UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended JUNE 30, 2008
----------------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to_________________
Commission file number: 0-13649
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BERKSHIRE BANCORP INC.
----------------------
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 94-2563513
---------------------------- ----------------------
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
160 BROADWAY, NEW YORK, NEW YORK 10038
------------------------------------- ----------------------
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code: (212) 791-5362
---------------
N/A
-------------------------------------------------------------------------------
(Former Name, Former Address and Former Fiscal Year, if Changed Since
Last Report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. (See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.) (Check one):
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [X]
(Do not check if a smaller
reporting company)
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act. Yes [ ] No [X]
As of August 11, 2008, there were 7,054,183 outstanding shares of the issuer's
Common Stock, $.10 par value.
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
FORWARD-LOOKING STATEMENTS
FORWARD-LOOKING STATEMENTS. STATEMENTS IN THIS QUARTERLY REPORT ON FORM 10-Q
THAT ARE NOT BASED ON HISTORICAL FACT MAY BE "FORWARD-LOOKING STATEMENTS" WITHIN
THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. WORDS SUCH
AS "BELIEVE", "MAY", "WILL", "EXPECT", "ESTIMATE", "ANTICIPATE", "CONTINUE" OR
SIMILAR TERMS IDENTIFY FORWARD-LOOKING STATEMENTS. A WIDE VARIETY OF FACTORS
COULD CAUSE THE ACTUAL RESULTS AND EXPERIENCES OF BERKSHIRE BANCORP INC. (THE
"COMPANY") 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 THIS QUARTERLY REPORT AND IN ITEM 1A, "RISK
FACTORS", OF THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED
DECEMBER 31, 2007.
CERTAIN INFORMATION CUSTOMARILY DISCLOSED BY FINANCIAL INSTITUTIONS,
SUCH AS ESTIMATES OF INTEREST RATE SENSITIVITY AND THE ADEQUACY OF THE LOAN LOSS
ALLOWANCE, ARE INHERENTLY FORWARD-LOOKING STATEMENTS BECAUSE, BY THEIR NATURE,
THEY REPRESENT ATTEMPTS TO ESTIMATE WHAT WILL OCCUR IN THE FUTURE.
THE COMPANY CAUTIONS READERS NOT TO PLACE UNDUE RELIANCE UPON ANY
FORWARD-LOOKING STATEMENT CONTAINED IN THIS QUARTERLY REPORT. FORWARD-LOOKING
STATEMENTS SPEAK ONLY AS OF THE DATE THEY WERE MADE AND THE COMPANY ASSUMES NO
OBLIGATION TO UPDATE OR REVISE ANY SUCH STATEMENTS UPON ANY CHANGE IN APPLICABLE
CIRCUMSTANCES.
2
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
INDEX
PAGE NO.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of
June 30, 2008 (unaudited) and
December 31, 2007 4
Consolidated Statements of Income
For The Three and Six Months Ended
June 30, 2008 and 2007 (unaudited) 5
Consolidated Statement of Stockholders'
Equity For The Six Months Ended
June 30, 2008 and 2007 (unaudited) 6
Consolidated Statements of Cash Flows
For The Six Months Ended
June 30, 2008 (unaudited) 7
Notes to Consolidated Financial Statements 9
Item 2. Management's Discussion and Analysis
of Financial Condition and Results
of Operations 18
Item 3. Quantitative and Qualitative Disclosure
About Market Risk 26
Item 4T. Controls and Procedures 34
PART II OTHER INFORMATION
Item 4. Submission of Matters to a Vote of
Security Holders 35
Item 6. Exhibits 35
Signature 36
Index of Exhibits 37
3
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
JUNE 30, DECEMBER 31,
2008 2007
---------------------------------------
ASSETS
Cash and due from banks $ 8,806 $ 8,614
Interest bearing deposits 17,735 7,579
Federal funds sold 22,250 31,000
----------- -----------
Total cash and cash equivalents 48,791 47,193
Investment Securities:
Available-for-sale 514,926 598,961
Held-to-maturity, fair value of $388
in 2008 and $405 in 2007 384 395
----------- -----------
Total investment securities 515,310 599,356
Loans, net of unearned income 460,371 434,785
Less: allowance for loan losses (5,052) (4,183)
----------- -----------
Net loans 455,319 430,602
Accrued interest receivable 8,147 8,602
Premises and equipment, net 9,074 9,362
Goodwill, net 18,549 18,549
Other assets 16,573 6,854
----------- -----------
Total assets $ 1,071,763 $ 1,120,518
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 57,044 $ 53,805
Interest bearing 765,245 799,410
----------- -----------
Total deposits 822,289 853,215
Securities sold under agreements to repurchase 55,932 76,842
Long term borrowings 50,142 31,607
Subordinated debt 22,681 22,681
Accrued interest payable 5,872 9,089
Other liabilities 2,448 2,826
----------- -----------
Total liabilities 959,364 996,260
----------- -----------
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 --
June 30, 2008, 7,054,183 shares
December 31, 2007, 7,054,183 shares 770 770
Additional paid-in capital 90,986 90,986
Retained earnings 46,940 42,352
Accumulated other comprehensive loss, net (19,886) (3,439)
Treasury Stock
June 30, 2008, 644,102 shares
December 31, 2007, 644,102 shares (6,411) (6,411)
----------- -----------
Total stockholders' equity 112,399 124,258
----------- -----------
$ 1,071,763 $ 1,120,518
=========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS
4
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------ -----------------------------
2008 2007 2008 2007
-------- -------- -------- --------
INTEREST INCOME
Loans $ 8,096 $ 7,240 $ 16,301 $ 14,478
Investment securities 7,254 6,416 15,121 12,251
Federal funds sold and
interest bearing deposits 200 376 424 1,062
-------- -------- -------- --------
Total interest income 15,550 14,032 31,846 27,791
-------- -------- -------- --------
INTEREST EXPENSE
Deposits 6,355 7,825 14,088 15,269
Sexurities sold under agreements
to repurchase 520 433 1,114 866
Long-term borrowings and
subordinated debt 804 915 1,610 1,906
-------- -------- -------- --------
Total interest expense 7,679 9,173 16,812 18,041
-------- -------- -------- --------
Net interest income 7,871 4,859 15,034 9,750
PROVISION FOR LOAN LOSSES 654 75 804 150
-------- -------- -------- --------
Net interest income after
provision for loan losses 7,217 4,784 14,230 9,600
-------- -------- -------- --------
NON-INTEREST INCOME
Service charges on deposits accounts 138 183 293 364
Investment securities gains 20 -- 78 125
Other income 219 208 472 417
-------- -------- -------- --------
Total non-interest income 377 391 843 906
-------- -------- -------- --------
NON-INTEREST EXPENSE
Salaries and employee benefits 2,417 2,142 4,816 4,376
Net occupancy expense 507 440 1,045 916
Equipment expense 97 98 192 200
FDIC assessment 132 20 238 40
Data processing expense 110 99 221 195
Other 714 727 1,375 1,252
-------- -------- -------- --------
Total non-interest expense 3,977 3,526 7,887 6,979
-------- -------- -------- --------
Income before provision for taxes 3,617 1,649 7,186 3,527
Provision for income taxes 975 629 1,895 1,407
-------- -------- -------- --------
Net income $ 2,642 $ 1,020 $ 5,291 $ 2,120
======== ======== ======== ========
Net income per share:
Basic $ .37 $ .15 $ .75 $ .31
======== ======== ======== ========
Diluted $ .37 $ .15 $ .75 $ .30
======== ======== ======== ========
Number of shares used to compute net income per share:
Basic 7,054 6,948 7,054 6,922
======== ======== ======== ========
Diluted 7,055 6,958 7,055 6,957
======== ======== ======== ========
Dividends per share $ .10 $ .09 $ .10 $ .09
======== ======== ======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
5
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED JUNE 30, 2008 AND 2007
(In Thousands)
(Unaudited)
ACCUMULATED
STOCK ADDITIONAL OTHER
COMMON PAR PAID-IN COMPREHENSIVE RETAINED TREASURY
SHARES VALUE CAPITAL LOSS, NET EARNINGS STOCK
------ ----- -------- ---------- -------- --------
BALANCE AT JANUARY 1, 2007 7,698 $770 $90,659 $ (4,772) $ 37,285 $ (8,165)
Adoption of FIN 48 965
Adjusted balance at January 1, 2007 38,250
Net income 2,120
Exercise of stock options (17) 1,610
Other comprehensive loss net
of reclassification adjustment
and taxes (3,069)
Comprehensive loss
Cash dividends (620)
------ ---- ------- -------- -------- --------
BALANCE AT JUNE 30, 2007 7,698 $770 $90,642 $ (7,841) $ 39,750 $ (6,555)
====== ==== ======= ======== ======== ========
BALANCE AT JANUARY 1, 2008 7,698 $770 $90,986 $ (3,439) $ 42,352 $ (6,411)
Net income 5,291
Other comprehensive loss net
of reclassification adjustment
and taxes (16,447)
Comprehensive loss
Cash dividends (703)
------ ---- ------- -------- -------- --------
BALANCE AT JUNE 30, 2008 7,698 $770 $90,986 $(19,886) $ 46,940 $ (6,411)
====== ==== ======= ======== ======== ========
TOTAL
COMPREHENSIVE STOCKHOLDERS'
LOSS EQUITY
------------- -------------
BALANCE AT JANUARY 1, 2007 $115,777
Adoption of FIN 48 965
--------
Adjusted balance at January 1, 2007 116,742
Net income 2,120 2,120
Exercise of stock options 1,593
Other comprehensive loss net
of reclassification adjustment
and taxes (3,069) (3,069)
--------
Comprehensive loss $ (949)
========
Cash dividends (620)
--------
BALANCE AT JUNE 30, 2007 $116,766
========
BALANCE AT JANUARY 1, 2008 $124,258
Net income 5,291 5,291
Other comprehensive loss net
of reclassification adjustment
and taxes (16,447) (16,447)
--------
Comprehensive loss $(11,156)
========
Cash dividends (703)
--------
BALANCE AT JUNE 30, 2008 $112,399
========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THIS STATEMENT.
6
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
FOR THE SIX MONTHS ENDED
JUNE 30,
-------------------------------------
2008 2007
------ ------
Cash flows from operating activities:
Net income $ 5,291 $ 2,120
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Realized gains on investment securities (78) (125)
Net (accretion) of premiums of
investment securities (59) (845)
Depreciation and amortization 318 360
Provision for loan losses 804 150
Decrease (increase) in accrued interest receivable 455 (837)
Increase in other assets (9,719) (742)
Decrease in accrued interest payable
and other liabilities (3,595) (3,883)
----------- -----------
Net cash used in operating activities (6,583) (3,802)
----------- -----------
Cash flows from investing activities:
Investment securities available for sale
Purchases (2,049,002) (819,862)
Sales, maturities and calls 2,116,727 780,248
Investment securities held to maturity
Maturities 11 70
Net increase in loans (25,521) (9,908)
Acquisition of premises and equipment (30) (706)
----------- -----------
Net cash provided by (used in) investing activities 42,185 (50,158)
----------- -----------
7
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
FOR THE SIX MONTHS ENDED
JUNE 30,
-------------------------------------
2008 2007
------ ------
Cash flows from financing activities:
Net increase in non interest bearing deposits 3,239 727
Net (decrease) increase in interest bearing deposits (34,165) 94,860
Decrease in securities sold under agreements
to repurchase (20,910) (32,930)
Proceeds from long term debt 25,000 1,000
Repayment of long term debt (6,465) (15,455)
Proceeds from exercise of common stock options -- 1,593
Dividends paid (703) (620)
-------- --------
Net cash (used in) provided by financing activities (34,004) 49,175
-------- --------
Net increase (decrease) in cash and cash equivalents 1,598 (4,785)
Cash and cash equivalents at beginning of period 47,193 24,311
-------- --------
Cash and cash equivalents at end of period $ 48,791 $ 19,526
======== ========
Supplemental disclosure of cash flow information:
Cash used to pay interest $ 20,029 $ 20,484
Cash used to pay taxes, net of refunds $ 1,690 $ 1,785
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS.
8
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2008 AND 2007
NOTE 1. GENERAL
Berkshire Bancorp Inc., a Delaware corporation, is a bank holding
company registered under the Bank Holding Company Act of 1956. References herein
to "Berkshire", the "Company" or "we" and similar pronouns, shall be deemed to
refer to Berkshire Bancorp Inc. and its consolidated subsidiaries unless the
context otherwise requires. Berkshire's principal activity is the ownership and
management of its indirect wholly-owned subsidiary, The Berkshire Bank (the
"Bank"), a New York State chartered commercial bank. The Bank is owned through
Berkshire's wholly-owned subsidiary, Greater American Finance Group, Inc.
("GAFG").
The accompanying financial statements of Berkshire Bancorp Inc. and
subsidiaries includes the accounts of the parent company, Berkshire Bancorp
Inc., and its wholly-owned subsidiaries: The Berkshire Bank, GAFG and East 39,
LLC.
We have prepared the accompanying financial statements pursuant to the
rules and regulations of the Securities and Exchange Commission (the "SEC") for
interim financial reporting. These consolidated financial statements are
unaudited and, in our opinion, include all adjustments, consisting of normal
recurring adjustments and accruals necessary for a fair presentation of our
consolidated balance sheets, operating results, and cash flows for the periods
presented. Operating results for the periods presented are not necessarily
indicative of the results that may be expected for the remaining quarters of
fiscal 2008 due to a variety of factors. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with accounting principles generally accepted in the United States ("U.S. GAAP")
have been omitted in accordance with the rules and regulations of the SEC. These
consolidated financial statements should be read in conjunction with the audited
consolidated financial statements and accompanying notes included in our 2007
Annual Report on Form 10-K.
NOTE 2. TRUST PREFERRED SECURITIES.
As of May 18 2004, the Company established Berkshire Capital Trust I, a
Delaware statutory trust, ("BCTI"). The Company owns all the common capital
securities of BCTI. BCTI issued $15.0 million of preferred capital securities to
investors in a private transaction and invested the proceeds, combined with the
proceeds from the sale of BCTI's common capital securities, in the Company
through the purchase of $15.464 million aggregate principal amount of Floating
Rate Junior Subordinated Debentures (the "2004 Debentures") issued by the
Company. The 2004 Debentures, the sole assets of BCTI, mature on July 23, 2034
and bear interest at a floating rate, three month LIBOR plus 2.70%, currently
5.62%.
On April 1, 2005, the Company established Berkshire Capital Trust II, a
Delaware statutory trust, ("BCTII"). The Company owns all the common capital
securities of BCTII. BCTII issued $7.0 million of preferred capital securities
to investors in a private transaction and invested the proceeds, combined with
the proceeds from the sale of BCTII's common capital securities, in the Company
through the purchase of $7.217 million aggregate principal amount of Floating
Rate Junior Subordinated Debentures (the "2005 Debentures") issued by the
Company. The 2005 Debentures, the sole assets of BCTII, mature on May 23, 2035
and bear interest at a floating rate, three month LIBOR plus 1.95%, currently
4.59%.
9
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. - (CONTINUED)
Based on current interpretations of the banking regulators, the 2004
Debentures and 2005 Debentures (collectively, the "Debentures") qualify under
the risk-based capital guidelines of the Federal Reserve as Tier 1 capital,
subject to certain limitations. The Debentures are callable by the Company,
subject to any required regulatory approvals, at par, in whole or in part, at
any time after five years from the date of issuance. The Company's obligations
under the Debentures and related documents, taken together, constitute a full,
irrevocable and unconditional guarantee on a subordinated basis by the Company
of the obligations of BCTI and BCTII under the preferred capital securities sold
by BCTI and BCTII to investors. FIN46(R) precludes consideration of the call
option embedded in the preferred capital securities when determining if the
Company has the right to a majority of BCTI and BCTII expected residual returns.
Accordingly, BCTI and BCTII are not included in the consolidated balance sheet
of the Company.
The Federal Reserve has issued guidance on the regulatory capital
treatment for the trust-preferred securities issued by BCTI and BCTII. This rule
would retain the current maximum percentage of total capital permitted for Trust
Preferred Securities at 25%, but would enact other changes to the rules
governing Trust Preferred Securities that affect their use as part of the
collection of entities known as "restricted core capital elements." The rule
would take effect March 31, 2009; however, a five year transition period
starting March 31, 2004 and leading up to that date would allow bank holding
companies to continue to count Trust Preferred Securities as Tier 1 Capital
after applying FIN46(R). Management has evaluated the effects of this rule and
does not anticipate a material impact on its capital ratios when the proposed
rule is finalized.
NOTE 3. EARNINGS PER SHARE
Basic earnings per share is calculated by dividing income available to
common stockholders by the weighted average common shares outstanding, excluding
stock options from the calculation. In calculating diluted earnings per share,
the dilutive effect of stock options is calculated using the average market
price for the Company's common stock during the period. The following table
presents the calculation of earnings per share for the periods indicated:
FOR THE THREE MONTHS ENDED
--------------------------------------------------------------------------------------
JUNE 30, 2008 JUNE 30, 2007
--------------------------------------- ---------------------------------------
Income Shares Per share Income Shares Per share
(numerator) (denominator) amount (numerator) (denominator) amount
----------- ------------- --------- ----------- ------------- ---------
(In thousands, except per share data)
Basic earnings per share
Net income available to
common stockholders $2,642 7,054 $.37 $1,020 6,948 $.15
Effect of dilutive securities
Options -- 1 .-- -- 10 .--
------ ----- ---- ------ ----- ----
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $2,642 7,055 $.37 $1,020 6,958 $.15
====== ===== ==== ====== ===== ====
10
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3. - (CONTINUED)
FOR THE SIX MONTHS ENDED
--------------------------------------------------------------------------------------
JUNE 30, 2008 JUNE 30, 2007
-------------------------------------- -----------------------------------------
Income Shares Per share Income Shares Per share
(numerator) (denominator) amount (numerator) (denominator) amount
----------- ------------- --------- ----------- ------------- ---------
(In thousands, except per share data)
Basic earnings per share
Net income available to
common stockholders $5,291 7,054 $.75 $2,120 6,922 $.31
Effect of dilutive securities
Options -- 1 .-- -- 35 .01
------ ----- ---- ------ ----- ----
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $5,291 7,055 $.75 $2,120 6,957 $.30
====== ===== ==== ====== ===== ====
NOTE 4. LOAN PORTFOLIO
The following table sets forth information concerning the Company's
loan portfolio by type of loan at the dates indicated:
JUNE 30, 2008 DECEMBER 31, 2007
------------------------ ------------------------
% OF % OF
AMOUNT TOTAL AMOUNT TOTAL
------ ----- ------ ------
(Dollars in thousands)
Commercial and professional loans $ 61,501 13.3% $ 76,132 17.4%
Secured by real estate
1-4 family 140,179 30.4 142,140 32.6
Multi family 3,282 0.7 3,506 0.8
Non-residential (commercial) 255,592 55.4 212,850 48.8
Consumer 1,109 0.2 1,691 0.4
-------- ----- -------- -----
Total loans 461,663 100.0% 436,319 100.0%
===== =====
Deferred loan fees (1,292) (1,534)
Allowance for loan losses (5,052) (4,183)
-------- --------
Loans, net $455,319 $430,602
======== ========
Total non-performing loan assets, comprised of non-accrual and
delinquent loans, were $305,000 and $467,000 as of June 30, 2008 and December
31, 2007, respectively. Non-accrual loans totalled $141,000 and $153,000, and
loans contractually past due 90 days or more but still accruing interest were
$164,000 and $314,000 at June 30, 2008 and December 31, 2007, respectively.
11
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. DEPOSITS
The following table summarizes the composition of the average balances
of major deposit categories:
JUNE 30, 2008 DECEMBER 31, 2007
-------------------- --------------------
AVERAGE AVERAGE AVERAGE AVERAGE
AMOUNT YIELD AMOUNT YIELD
------ ----- ------ -----
(Dollars in thousands)
Demand deposits $ 54,683 -- $ 50,647 --
NOW and money market 44,557 1.78% 29,984 0.76%
Savings deposits 266,343 3.15 261,065 3.83
Time deposits 456,976 4.17 449,754 4.83
-------- ---- -------- ----
Total deposits $822,559 3.30% $791,450 4.04%
======== ==== ======== ====
NOTE 6. COMPREHENSIVE INCOME
The Company follows the provisions of Statement of Financial Accounting
Standards ("SFAS") No. 130, "REPORTING COMPREHENSIVE INCOME" which includes net
income as well as certain other items which result in a change to equity during
the period. The following table presents the components of comprehensive income,
based on the provisions of SFAS No. 130.:
FOR THE SIX MONTHS ENDED
------------------------------------------------------------------------------------------------
JUNE 30, 2008 JUNE 30, 2007
---------------------------------------------- -------------------------------------------
TAX TAX
BEFORE TAX (EXPENSE) NET OF TAX BEFORE TAX (EXPENSE) NET OF TAX
AMOUNT BENEFIT AMOUNT AMOUNT BENEFIT AMOUNT
------------ ----------- ------------ ------------ ----------- -----------
(In thousands)
Unrealized (losses)
gains on investment
securities:
Unrealized holding
losses arising during
period $(27,630) $ 11,106 $(16,524) $(5,326) $2,111 $ (3,215)
Less reclassification
adjustment for gains
realized in net income 78 (31) 47 125 (50) 75
-------- -------- -------- -------- ------ --------
Unrealized loss on
investment securities (27,552) 11,075 (16,477) (5,201) 2,061 (3,140)
Change in minimum
pension liability 30 -- 30 71 -- 71
-------- -------- -------- -------- ------ --------
Other comprehensive
income (loss), net $(27,522) $ 11,075 $(16,447) $ (5,130) $2,061 $ (3,069)
======== ======== ======== ======== ====== ========
12
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. ACCOUNTING FOR STOCK BASED COMPENSATION
At June 30, 2008, the Company has one stock-based employee compensation
plan. The Company accounts for the plan in accordance with SFAS No. 123(R),
"Share Based Payment". Under the fair value recognition provisions of SFAS 123R,
share-based compensation cost is measured at the grant date based on the fair
value of the award and is recognized as expense over the vesting period.
Determining the fair value of share-based awards at the grant date requires
judgement, including estimating the Company's stock price volatility, employee
stock option exercise behaviors and employee option forfeiture rates.
The Company did not grant stock options, nor did any stock options vest
during the six-month periods ended June 30, 2008 and 2007, as a result of which,
no stock based compensation expense was recorded in either of those periods. The
disclosures required under SFAS No. 123(R) are omitted due to materiality.
NOTE 8. EMPLOYEE BENEFIT PLANS
The Company has a Retirement Income Plan (the "Plan"), a
noncontributory defined benefit plan covering substantially all full-time,
non-union United States employees of the Company. The following interim-period
information is being provided in accordance with FASB Statement 132(R),
"EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS - AN
AMENDMENT OF FASB STATEMENTS NO. 87, 88 AND 106."
FOR THE FOR THE
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------- ------------------------------------
2008 2007 2008 2007
--------------- -------------- ---------------- -----------------
Service cost $ 105,250 $90,750 $ 210,500 $ 181,500
Interest cost 54,750 43,500 109,500 87,000
Expected return on plan assets (62,250) (46,000) (124,500) (92,000)
Amortization and Deferral:
Prior service cost 4,500 4,500 9,000 9,000
Loss 10,750 11,750 21,500 23,500
--------- --------- --------- ---------
Net periodic pension cost $ 113,000 $ 104,500 $ 226,000 $ 209,000
========= ========= ========= =========
The Pension Protection Act of 2006 (the "PPA") changes the funding
rules for defined benefit pension plans, beginning in 2008. A key element of the
PPA is the introduction of benefit restrictions on plans that are funded below
80% of the plan's target liabilities. In order to avoid these restrictions,
during the fiscal year ending December 31, 2008, we expect to contribute
approximately $869,000 to the Plan, of which $674,500 has been paid through June
30, 2008. In July 2008, another payment of $97,000 was made. During the first
half of 2007, we contributed approximately $205,000 to the Plan.
NOTE 9. FAIR VALUE MEASUREMENTS
Effective January 1, 2008, the Company adopted SFAS No. 157, "Fair
Value Measurements." SFAS 157 defines fair value, establishes a framework for
measuring fair value, and expands disclosure about fair value. SFAS 157 defines
fair value as the price that would be received to sell an asset or paid to
transfer a liability (an exit price) in an orderly transaction between market
participants on the measurement date. SFAS 157 also establishes a fair value
hierarchy which requires an entity to maximize the use of observable inputs and
minimize the use of unobservable inputs when measuring fair value. The standard
describes three levels of inputs that may be used to measure fair value. A
financial instrument's level within the fair value hierarchy is based on the
lowest level of input significant to the fair value measurement. There have been
no material changes in valuation techniques as a result of the adoption of SFAS
No. 157.
13
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9. - (CONTINUED)
Level 1 - Quoted prices (unadjusted) in active markets for identical assets or
liabilities that the Company has the ability to access at the measurement date.
Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for
similar assets or liabilities in active markets; quoted prices in markets that
are not active for identical or similar assets or liabilities; or other inputs
that are observable or can be corroborated by observable market data for
substantially the full term of the assets or liabilities.
Level 3 - Unobservable inputs that are supported by little or no market activity
and significant to the fair value of the assets or liabilities that are
developed using the reporting entities' estimates and assumptions, which reflect
those that market participants would use.
ASSETS AND LIABILITIES MEASURED AT FAIR VALUE ON A RECURRING BASIS
A description of the valuation methodologies used for financial
instruments measured at fair value on a recurring basis, as well as the
classification of the instruments pursuant to the valuation hierarchy, are as
follows:
SECURITIES AVAILABLE FOR SALE
Securities classified as available for sale are reported using Level 1,
Level 2 and Level 3 inputs. Level 1 securities generally include equity
securities valued based on quoted market prices in active markets. Level 2
instruments include U.S. government agency obligations, state and municipal
bonds, mortgage-backed securities, collateralized mortgage obligations and
corporate bonds. For these securities, the Company obtains fair value
measurements from an independent pricing service. The fair value measurements
consider observable data that may include dealer quotes, market spreads, cash
flows, the U.S. Treasury yield curve, live trading levels, trade execution data,
market consensus prepayment speeds, credit information and the bond's terms and
conditions, among other things. Level 3 securities available for sale consist of
instruments that are not readily marketable and may only be redeemed with the
issuer at par such as Federal Home Loan Bank and Federal Reserve Bank stock.
These securities are stated at par value.
Assets measured at fair value on a recurring basis are summarized
below.
FAIR VALUE MEASUREMENT USING
---------------------------------------------------------------------------
QUOTED PRICES IN SIGNIFICANT
ACTIVE MARKETS OTHER SIGNIFICANT
FOR IDENTICAL OBSERVABLE UNOBSERVABLE BALANCE
ASSETS/LIABILITIES INPUTS INPUTS JUNE 30,
(LEVEL 1) (LEVEL 2) (LEVEL 3) 2008
------------------ ----------- ------------ --------
(Dollars in thousands)
ASSETS
Investment securities
available for sale $ 9,625 $339,230 $166,071 $514,926
------- -------- -------- --------
Total assets $ 9,625 $339,230 $166,071 $514,926
======= ======== ======== ========
14
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 9. - (CONTINUED)
ASSETS AND LIABILITIES MEASURED AT FAIR VALUE ON A RECURRING BASIS USING
SIGNIFICANT UNOBSERVABLE INPUTS (LEVEL 3)
The table below presents a reconciliation for assets measured at fair
value on a recurring basis for which the Company has utilized significant
unobservable inputs (Level 3).
INVESTMENT
SECURITIES
AVAILABLE
(Dollars in thousands) FOR SALE
-------------------
Balance, January 1, 2008 $184,597
Total gains/losses (realized/unrealized)
Included in earnings (or changes in net assets) --
Included in other comprehensive income (14,198)
Purchases, Sales, Issuances and Settlements 7,122
Redemptions (11,450)
Interest --
Capital deductions for operating expenses --
--------
Balance, June 30, 2008 $166,071
========
The amount of total gains or losses for the
period included in earnings (or changes in net
assets) attributable to the change in unrealized
gains or losses relating to assets still held at
June 30, 2008
$ --
NOTE 10. NEW ACCOUNTING PRONOUNCEMENTS
ACCOUNTING FOR FAIR VALUE MEASUREMENT
In September 2006, the Financial Accounting Standards Board (the
"FASB") issued SFAS No. 157, "Fair Value Measurements" ("SFAS No. 157"). SFAS
No. 157 is effective for all financial statements issued for fiscal years
beginning after November 15, 2007, or January 1, 2008 as to the Company. The
Statement defines fair value as the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date, establishes a framework for measuring fair
value, and expands disclosures about fair value measurements. The adoption of
SFAS No. 157 did not have a material impact on the Company's results of
operations or financial condition.
FAIR VALUE OPTION FOR FINANCIAL ASSETS AND LIABILITIES
In February 2007, the FASB issued Statement 159, "The Fair Value Option
for Financial Assets and Financial Liabilities" ("SFAS No. 159"). The objective
of SFAS No. 159 is to provide companies with the option to recognize most
financial assets and liabilities and certain other items at fair value.
Statement 159 allows companies the opportunity to mitigate earnings volatility
caused by measuring related assets and liabilities differently without having to
apply complex hedge accounting. Unrealized gains and losses on items for which
the fair value option has been elected should be reported in earnings. The fair
value
15
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 10. - (CONTINUED)
option election is applied on an instrument by instrument basis (with some
exceptions), is irrevocable, and is applied to an entire instrument. The
election may be made as of the date of initial adoption for existing eligible
items. Subsequent to initial adoption, the Company may elect the fair value
option at initial recognition of eligible items or on entering into an eligible
firm commitment. The Company can only elect the fair value option after initial
recognition in limited circumstances.
SFAS No. 159 requires similar assets and liabilities for which the
Company has elected the fair value option to be displayed on the face of the
balance sheet either (a) together with financial instruments measured using
other measurement attributes with parenthetical disclosure of the amount
measured at fair value or (b) in separate line items. In addition, SFAS No. 159
requires additional disclosures to allow financial statement users to compare
similar assets and liabilities measured differently either within the financial
statements of the Company or between financial statements of different
companies.
SFAS No. 159 was adopted by the Company on January 1, 2008, concurrent
with the adoption of SFAS No. 157. At June 30, 2008, the Company has not elected
the fair value measurement option for any of its assets or liabilities.
ACCOUNTING FOR BUSINESS COMBINATIONS
In December 2007, the FASB issued SFAS 141(R), "Accounting for Business
Combinations." This Statement replaces FASB Statement No. 141, "Business
Combinations" and is effective as of the beginning of the fiscal year beginning
on or after December 15, 2008, or January 1, 2009 as to the Company. SFAS 141(R)
establishes principles and requirements for how the acquirer of a business (i)
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree, (ii) recognizes and measures the goodwill acquired in the business
combination or a gain from a bargain purchase, and (iii) determines the
information to disclose in its financial statements with respect to the nature
and financial effects of the business combination. The adoption of SFAS 141(R)
is not expected to have a material impact on the Company's results of operations
or financial condition.
16
INTERNAL CONTROL OVER FINANCIAL REPORTING
The objective of the Company's Internal Control Program is to allow the
Bank and management to comply with Part 363 of the FDIC's regulations ("FDICIA")
and to allow the Company to comply with Section 302 of the Sarbanes-Oxley Act of
2002 (the "Act"). In November 2005, the FDIC amended Part 363 of its regulations
by raising the asset-size threshold from $500 million to $1 billion for internal
control assessments by management and external auditors. The final rule was
effective December 28, 2005.
Section 302 of the Act requires the CEOs and CFOs of the Company to (i)
certify that the annual and quarterly reports filed with the Securities and
Exchange Commission are accurate and (ii) acknowledge that they are responsible
for establishing, maintaining and periodically evaluating the effectiveness of
the disclosure controls and procedures. Section 404 of the Act requires
management to (i) report on internal control over financial reporting, (ii)
assess the effectiveness of such internal controls, and (iii) obtain an external
auditor's report on management's assessment of its internal control. The Company
is not an accelerated filer as defined in Rule 12b-2 of the Securities Exchange
Act of 1934. Therefore, the Company was first required to comply with Section
404 for the fiscal year ended December 31, 2007.
The Committee of Sponsoring Organizations (COSO) methodology may be
used to document and test the internal controls pertaining to the accuracy of
Company issued financial statements and related disclosures. COSO requires a
review of the control environment (including anti-fraud and audit committee
effectiveness), risk assessment, control activities, information and
communication, and ongoing monitoring.
17
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following discussion and analysis is intended to provide a better
understanding of the consolidated financial condition and results of operations
of Berkshire Bancorp Inc., a Delaware corporation, and its subsidiaries. All
references to earnings per share, unless stated otherwise, refer to earnings per
diluted share. References to Notes herein are references to the "Notes to
Consolidated Financial Statements" of the Company located in Item 1 herein.
The accompanying financial statements of Berkshire Bancorp Inc. and
subsidiaries includes the accounts of the parent company, Berkshire Bancorp
Inc., and its wholly-owned subsidiaries: The Berkshire Bank, Greater American
Finance Group, Inc. and East 39, LLC.
CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
The accounting and reporting policies of the Company conform with
accounting principles generally accepted in the United States of America and
general practices within the financial services industry. The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and the
assumptions that affect the amounts reported in the financial statements and the
accompanying notes. Actual results could differ from those estimates.
The Company considers that the determination of the allowance for loan
losses involves a higher degree of judgment and complexity than any of its other
significant accounting policies. The allowance for loan losses is calculated
with the objective of maintaining a reserve level believed by management to be
sufficient to absorb estimated credit losses. Management's determination of the
adequacy of the allowance is based on periodic evaluations of the loan portfolio
and other relevant factors. However, this evaluation is inherently subjective as
it requires material estimates, including, among others, expected default
probabilities, loss given default, the amounts and timing of expected future
cash flows on impaired loans, mortgages, and general amounts for historical loss
experience. The process also considers economic conditions, uncertainties in
estimating losses and inherent risks in the loan portfolio. All of these factors
may be susceptible to significant change. To the extent actual outcomes differ
from management estimates, additional provisions for loan losses may be required
that would adversely impact earnings in future periods.
With the adoption of "SFAS" No. 142 "GOODWILL AND OTHER INTANGIBLE
ASSETS" on January 1, 2002, the Company discontinued the amortization of
goodwill resulting from acquisitions. Goodwill is now subject to impairment
testing at least annually to determine whether write-downs of the recorded
balances are necessary. The Company tests for impairment based on the goodwill
maintained at the Bank. A fair value is determined for each reporting unit based
on at least one of three various market valuation methodologies. If the fair
values of the reporting units exceed their book values, no write-down of
recorded goodwill is necessary. If the fair value of the reporting unit is less,
an expense may be required on the Company's books to write down the related
goodwill to the proper carrying value. As of December 31, 2007, the Company
completed its annual testing, which determined that no impairment charge was
necessary. During the six months ended June 30, 2008, there was no evidence of
any impairment indicators.
The Company recognizes deferred tax assets and liabilities for the
future tax effects of temporary differences, net operating loss carryforwards
and tax credits. Deferred tax assets are subject to management's judgment based
upon available evidence that future realization is more likely than not. If
management determines that the Company may be unable to realize all or part of
net deferred tax assets in the future, a direct charge to income tax expense may
be required to reduce the recorded value of the net deferred tax asset to the
expected realizable amount.
18
The following table presents the total dollar amount of interest income
from average interest-earning assets and the resultant yields, as well as the
interest expense on average interest-bearing liabilities, expressed in both
dollars and rates.
FOR THE THREE MONTHS ENDED JUNE 30,
-------------------------------------------------------------------------------------
2008 2007
------------------------------------------- ---------------------------------------
INTEREST INTEREST
AVERAGE AND AVERAGE AVERAGE AND AVERAGE
BALANCE DIVIDENDS YIELD/RATE BALANCE DIVIDENDS YIELD/RATE
---------- --------- ---------- ---------- --------- ----------
(Dollars in Thousands)
INTEREST-EARNING ASSETS:
Loans (1) $ 456,232 $ 8,096 7.10% $ 379,449 $ 7,240 7.63%
Investment securities 541,773 7,254 5.36 553,461 6,416 4.64
Other (2)(5) 36,951 200 2.17 30,087 376 5.00
------------ ---------- ------------ ------------ ---------- ---------
Total interest-earning assets 1,034,956 15,550 6.01 962,997 14,032 5.83
------------ ---------
Noninterest-earning assets 39,946 45,394
------------ ------------
Total Assets $1,074,902 $1,008,391
============ ============
INTEREST-BEARING LIABILITIES:
Interest bearing deposits 299,143 1,921 2.57% 291,027 2,541 3.49%
Time deposits 466,044 4,434 3.81 439,936 5,284 4.80
Other borrowings 126,183 1,324 4.20 96,849 1,348 5.57
------------ ---------- ------------ ------------ ---------- ---------
Total interest-bearing
liabilities 891,370 7,679 3.45 827,812 9,173 4.43
---------- ------------ --------- ---------
Demand deposits 55,546 50,438
Noninterest-bearing liabilities 4,582 11,010
Stockholders' equity (5) 123,404 119,131
------------ ------------
Total liabilities and
stockholders' equity $1,074,902 $1,008,391
============ ============
Net interest income 7,871 4,859
========== ==========
Interest-rate spread (3) 2.56% 1.40%
============ =========
Net interest margin (4) 3.04% 2.02%
============ =========
Ratio of average interest-earning
assets to average interest bearing
liabilities 1.16 1.16
============ ============
----------------------
(1) Includes nonaccrual loans.
(2) Includes interest-bearing deposits, federal funds sold and securities
purchased under agreements to resell.
(3) Interest-rate spread represents the difference between the average yield
on interest-earning assets and the average cost of interest bearing
liabilities.
(4) Net interest margin is net interest income as a percentage of average
interest-earning assets.
(5) Average balances are daily average balances except for the parent company
which have been calculated on a monthly basis.
19
FOR THE SIX MONTHS ENDED JUNE 30,
-------------------------------------------------------------------------------------
2008 2007
------------------------------------------- ---------------------------------------
INTEREST INTEREST
AVERAGE AND AVERAGE AVERAGE AND AVERAGE
BALANCE DIVIDENDS YIELD/RATE BALANCE DIVIDENDS YIELD/RATE
---------- --------- ---------- ---------- --------- ----------
(Dollars in Thousands)
INTEREST-EARNING ASSETS:
Loans (1) $ 451,626 $ 16,301 7.22% $ 378,189 $ 14,478 7.66%
Investment securities 545,124 15,121 5.55 530,669 12,251 4.62
Other (2)(5) 31,420 424 2.70 42,165 1,062 5.04
------------ ---------- ------------ ------------ ---------- ---------
Total interest-earning assets 1,028,170 31,846 6.12 951,023 27,791 5.84
------------ ---------
Noninterest-earning assets 46,810 45,314
------------ ------------
Total Assets $1,074,980 $ 996,337
============ ============
INTEREST-BEARING LIABILITIES:
Interest bearing deposits 310,900 4,570 2.94% 282,127 4,861 3.45%
Time deposits 456,976 9,518 4.17 432,463 10,408 4.81
Other borrowings 120,308 2,724 4.53 101,732 2,772 5.45
------------ ---------- ------------ ------------ ---------- ---------
Total interest-bearing
liabilities 888,184 16,812 3.79 816,322 18,041 4.42
---------- ------------ ---------- ---------
Demand deposits 54,683 49,358
Noninterest-bearing liabilities 10,546 12,273
Stockholders' equity (5) 121,567 118,384
------------ ------------
Total liabilities and
stockholders' equity $1,074,980 $ 996,337
============ ============
Net interest income 15,034 9,750
========== ==========
Interest-rate spread (3) 2.33% 1.42%
============ =========
Net interest margin (4) 2.92% 2.05%
============ =========
Ratio of average interest-earning
assets to average interest bearing
liabilities 1.16 1.17
============= ============
----------------------
(1) Includes nonaccrual loans.
(2) Includes interest-bearing deposits, federal funds sold and securities
purchased under agreements to resell.
(3) Interest-rate spread represents the difference between the average yield
on interest-earning assets and the average cost of interest bearing
liabilities.
(4) Net interest margin is net interest income as a percentage of average
interest-earning assets.
(5) Average balances are daily average balances except for the parent company
which have been calculated on a monthly basis.
20
RESULTS OF OPERATIONS
RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2008 COMPARED
TO THE THREE AND SIX MONTHS ENDED JUNE 30, 2007.
GENERAL. Berkshire Bancorp Inc., a bank holding company registered under the
Bank Holding Company Act of 1956, has one indirect wholly-owned banking
subsidiary, The Berkshire Bank, a New York State chartered commercial bank. The
Bank is headquartered in Manhattan and has twelve branch locations; seven
branches in New York City, four branches in Orange and Sullivan counties New
York, and one branch in Ridgefield, New Jersey.
NET INCOME. Net income for the three-month period ended June 30, 2008 increased
by $1.62 million to $2.64 million, or $.37 per share, from $1.02 million, or
$.15 per share, for the three-month period ended June 30, 2007. Net income for
the six-month period ended June 30, 2008 increased by $3.17 million to $5.29
million, or $.75 per share, from $2.12 million, or $.30 per share, for the
six-month period ended June 30, 2007.
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.
NET INTEREST INCOME. The Company's primary source of revenue is net interest
income, or the difference between interest income earned on earning assets, such
as loans and investment securities, and interest expense on interest-bearing
liabilities such as deposits and borrowings. 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.
For the quarter ended June 30, 2008, net interest income increased by
$3.01 million to $7.87 million from $4.86 million for the quarter ended June 30,
2007. The quarter over quarter increase in net interest income was primarily due
to the 98 basis point decrease in the average rates paid on the average amount
of interest-bearing liabilities to 3.45% in the 2008 quarter from 4.43% in the
2007 quarter, and further benefited by the 18 basis point increase in average
yields earned on the average amounts of interest-earning assets to 6.01% in the
2008 quarter from 5.83% in the 2007 quarter. The Company's interest-rate spread,
the difference between the average yield on interest-earning assets and the
average cost of interest-bearing liabilities, increased by 116 basis points to
2.56% for the three months ended June 30, 2008 from 1.40% for the three months
ended June 30, 2007.
For the six-month period ended June 30, 2008, net interest income
increased by $5.28 million to $15.03 million from $9.75 million for the
six-month period ended June 30, 2007. The period over period increase in net
interest income was primarily due to the 63 basis point decrease in the average
rates paid on the average amount of interest-bearing liabilities to 3.79% in the
2008 six-month period from 4.42% in the 2007 six-month period, and further
benefited by the 28 basis point increase in the average yields earned on the
average amounts of interest-earning assets to 6.12% from 5.84% in the 2008 and
2007 six-month periods, respectively. The Company's interest-rate spread
increased by 91 basis points to 2.33% in the 2008 period from 1.42% in the 2007
period.
21
NET INTEREST MARGIN. Net interest margin, or annualized net interest income as a
percentage of average interest-earning assets, increased by 102 basis points to
3.04% for the quarter ended June 30, 2008 from 2.02% for the quarter ended June
30, 2007. Net interest margin increased by 87 basis points to 2.92% in the
six-months ended June 30, 2008 from 2.05% in the six-months ended June 30, 2007.
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 and adjustable rate loans,
investment securities and short-term interest-earning assets. The increase in
net interest margin during fiscal year 2008 is primarily due to the increase in
net interest income as discussed above and by the increase in the average amount
of higher yielding loans as a percentage of our total mix of interest-earning
assets.
The average amount of loans in our loan portfolio increased by $76.78
million and $73.44 million during the three and six month-periods ended June 30,
2008, respectively, to $456.23 million and $451.63 million, respectively, from
$379.45 million and $378.19 million during the three and six-month periods ended
June 30, 2007, respectively. The average amount of investment securities in our
portfolio decreased by $11.69 million to $541.77 million in the three months
ended June 30, 2008 from $553.46 million in the three months ended June 30,
2007, and increased by $14.46 million to $545.12 million in the six months ended
June 30, 2008 from $530.67 million in the three months ended June 30, 2007. The
average yields earned on investment securities increased to 5.36% and 5.55%
during the three and six months ended June 30, 2008, respectively, from 4.64%
and 4.62% during the three and six months ended June 30, 2007, respectively.
INTEREST INCOME. Total interest income for the quarter ended June 30, 2008
increased by $1.52 million to $15.55 million from $14.03 million for the quarter
ended June 30, 2007. Total interest income increased by $4.06 million to $31.85
million for the six months ended June 30, 2008 from $27.79 million for the six
months ended June 30, 2007.
The following tables present the composition of interest income for the
indicated periods:
------------------------------------------------------
THREE MONTHS ENDED JUNE 30,
------------------------------------------------------
2008 2007
------------------------- ------------------------
INTEREST % OF INTEREST % OF
INCOME TOTAL INCOME TOTAL
(In thousands, except percentages)
Loans $ 8,096 52.06% $ 7,240 51.60%
Investment Securities 7,254 46.65 6,416 45.72
Other 200 1.29 376 2.68
------- ------ ------- ------
Total Interest Income $15,550 100.00% $14,032 100.00%
--------------------------------------------------------
SIX MONTHS ENDED JUNE 30,
------------------------------------------------------
2008 2007
------------------------- ------------------------
INTEREST % OF INTEREST % OF
INCOME TOTAL INCOME TOTAL
(In thousands, except percentages)
Loans $16,301 51.19% $14,478 52.10%
Investment Securities 15,121 47.48 12,251 44.08
Other 424 1.33 1,062 3.82
------- ------ ------- ------
Total Interest Income $31,846 100.00% $27,791 100.00%
22
Loans, which are inherently risky and therefore command a higher return
than our portfolio of investment securities and other interest-earning assets,
increased to 44.1% and 43.9% of total average interest-earning assets during the
three and six months ended June 30, 2008, respectively, from 39.4% and 39.8%
during the three and six months ended June 30, 2007, respectively. Investment
securities comprised 52.4% and 53.0% of total average interest-earning assets
during the three and six-month periods ended June 30, 2008, respectively, from
57.5% and 55.8% during the three and six-month periods ended June 30, 2007,
respectively. 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.
At June 30, 2008, our portfolio of investment securities included
approximately $166.1 million of auction rate securities. These investments have
high credit quality ratings of AA or AAA and are fully collateralized by bonds
and other financial instruments. Auction rate securities are generally long-term
debt instruments that provide liquidity through a Dutch auction process that
resets the applicable interest rate at pre-determined calendar intervals,
generally every 90 days for the securities in our portfolio.
Recent uncertainties in the credit markets have negatively impacted our
ability to liquidate, if necessary, investments in auction rate securities
because, in recent auctions, the amount of securities submitted for sale has
exceeded the amount of purchase orders. We are not certain as to when the
liquidity issues relating to these investments will improve. As a result of the
timing of the recent auction failures beginning in February 2008, we recorded an
unrealized loss in accordance with SFAS No. 115, "Accounting for Certain Debt
and Equity Securities," totalling approximately $14.2 million as of June 30,
2008. Based on the fair market value of the auction rate securities and an
analysis of other-than-temporary impairment factors, including, but not limited
to, whether the credit ratings of the issuers or the insurers deteriorate, or
the collateral of the securities deteriorates, we determined that none of the
auction rate securities are other-than-temporarily impaired.
Based on our expected operating cash flows, and our other sources of
cash, we do not expect the potential lack of liquidity in these investments to
affect our capital, liquidity or ability to execute our current business plan.
INTEREST EXPENSE. Total interest expense for the quarter ended June 30, 2008
decreased by $1.49 million to $7.68 million from $9.17 million for the quarter
ended June 30, 2007. The decrease in interest expense was primarily due to the
98 basis point decrease in the average rates paid on the average amount of
interest-bearing liabilities to 3.45% in the 2008 quarter from 4.43% in the 2007
quarter, partially offset by the increase in the average amount of
interest-bearing liabilities to $891.37 million from $$827.81 million for the
quarters ended June 30, 2008 and 2007, respectively.
Total interest expense for the six-month period ended June 30, 2008
decreased by $1.23 million to $16.81 million from $18.04 million for the
six-month period ended June 30, 2007. The decrease in interest expense was
primarily due to the 63 basis point decrease in the average rates paid on the
average amount of interest-bearing liabilities to 3.79% in the 2008 six-month
period from 4.42% in the 2007 six-month periods, partially offset by the
increase in the average amount of interest-bearing liabilities to $$888.18
million from $816.32 million for the six months ended June 30, 2008 and 2007,
respectively.
23
The following tables present the components of interest expense as of
the dates indicated:
------------------------------------------------------
THREE MONTHS ENDED JUNE 30,
------------------------------------------------------
2008 2007
------------------------- ------------------------
INTEREST % OF INTEREST % OF
INCOME TOTAL INCOME TOTAL
(In thousands, except percentages)
Interest-Bearing Deposits $ 1,921 25.02% $2,541 27.70%
Time Deposits 4,434 57.74 5,284 57.60
Other Borrowings 1,324 17.24 1,348 14.70
-------- ------ -------- ------
Total Interest Expense $ 7,679 100.00% $9,173 100.00%
--------------------------------------------------------
SIX MONTHS ENDED JUNE 30,
------------------------------------------------------
2008 2007
------------------------- ------------------------
INTEREST % OF INTEREST % OF
INCOME TOTAL INCOME TOTAL
(In thousands, except percentages)
Interest-Bearing Deposits $ 4,570 27.18% $ 4,861 26.94%
Time Deposits 9,518 56.62 10,408 57.69
Other Borrowings 2,724 16.20 2,772 15.37
-------- ------ ------- ------
Total Interest Expense $ 16,812 100.00% $18,041 100.00%
NON-INTEREST INCOME. Non-interest income consists primarily of realized gains on
sales of marketable securities and service fee income. For the three and six
months ended June 30, 2008, non-interest income amounted to $377,000 and
$843,000, respectively, compared to non-interest income of $391,000 and $906,000
for the three and six months ended June 30, 2007 and 2008, respectively.
NON-INTEREST EXPENSE. Non-interest expense includes salaries and employee
benefits, occupancy and equipment expenses, legal and professional fees and
other operating expenses associated with the day-to-day operations of the
Company. Total non-interest expense for the three and six-month periods ended
June 30, 2008 was $3.98 million and $7.89 million, respectively, compared to
$3.53 million and $6.98 million for the three and six month-periods ended June
30, 2007, respectively. The largest component of non-interest expense are
salaries and employee benefits which have increased to $2.42 million and $4.82
million in the three and six-month periods ended June 30, 2008, respectively,
from $3.53 million and $6.98 million in the three and six month periods ended
June 30, 2007. The increase is primarily due to the expansion of our business.
We have added personnel to maintain and enhance customer service levels and to
insure our compliance with various regulatory matters.
24
The following tables present the components of non-interest expense as
of the dates indicated:
------------------------------------------------------
THREE MONTHS ENDED JUNE 30,
------------------------------------------------------
2008 2007
------------------------- ------------------------
NON-INTEREST % OF NON-INTEREST % OF
INCOME TOTAL INCOME TOTAL
(In thousands, except percentages)
Salaries and Employee Benefits $ 2,417 60.77% $ 2,142 60.74%
Net Occupancy Expense 507 12.75 440 12.48
Equipment Expense 97 2.44 98 2.78
FDIC Assessment 132 3.32 20 0.57
Data Processing Expense 110 2.77 99 2.81
Other 714 17.95 727 20.62
------- ------ ------- ------
Total Non-Interest Expense $ 3,977 100.00% $ 3,526 100.00%
--------------------------------------------------------
SIX MONTHS ENDED JUNE 30,
------------------------------------------------------
2008 2007
------------------------- ------------------------
NON-INTEREST % OF NON-INTEREST % OF
INCOME TOTAL INCOME TOTAL
(In thousands, except percentages)
Salaries and Employee Benefits $ 4,816 61.07% $ 4,376 62.70%
Net Occupancy Expense 1,045 13.25 916 13.13
Equipment Expense 192 2.43 200 2.87
FDIC Assessment 238 3.02 40 0.57
Data Processing Expense 221 2.80 195 2.79
Other 1,375 17.43 1,252 17.94
------- ------ ------- ------
Total Non-Interest Expense $ 7,887 100.00% $ 6,979 100.00%
PROVISION FOR INCOME TAX. During the three and six-month periods ended June 30,
2008, the Company recorded income tax expense of $975,000 and $1.90 million,
respectively, compared to income tax expense of $629,000 and $1.41 million,
respectively, for the three and six-month periods ended June 30, 2007. The tax
provisions for federal, state and local taxes recorded for the first six months
of 2008 and 2007 represent effective tax rates of 26.37% and 39.89%,
respectively. The decrease in the effective tax rate in the 2008 period compared
to the 2007 period is primarily due to the tax-free income earned on certain of
the auction rate securities in our investment portfolio. The effective tax rate
for the three months ended June 30, 2008 and 2007 were 26.95% and 38.14%,
respectively. The decrease in the effective tax rate for the three months ended
June 30, 2008 is due to the tax-free income earned on certain of the auction
rate securities in our investment portfolio.
ISSUER PURCHASES OF EQUITY SECURITIES
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 June 30, 2008, the Company has purchased a total of 1,898,909
shares of its Common Stock. We did not repurchase shares of the Company's Common
Stock during the first and second quarters of 2008. At June 30, 2008, there were
501,091 shares of Common Stock which may yet be purchased under our stock
purchase plan.
25
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
INTEREST RATE RISK. Fluctuations in market interest rates can have a material
effect on the Company's net interest income because the yields earned on loans
and investments may not adjust to market rates of interest with the same
frequency, or with the same speed, as the rates paid by the Bank on its
deposits.
Most of the Bank's deposits are either interest-bearing demand deposits
or short term certificates of deposit and other interest-bearing deposits with
interest rates that fluctuate as market rates change. Management of the Bank
seeks to reduce the risk of interest rate fluctuations by concentrating on loans
and securities investments with either short terms to maturity or with
adjustable rates or other features that cause yields to adjust based upon
interest rate fluctuations. In addition, to cushion itself against the potential
adverse effects of a substantial and sustained increase in market interest
rates, the Bank has from time to time 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, when written, 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.
26
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 JUNE 30, 2008
(IN THOUSANDS, EXCEPT FOR PERCENTAGES)
----------------------------------------------------------------------------------
3 MONTHS 3 THROUGH 1 THROUGH OVER
OR LESS 12 MONTHS 3 YEARS 3 YEARS TOTAL
------------- ------------- ------------- ------------- -------------
Federal funds sold 22,250 -- -- -- 22,250
(Rate) 2.39% 2.39
Interest bearing deposits in banks 17,735 -- -- -- 17,735
(Rate) 2.23% 2.23%
Loans (1)(2)
Adjustable rate loans 124,332 15,689 25,236 45,118 210,375
(Rate) 6.74% 6.87% 6.82% 7.15% 6.85%
Fixed rate loans 9,592 26,690 37,644 177,362 251,288
(Rate) 6.56% 6.67% 8.05% 6.30% 6.61%
--------- --------- --------- --------- ----------
Total loans 133,924 42,379 62,880 222,480 461,663
Investments (3)(4) 270,572 14,725 37,811 223,581 546,689
(Rate) 5.39% 6.00% 4.85% 5.55% 5.43%
--------- --------- --------- --------- ----------
Total rate-sensitive assets 444,481 57,104 100,691 446,061 1,048,337
--------- --------- --------- --------- ----------
Deposit accounts (5)
Savings and NOW 264,417 -- -- -- 264,417
(Rate) 2.46% 2.46%
Money market 31,752 -- -- -- 31,752
(Rate) 1.95% 1.95%
Time Deposits 308,083 157,546 1,251 2,196 469,076
(Rate) 3.68% 3.18% 2.87% 1.80% 3.50%
--------- --------- --------- --------- ----------
Total deposit accounts 604,252 157,546 1,251 2,196 765,245
Repurchase Agreements 13,932 -- -- 42,000 55,932
(Rate) 2.05% 4.12% 3.60%
Other borrowings 718 5,675 22,533 43,897 72,823
(Rate) 3.15% 2.76% 5.37% 4.69% 4.73%
--------- --------- --------- --------- ----------
Total rate-sensitive liabilities 618,902 163,221 23,784 88,093 894,000
--------- --------- -------- --------- ----------
Interest rate caps 40,000 -- (40,000) --
Gap (repricing differences) (214,421) (106,117) 76,907 397,968 154,337
========= ========= ========= ========= ==========
Cumulative Gap (214,421) (320,538) (243,631) 154,337
========= ========= ========= =========
Cumulative Gap to Total Rate Sensitive
Assets (20.45)% (30.58)% (23.24)% 14.72%
========= ========= ========= =========
-------------------------------
(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 investments) 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.
27
PROVISION FOR LOAN LOSSES. The allowance for loan losses is the estimated amount
considered necessary to cover credit losses inherent in the loan portfolio at
the balance sheet date. The allowance is established through the provision for
loan losses that is charged against income. In determining the allowance for
loan losses, management makes significant estimates and therefore has identified
the allowance as a critical accounting policy. The methodology for determining
the allowance for loan losses is considered a critical accounting policy by
management due to the high degree of judgment involved, the subjectivity of the
assumptions utilized, and the potential for changes in the economic environment
that could result in changes to the amount of the recorded allowance for loan
losses.
The allowance for loan losses has been determined in accordance with
U.S. GAAP, principally "SFAS" No. 5, "Accounting for Contingencies" and SFAS No.
114, "Accounting by Creditors for Impairment of a Loan, an amendment to FASB
Statements No. 5 and 15," as amended. Under the above accounting principles, we
are required to maintain an allowance for probable losses at the balance sheet
date. We are responsible for the timely and periodic determination of the amount
of the allowance required. Management believes that the allowance for loan
losses is adequate to cover specifically identifiable losses, as well as
estimated losses inherent in our portfolio for which certain losses are probable
but not specifically identifiable.
Management performs a quarterly evaluation of the adequacy of the
allowance for loan losses. The analysis of the allowance for loan losses has two
components: specific and general allocations. Specific allocations are made for
loans determined to be impaired. Impairment is measured by determining the
present value of expected future cash flows or, as a practical expedient for
collateral-dependent loans, the fair value of the collateral adjusted for market
conditions and selling expenses. The Bank considers its investment in
one-to-four family real estate loans and consumer loans to be smaller balance
homogeneous loans and therefore excluded from separate identification for
evaluation of impairment. These homogeneous loan groups are evaluated for
impairment on a collective basis under SFAS No. 5, "Accounting for
Contingencies".
The general allocation is determined by segregating the remaining loans
by type of loan, risk weighting (if applicable) and payment history. Management
also analyzes historical loss experience, delinquency trends, general economic
conditions, geographic concentrations, and industry and peer comparisons. This
analysis establishes factors that are applied to the loan segments to determine
the amount of the general allocations. This evaluation is inherently subjective
as it requires material estimates that may be susceptible to significant
revisions based upon changes in economic and real estate market conditions.
Actual loan losses may be significantly more than the allowance for loan losses
management has established which could have a material negative effect on the
Company's financial results.
On a quarterly basis, the Bank's management committee reviews the
current status of various loan assets in order to evaluate the adequacy of the
allowance for loan losses. In this evaluation process, specific loans are
analyzed to determine their potential risk of loss. This process includes all
loans, concentrating on non-accrual and classified loans. Each non-accrual or
classified loan is evaluated for potential loss exposure. Any shortfall results
in a recommendation of a specific allowance if the likelihood of loss is
evaluated as probable. To determine the adequacy of collateral on a particular
loan, an estimate of the fair market value of the collateral is based on the
most current appraised value available. This appraised value is then reduced to
reflect estimated liquidation expenses.
28
As a substantial amount of our loan portfolio is collateralized by real
estate, appraisals of the underlying value of property securing loans are
critical in determining the amount of the allowance required for specific loans.
Assumptions for appraisal valuations are instrumental in determining the value
of properties. Overly optimistic assumptions or negative changes to assumptions
could significantly impact the valuation of a property securing a loan and the
related allowance determined. The assumptions supporting such appraisals are
carefully reviewed by management to determine that the resulting values
reasonably reflect amounts realizable on the related loans. Based on the
composition of our loan portfolio, management believes the primary risks are
increases in interest rates, a decline in the economy, generally, and a decline
in real estate market values in the New York metropolitan area. Any one or
combination of these events may adversely affect our loan portfolio resulting in
increased delinquencies, loan losses and future levels of loan loss provisions.
Management believes the allowance for loan losses reflects the inherent credit
risk in our portfolio, the level of our non-performing loans and our charge-off
experience. Based upon our analysis, we added $804,000 to the allowance for loan
losses for the six months ended June 30, 2008.
Although management believes that we have established and maintained
the allowance for loan losses at adequate levels, additions may be necessary if
future economic and other conditions differ substantially from the current
operating environment. Although management uses the best information available,
the level of the allowance for loan losses remains an estimate that is subject
to significant judgment and short-term change. In addition, the Federal Deposit
Insurance Corporation, New York State Banking Department, and other regulatory
bodies, as an integral part of their examination process, will periodically
review our allowance for loan losses. Such agencies may require us to recognize
adjustments to the allowance based on its judgments about information available
to them at the time of their examination.
The following table sets forth information with respect to activity in
the Company's allowance for loan losses during the periods indicated (in
thousands, except percentages):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- --------------------------
2008 2007 2008 2007
---- ---- ---- ----
Average loans outstanding $456,232 $379,449 $451,626 $378,189
======== ======== ======== ========
Allowance at beginning of period 4,398 3,848 4,183 3,771
Charge-offs:
Commercial and other loans -- -- 1 --
Real estate loans -- -- -- --
-------- -------- -------- --------
Total loans charged-off -- -- 1 --
-------- -------- -------- --------
Recoveries:
Commercial and other loans -- 5 66 7
Real estate loans -- -- -- --
-------- -------- -------- --------
Total loans recovered -- 5 66 7
-------- -------- -------- --------
Net recoveries (charge-offs) -- 5 65 7
-------- -------- -------- --------
Provision for loan losses
charged to operating expenses 654 75 804 150
-------- -------- -------- --------
Allowance at end of period 5,052 3,928 5,052 3,928
-------- -------- -------- --------
Ratio of net recoveries (charge-offs)
to average loans outstanding 0.00% 0.00% 0.01% 0.00%
======== ======== ======== ========
Allowance as a percent of total loans 1.10% 1.03% 1.10% 1.03%
======== ======== ======== ========
Total loans at end of period $460,371 $382,084 $460,371 $382,084
======== ======== ======== ========
29
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 June 30, 2008 and December 31, 2007, the Company had loans, net of
unearned income, of $460.37 million and $434.79 million, respectively, and
allowances for loan losses of $5.05 million and $4.18 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.
30
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. At June 30, 2008
and 2007, approximately $61.50 million and $59.35 million, respectively, or
13.32% and 15.53%, respectively, of the Company's total loan portfolio consisted
of such loans.
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 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 June 30, 2008 and 2007,
approximately $140.18 million and $136.40 million, respectively, or 30.36% and
35.70%, respectively, of the Company's total loan portfolio consisted of such
loans. The Bank 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 June 30, 2008 and 2007,
approximately 12.98% and 14.13%, respectively, of the Bank's residential one-to-
four family owner-occupied first mortgage portfolio were ARMs and approximately
87.02% and 85.87%, 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.
31
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. At June 30, 2008 and
2007, the Company's loan portfolio was comprised of $259.98 million and $186.34
million, respectively, or 56.31% and 48.77%, respectively, of other loan
products.
CAPITAL ADEQUACY
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set forth in
the table below) of total and Tier I capital (as defined in the regulations) to
risk-weighted assets, and of Tier I capital to average assets. Management
believes that, as of June 30, 2008, the Bank meets all capital adequacy
requirements to which it is subject.
The following tables set forth the actual and required regulatory
capital amounts and ratios of the Company and the Bank as of June 30, 2008
(dollars in thousands):
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
-------------- ------------------ --------------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
JUNE 30, 2008
Total Capital (to Risk-Weighted Assets)
Company $141,474 18.2% $62,111 >8.0% -- N/A
-
Bank 109,553 14.5% 60,634 >8.0% 75,793 >10.0%
- -
Tier I Capital (to Risk-Weighted Assets)
Company 136,422 17.6% 31,056 >4.0% -- N/A
-
Bank 104,500 13.8% 30,317 >4.0% 45,476 >6.0%
- -
Tier I Capital (to Average Assets)
Company 136,422 12.7% 42,999 >4.0% -- N/A
-
Bank 104,500 10.1% 41,258 >4.0% 51,573 >5.0%
- -
32
LIQUIDITY
The management of the Company's liquidity focuses on ensuring that
sufficient funds are available to meet loan funding commitments, withdrawals
from deposit accounts, the repayment of borrowed funds, and ensuring that the
Bank and the Company comply with regulatory liquidity requirements. Liquidity
needs of the Bank have historically been met by deposits, investments in federal
funds sold, principal and interest payments on loans, and maturities of
investment securities.
At June 30, 2008, our portfolio of investment securities included
approximately $166.1 million of auction rate securities. These investments have
high credit quality ratings of AA or AAA and are fully collateralized by bonds
and other financial instruments. Auction rate securities are generally long-term
debt instruments that provide liquidity through a Dutch auction process that
resets the applicable interest rate at pre-determined calendar intervals,
generally every 90 days for the securities in our portfolio.
Recent uncertainties in the credit markets have negatively impacted our
ability to liquidate, if necessary, investments in auction rate securities
because, in recent auctions, the amount of securities submitted for sale has
exceeded the amount of purchase orders. We are not certain as to when the
liquidity issues relating to these investments will improve; however, we have
the ability to hold these available for sale securities to maturity,
(predominately greater than 19 years after June 30, 2008) thereby recovering our
investment.
Based on our expected operating cash flows, and our other sources of
cash, we do not expect the potential lack of liquidity in these investments to
affect our capital, liquidity or our ability to execute our current business
plan.
For the parent company, Berkshire Bancorp Inc., liquidity means having
cash available to fund operating expenses and to pay stockholder dividends, when
and if declared by the Company's Board of Directors. The ability of the Company
to meet all of its obligations, including the payment of dividends, is not
dependent upon the receipt of dividends from the Bank. At June 30, 2008, the
Company had cash of approximately $11.2 million and investment securities with a
fair market value of $8.3 million.
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, approximately $46.65 million at June 30, 2008,
include commitments to extend credit, stand-by letters of credit and loan
commitments. The Bank also had interest rate caps with a notional amount of
$40.0 million.
At June 30, 2008, the Bank had outstanding contractual commitments of
approximately $523.51 million; including $50.14 million of long-term debt, $4.29
million of operating leases, and $469.08 million of time deposits. These
commitments include $472.99 million that mature or renew within one year, $25.44
million that mature or renew after one year and within three years, $24.59
million that mature or renew after three years and within five years and
$501,000 that mature or renew after five years.
33
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.
ITEM 4T - CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES.
As of the end of the period covered by this Quarterly Report on Form 10-Q, the
Company evaluated the effectiveness of the design and operation of its
"disclosure controls and procedures" as defined in Rule 13a-15(e) of the
Securities Exchange Act of 1934 ("Disclosure Controls"). This evaluation
("Controls Evaluation") was done under the supervision and with the
participation of the Company's management, including the Chief Executive Officer
("CEO"), who is also the Chief Financial Officer ("CFO"). Based upon the
Controls Evaluation, the CEO/CFO has concluded that the Disclosure Controls are
effective in reaching a reasonable level of assurance that information required
to be disclosed by the Company is recorded, processed, summarized and reported
within the time period specified in the Securities and Exchange Commission's
rules and forms and that any material information relating to the Company is
accumulated and communicated with management, including its principal
executive/financial officer to allow timely decisions regarding required
disclosure.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING.
In accordance with SEC requirements, the CEO/CFO notes that during the fiscal
quarter ended June 30, 2008, no changes in the Company's Internal Control have
occurred that have materially affected or are reasonably likely to materially
affect the Company's Internal Control.
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.
34
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The 2007 Annual Meeting of Stockholders was held on May 15, 2008. Each
of the six individuals nominated to serve as directors of the Company was
elected by the following votes:
DIRECTOR SHARES FOR SHARES WITHHELD
-------- ---------- ---------------
William L. Cohen 6,782,213 40,438
Martin A. Fischer 6,782,453 40,198
Moses Krausz 6,582,337 240,314
Moses Marx 6,576,614 246,037
Steven Rosenberg 6,577,136 245,515
Randolph B. Stockwell 6,777,834 44,817
ITEM 6. EXHIBITS
Exhibit
Number Description
------- -----------
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.
35
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
BERKSHIRE BANCORP INC.
----------------------
(REGISTRANT)
Date: August 11, 2008 By: /s/ Steven Rosenberg
------------------- ----------------------
STEVEN ROSENBERG
PRESIDENT AND CHIEF
FINANCIAL OFFICER
36
EXHIBIT INDEX
Exhibit
Number Description
------- -----------
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.
37