172) (2,965)
Sales 3,874 9,451 775
Net decrease (increase) in loans 185 2,176 (1,942)
Contribution to the Bank (14,791) -- --
Transfer of premises and equipment -- -- (1,292)
-------- -------- --------
Net cash provided by (used in) investing activities (19,882) 6,455 (5,424)
-------- -------- --------
Financing activities:
Proceeds from exercise of common stock options 1,271 205 102
Acquisition of treasury stock (69) (1,350) (4,422)
Cash paid for fractional shares (463) -- --
Issuance of subordinated debentures 14,791 -- --
Dividends paid (735) (600) (505)
-------- -------- --------
Net cash provided by (used in) financing activities 14,795 (1,745) (4,825)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents (4,620) 4,596 (9,010)
Cash and cash equivalents at beginning of year 12,035 7,439 16,449
-------- -------- --------
Cash and cash equivalents at end of year $ 7,415 $ 12,035 $ 7,439
======== ======== ========
Supplemental disclosures of cash flow information:
Cash used to pay interest $ 273 $ -- $ --
Cash used to pay income taxes $ 419 $ 375 $ 146
Transfer of premises and equipment to
subsidiary for note receivable $ -- $ 5,056 $ --
74
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
---------- ---------- ------------ -----------
2004
----
Interest income $ 9,638 $ 9,626 $ 10,276 $ 10,468
Interest expense (3,720) (3,796) (4,103) (4,297)
-------- -------- -------- --------
Net interest income 5,918 5,830 6,173 6,171
Provision for loan losses (45) (45) (45) (45)
Gains on sales of securities 93 49 173 478
Non-interest income 325 202 282 217
Non-interest expenses (2,962) (3,172) (3,126) (2,835)
-------- -------- -------- --------
Income before taxes 3,329 2,864 3,457 3,986
Provision for taxes (1,378) (1,383) (1,489) (1,884)
-------- -------- -------- --------
Net income $ 1,951 $ 1,481 $ 1,968 $ 2,102
======== ======== ======== ========
Per share data
Net income per common share
Basic $ .29 $ .22 $ .30 $ .31
======== ======== ======== ========
Diluted $ .28 $ .22 $ .30 $ .30
======== ======== ======== ========
Three Months Ended
------------------------------------------------------------------
March 31 June 30 September 30 December 31
---------- ---------- ------------ -----------
2003
----
Interest income $ 8,378 $ 8,480 $ 8,621 $ 8,947
Interest expense (3,388) (3,395) (3,332) (3,532)
-------- -------- -------- --------
Net interest income 4,990 5,085 5,289 5,415
Provision for loan losses (105) (45) (45) (45)
Gains on sales of securities 628 1,491 183 444
Non-interest income 364 305 297 271
Non-interest expenses (2,712) (2,727) (3,093) (2,931)
-------- -------- -------- --------
Income before taxes 3,165 4,109 2,631 3,154
Provision for taxes (1,423) (1,801) (1,223) (1,197)
-------- -------- -------- --------
Net income $ 1,742 $ 2,308 $ 1,408 $ 1,957
======== ======== ======== ========
Per share data
Net income per common share
Basic $ .26 $ .35 $ .21 $ .30
======== ======== ======== ========
Diluted $ .26 $ .34 $ .21 $ .29
======== ======== ======== ========
75
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 13(a)-15(f) of
the Securities Exchange Act of 1934 ("Internal Control") will prevent all error
and all fraud. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Further, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be
considered relative to their costs. Because of the inherent limitations in all
control systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within the Company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people, or by management
override of the control. The design of any system of controls also is based in
part upon certain assumptions about the likelihood of future events, and there
can be no assurance that any design will succeed in achieving its stated goals
under all potential future conditions; over time, control may become inadequate
because of changes in conditions, or the degree of compliance with the policies
or procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur and
not be detected.
Conclusions. Based upon the Controls Evaluation, the CEO/CFO has concluded that,
subject to the limitations noted above, the Disclosure Controls are effective in
reaching a reasonable level of assurance that information required to be
disclosed by the Company is recorded, processed, summarized and reported within
the time period specified in the Securities and Exchange Commission's rules and
forms. In accordance with SEC requirements, the CEO/CFO notes that during the
fiscal quarter ended December 31, 2004, no changes in Internal Control have
occurred that have materially affected or are reasonably likely to materially
affect Internal Control.
ITEM 9B. Other Information
Not Applicable
76
PART III
ITEM 10. Directors and Executive Officers of the Registrant.
The following are the current directors and executive officers of the Company:
Name Age Position(s)
---- --- ----------------------------
Steven Rosenberg 56 President, Director
William L. Cohen 63 Director
Thomas V. Guarino 51 Director
Moses Marx 69 Director
Randolph B. Stockwell 58 Director
Moses Krausz 64 President of The Berkshire Bank
David Lukens 55 Executive Vice President, Chief Financial
Officer of The Berkshire Bank
Mr. Rosenberg has served as President and Chief Executive Officer of
the Company since March 1999 and as Vice President and Chief Financial Officer
of the Company from April 1990 to March 1999. He continues to serve as Chief
Financial Officer. Mr. Rosenberg was elected a director in May 1995. From
September 1987 through April 1990, he served as President and Director of Scomel
Industries, Inc., a company engaged in international marketing and consulting.
Mr. Rosenberg is a director of The Cooper Companies, Inc. (a developer and
manufacturer of healthcare products).
Mr. Cohen was elected a director in July 1993. He has served as the
Chief Executive Officer of Andover Properties, LLC, a real estate development
company specializing in self storage facilities since November 2003, and has
been a private investor for over six years. Mr. Cohen served as President, Chief
Executive Officer and Chairman of the Board of The Andover Apparel Group, Inc.,
an apparel manufacturing company, from 1980 to 2000.
Mr. Guarino was elected a director in March 2001. He served as a
director of Goshen Savings Bank from 1996, and chairman of the Board of
Directors of GSB Financial Corporation from April 1998, until the respective
mergers of those companies into The Berkshire Bank and the Company in March
2001. Mr. Guarino is the President and Senior Portfolio Manager of the Hudson
Valley Investment Advisors, Inc., an investment management and advisory company,
a position he has held since 1995. Prior to that, he had been, since 1988, a
Vice President of Fleet Investment Advisors, Inc. and was Vice President in
charge of investments of Norstar Bank of the Hudson Valley from 1981 to 1988.
Mr. Marx was elected a director in May 1995. Mr. Marx has been the
General Partner in United Equities Company since 1954 and General Partner in
United Equities Commodities Company since 1972. He is also President of Momar
Corp. All of these are investment companies. Mr. Marx is a director of The
Cooper Companies, Inc.
Mr. Stockwell was elected a director in July 1988. He has been a
private investor for over ten years. Since April 1999, Mr. Stockwell has served
as President of Yachting Systems of America, LLC, a small start-up company. In
addition, he served in various capacities with the Community Bank, a commercial
bank, from September 1972 to January 1987.
Mr. Krausz has held the position of President of The Berkshire Bank
since March 1992 and Chief Executive Officer since November 1993. Prior to
joining The Berkshire Bank, Mr. Krausz was Managing Director of SFS Management
Co., L.P., a mortgage banker, from 1987 to 1992 and was President of UMB Bank
and Trust Company, a New York State chartered bank, from 1978 to 1987.
Mr. Lukens has held the position of Senior Vice President and Chief
Financial Officer of The Berkshire Bank since December 1999, 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.
77
Audit Committee Members, Financial Expert and Independence
The Board of Directors of the Company has established an Audit
Committee comprised of three independent directors, Messrs. William L. Cohen,
Thomas V. Guarino and Randolph B. Stockwell. All of the members of the Audit
Committee meet the independence requirements under current NASDAQ corporate
governance standards for companies whose securities are quoted on NASDAQ. Based
upon their education and relevant experience, the Board of Directors has
determined that Messrs. Guarino and Stockwell each qualify as financial experts
as defined by the Sarbanes-Oxley Act of 2002 and the rules of the Securities and
Exchange Commission.
Corporate Code of Ethics
We have adopted a Corporate Code of Ethics that applies to the
directors, officers and employees, including the senior management: the chief
executive officer, chief financial officer, controller and persons performing
similar functions, of Berkshire Bancorp Inc. and its subsidiaries. Copies of our
Corporate Code of Ethics are available without charge upon written request to
the Company at its principal executive office.
ITEM 11. Executive Compensation
The following table shows the compensation paid in or with respect to
each of the last three fiscal years to the individual who served as the
Company's Chief Executive Officer for the fiscal year ended December 31, 2004,
and to each of the other executive officers who were paid more than $100,000
during the fiscal year ended December 31, 2004.
Summary Compensation Table
Annual Compensation
-------------------
Name and Principal Position All Other
--------------------------- Year Salary Bonus Compensation
---- ------ ----- ------------
Steven Rosenberg 2004 $182,000 $ 10,000 $ --
President, Chief Executive 2003 $175,500 $ -- $ --
Officer and Chief Financial 2002 $167,500 $ -- $ --
Officer
Moses Krausz 2004 $382,865 $200,000 $ 11,405(1)
President and Chief Executive 2003 $358,864 $175,000 $ 10,405(1)
Officer of The Berkshire Bank 2002 $347,288 $175,000 $ 10,050(1)
David Lukens 2004 $155,000 $ 25,000 $ 7,350(2)
Executive Vice President and 2003 $138,500 $ 25,000 $ 5,968(2)
Chief Financial Officer of 2002 $125,000 $ 24,000 $ 5,367(2)
The Berkshire Bank
----------
(1) Consists of contributions by the Company to a 401(k) account of $8,000,
$7,000 and $6,000, respectively, in 2004, 2003 and 2002, and income
associated with life insurance coverage in excess of $50,000.
(2) Consists of contributions by the Company to a 401(k) account of $5,205,
$4,905 and $4,470, respectively, in 2004, 2003 and 2002, and income
associated with life insurance coverage in excess of $50,000. Does not
include the annual retirement credits of 5% of gross wages under the
Company's Retirement Income Plan.
78
Option Grants in Last Fiscal Year
There were no stock option grants during the fiscal year ended December 31,
2004.
Aggregated Option Exercises and Fiscal Year-End Option Values
The following table sets forth information concerning options exercised
during the fiscal year ended December 31, 2004, and the number of options owned
and the value of any in-the-money unexercised options as of December 31, 2004 by
each of the individuals named in the Summary Compensation Table.
Number of
Unexercised
Shares Options at
Acquired Fiscal Year-End Value of Unexercised
on Value (#) In-the-Money Options at
Exercise Realized Exercisable Fiscal Year-End ($)
Name (#) ($) /Unexercisable Exercisable/Unexercisable
---- ----- ----- -------------- -------------------------
Steven Rosenberg -0- -0- 30,000/0 315,000/0
Moses Krausz -0- -0- 150,000/0 1,334,700/0
David Lukens -0- -0- 30,000/0 306,300/0
----------
Year-end values for unexercised in-the-money options represent the positive
spread between the exercise price of such options and the fiscal year end market
value of the common stock. An Option is "in-the-money" if the fiscal year end
fair market value of the Common Stock exceeds the option exercise price.
Compensation of Directors
Each director who is not also an employee of the Company (a
"Non-Employee Director") receives a stipend of $18,000 per annum and $1,500 for
each day during which he participates in a meeting of the Board or a Committee
of the Board. Each Non-Employee Director also receives a fee of $1,000 for
telephonic meetings of the Board or a Board Committee. In addition, see "1999
Stock Incentive Plan" below.
1999 Stock Incentive Plan
The 1999 Stock Incentive Plan permits the granting of awards in the
form of nonqualified stock options, incentive stock options, restricted stock,
deferred stock, and other stock-based incentives. Up to 600,000 shares of common
stock of the Company may be issued pursuant to the 1999 Stock Incentive Plan
(subject to appropriate adjustment in the event of changes in the corporate
structure of the Company). Officers, directors and other key employees of the
Company or any subsidiary are eligible to receive awards under the 1999 Stock
Incentive Plan. The option exercise price of all options which are granted under
the 1999 Stock Incentive Plan must be at least equal to 100% of the fair market
value of a share of common stock of the Company on the date of grant. At
December 31, 2004, options to acquire 560,757 shares of common stock have been
granted under this plan and 39,243 options are available for future grants.
Retirement Income Plan
The Company has a Retirement Income Plan (the "Retirement Plan"), a
noncontributory plan covering substantially all full-time, non-union United
States employees of the Company. Benefits were based upon a combination of
employee compensation and years of service. The Company paid the entire cost of
the plan for its employees and funded such costs as they accrued. The Company's
funding policy was to make annual contributions within minimum and maximum
levels required by applicable regulations. The Company's customary contributions
were designed to fund normal cost on a current basis and fund over 30 years the
estimated prior service cost of benefit improvements (15 years of annual gains
and losses). The projected unit cost method was used to determine the annual
cost. Plan assets consist principally of equity and fixed income mutual funds.
79
Benefit accruals were frozen as of September 15, 1988, resulting in a
plan curtailment. As a result of such curtailment, the Company did not accrue
benefits for future services; however, the Company did continue to contribute as
necessary for any unfunded liabilities. In 2000, the Company reinstated the
Retirement Plan to cover substantially all full-time, non-union United States
employees of the Company.
A participant in the Plan accumulates a balance in his or her
retirement account by receiving: (i) an annual retirement credit of 5% of gross
wages paid during the year, but not in excess of the applicable annual maximum
compensation permitted to be taken into account under Internal Revenue Service
guidelines for each year of service; and (ii) an annual interest credit based
upon the 30-year U. S. Treasury securities rate. The Company pays the entire
cost of the Plan for its employees and funds such costs as they accrue.
The estimated annual benefits payable under the Plan upon retirement
(at the normal retirement age of 65) for Messrs. Rosenberg and Lukens are
approximately $160,000 and $16,000, respectively. In accordance with the laws
currently governing the Plan, the estimated annual benefit payable to Mr.
Rosenberg is not expected to increase. Mr. Krausz is not a participant in the
Plan. (see Note K of Notes to Consolidated Financial Statements).
ITEM 12. Security Ownership of Certain Beneficial Owners and
Management and Equity Compensation Plans.
The following table sets forth certain information as of March 24, 2005
with respect to the beneficial ownership of the Company's Common Stock by (i)
each person who is known by the Company to own beneficially more than 5% of the
Company's Common Stock, (ii) each of the Company's directors and executive
officers, and (iii) all executive officers and directors as a group.
Number of Percent
Shares of Class
--------------- -------------
William Cohen 7,500 (1) *
Thomas V. Guarino 99,370 (2) 1.5%
Moses Krausz 238,000 (3) 3.4%
David Lukens 30,600 (4) *
Moses Marx 3,560,693 (5) 52.7%
160 Broadway
New York, NY 10038
Steven Rosenberg 62,580 (6) *
Randolph B. Stockwell 24,000 (7) *
All executive officers and directors
as a group (7 persons) 4,022,743 (8) 57.3%
----------
* Less than 1%
(1) Includes 3,000 shares issuable upon the exercise of options which have
been granted to Mr. Cohen under the Company's 1999 Stock Incentive
Plan.
(2) Includes 43,650 shares issuable upon the exercise of options which
have been granted to Mr. Guarino under the Company's 1999 Stock
Incentive Plan. Includes 7,920 shares held in trust for minor
children and 900 shares held by Mr. Guarino's wife
(3) Includes 150,000 shares issuable upon the exercise of options which
have been granted to Mr. Krausz under the Company's 1999 Stock
Incentive Plan and 2,100 shares owned by Mr. Krausz's spouse.
(4) Includes 30,000 shares issuable upon the exercise of options which have
been granted to Mr. Lukens under the Company's 1999 Stock Incentive
Plan.
80
ITEM 12. (continued)
(5) Includes 3,000 shares issuable upon the exercise of options which have
been granted to Mr. Marx under the Company's 1999 Stock Incentive Plan,
285,000 shares owned by Momar Corporation and 391,163 shares owned by
Terumah Foundation. Does not include 129,201 shares representing 80.5%
of the shares owned by Eva and Esther, L.P., of which Mr. Marx has an
80.5% limited partnership interest. Mr. Marx's daughters and their
husbands are the general partners of Eva and Esther, L.P.
(6) Includes 30,000 shares issuable upon the exercise of options which have
been granted to Mr. Rosenberg under the Company's 1999 Stock Incentive
Plan.
(7) Includes 3,000 shares issuable upon the exercise of options which have
been granted to Mr. Stockwell under the Company's 1999 Stock Incentive
Plan.
(8) Includes 262,650 shares of Common Stock which are issuable upon the
exercise of outstanding options.
Equity Compensation Plans
The following table details information regarding the Company's
existing equity compensation plans as of December 31, 2004.
(c)
Number of securities
(a) (b) remaining available for
Number of securities to Weighted-average future issuance under
be issued upon exercise exercise price of equity compensation plans
of outstanding options, outstanding options, (excluding securities
Plan Category warrants and rights warrants and rights reflected in column (a)
------------- ----------------------- --------------------- ------------------------
Equity compensation 365,084 $10.65 39,243
plans approved by
security holders
Equity compensation -- -- --
plans not approved by
security holders
Total 365,084 $10.65 39,243
ITEM 13. Certain Relationships and Related Transactions.
In January 2000, the Bank entered into a lease agreement with Bowling
Green Associates, LP, the principal owner of which is Mr. Marx, for commercial
space to open a bank branch. The Company obtained an appraisal of the market
rental value of the space from an independent appraisal firm and management
believes that the terms of the lease, including the annual rent paid, $298,000
and $270,000 in fiscal 2004 and 2003, 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.
81
ITEM 14. Principal Accountant Fees and Services
The Company's principal accountant is Grant Thornton LLP ("Grant
Thornton"). The total fees paid to Grant Thornton for the last two fiscal years
are as follows:
Fiscal Year Ended Fiscal Year Ended
December 31, 2004 December 31, 2003
---------------------- -----------------------
Audit Fees $208,167 $146,153
Audit Related Fees: Professional services 16,250 6,815
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 55,070 72,096
returns
All Other Fees: Professional services 3,400 --
rendered for corporate support
The Audit Committee has established its pre-approval policies and
procedures, pursuant to which the Audit Committee approved the foregoing audit
and permissible non-audit services provided by Grant Thornton LLP in 2004 and
2003. Consistent with the Audit Committee's responsibility for engaging our
independent auditors, all audit and permitted non-audit services require
pre-approval by the Audit Committee. The full Audit Committee approves proposed
services and fee estimates for these services. The Audit Committee chairperson
has been designated by the Audit Committee to approve any services arising
during the year that were not pre-approved by the Audit Committee and services
that were pre-approved. Service approved by the Audit Committee chairperson are
communicated to the full Audit Committee at its next regular quarterly meeting
and the Audit Committee reviews services and fees for the fiscal year at each
such meeting. Pursuant to these procedures, the Audit Committee approved the
foregoing audit and permissible non-audit services provided by Grant Thornton
LLP.
PART IV
ITEM 15. Exhibits, Financial Statement Schedules.
(a) Documents filed as part of this Report:
(1) Financial Statements
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2004 and 2003
Consolidated Statements of Income for the Years Ended December 31,
2004, 2003 and 2002
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows for the Years Ended December 31,
2004, 2003 and 2002
Notes to Consolidated Financial Statements
82
ITEM 15. (continued)
Schedule
Number Description
------ -----------
None
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are not applicable and, therefore, have been omitted.
(3) Exhibits
Exhibit
Number Description
------ -----------
2.1 Agreement and Plan of Reorganization, dated as of August 16, 2000, by
and between Berkshire Bancorp Inc., Greater American Finance Group,
Inc., The Berkshire Bank, GSB Financial Corporation and Goshen Savings
Bank (incorporated by reference to the Companies Registration Statement
on Form S-4 dated October 13, 2000.
3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 to the Company's Current
Report on Form 8-K dated March 30, 1999, and the Company's Quarterly
Report on Form 10-Q for the Quarterly Period Ended June 30, 2004).
3.2 Amended and Restated By-laws of the Company (incorporated by reference
to Exhibit 3.2 to the Company's Current Report on Form 8-K dated March
30, 1999).
10.1 1999 Stock Incentive Plan of the Company (incorporated by reference to
Exhibit 10.8 to the Company's Current Report on Form 8-K dated March
30, 1999).+
10.2 Employment Agreement, dated May 1, 1999, between The Berkshire Bank and
Moses Krausz (incorporated by reference to Exhibit 10.3 to the
Company's Annual Report on Form 10-K for the Fiscal Year Ended December
31, 2000).+
10.3 Employment Agreement, dated January 1, 2001, between The Berkshire Bank
and David Lukens (incorporated by reference to Exhibit 10.4 to the
Company's Annual Report on Form 10-K for the Fiscal Year Ended December
31, 2000).+
10.4 Lease Agreement, dated October 26, 1999, between Braun Management, Inc.
as agent for Bowling Green Associates, L.P., and The Berkshire Bank
(incorporated by reference to Exhibit 10.5 to the Company's Quarterly
Report on Form 10-Q for the Quarterly Period Ended March 31, 2001).
10.5 Amendment No. 1 to Employment Agreement, dated August 1, 2001, by and
between The Berkshire Bank and Moses Krausz (incorporated by reference
to Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for the
Quarterly Period Ended September 30, 2001).+
10.6 Amendment No. 1 to Employment Agreement, dated June 3, 2002, by and
between The Berkshire Bank and David Lukens (incorporated by reference
to Exhibit 10.7 to the Company's Quarterly Report on Form 10-Q for the
Quarterly Period Ended June 30, 2002).+
10.7 Amendment No. 2 to Employment Agreement, dated August 1, 2001, by and
between The Berkshire Bank and Moses Krausz (incorporated by reference
to Exhibit 10.8 to the Company's Quarterly Report on Form 10-Q for the
Quarterly Period Ended June 30, 2002).+
21. Subsidiaries of the Company.
23. Consent of Independent Registered Public Accounting Firm 31.
Certification of Principal Executive and Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32. Certification of Principal Executive and Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
----------
+ Denotes a management compensation plan or arrangement.
83
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 24, 2005
------------------------------------
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 24, 2005
-------------------------
Steven Rosenberg
/s/ William Cohen Director March 24, 2005
-------------------------
William Cohen
/s/ Thomas V. Guarino Director March 24, 2005
-------------------------
Thomas V. Guarino
/s/ Moses Marx Director March 24, 2005
-------------------------
Moses Marx
/s/ Randolph B. Stockwell Director March 24, 2005
--------------------------
Randolph B. Stockwell
84
STATEMENT OF DIFFERENCES
------------------------
The greater-than-or-equal-to sign shall be expressed as.................. >=