UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
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x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended:December 31, 2013
o 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: 000-51584
BERKSHIRE HILLS BANCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware |
| 04-3510455 |
(State or other jurisdiction of incorporation or organization) |
| (I.R.S. Employer Identification No.) |
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24 North Street, Pittsfield, Massachusetts |
| 01201 |
(Address of principal executive offices) |
| (Zip Code) |
Registrant’s telephone number, including area code: (413) 443-5601
Securities registered pursuant to Section 12(b) of the Act:
Title of each class |
| Name of Exchange on which registered |
Common stock, par value $0.01 per share |
| New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
(Check(Check one)
Large Accelerated Filer o |
| Accelerated Filer x |
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Non-Accelerated Filer o |
| Smaller Reporting Company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
The aggregate market value of the voting and non-voting common equity held by non-affiliates was approximately $476$681 million, based upon the closing price of $22.00$27.76 as quoted on the NASDAQ Global Select MarketNew York Stock Exchange as of the last business day of the registrant’s most recently completed second fiscal quarter.
The number of shares outstanding of the registrant’s common stock as of March 14, 201311, 2014 was 25,348,594.25,105,136.
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Proxy Statement for the 20132014 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K.
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Residential mortgages |
| $ | 1,324.3 |
| 33 | % | $ | 1,020.4 |
| 34 | % | $ | 645.0 |
| 30 | % | $ | 609.0 |
| 31 | % | $ | 677.2 |
| 34 | % |
| $ | 1,384.3 |
| 33 | % | $ | 1,324.3 |
| 33 | % | $ | 1,020.4 |
| 34 | % | $ | 645.0 |
| 30 | % | $ | 609.0 |
| 31 | % |
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Commercial mortgages |
| 1,413.5 |
| 35 |
| 1,156.2 |
| 39 |
| 925.6 |
| 43 |
| 851.8 |
| 43 |
| 805.5 |
| 40 |
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| 1,417.1 |
| 34 |
| 1,413.5 |
| 35 |
| 1,156.2 |
| 39 |
| 925.6 |
| 43 |
| 851.8 |
| 43 |
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Commercial business |
| 600.1 |
| 15 |
| 410.3 |
| 14 |
| 286.1 |
| 13 |
| 186.0 |
| 10 |
| 178.9 |
| 9 |
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| 687.3 |
| 16 |
| 600.1 |
| 15 |
| 410.3 |
| 14 |
| 286.1 |
| 13 |
| 186.0 |
| 10 |
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Total commercial loans |
| 2,013.6 |
| 50 |
| 1,566.5 |
| 53 |
| 1,211.7 |
| 56 |
| 1,037.8 |
| 53 |
| 984.4 |
| 49 |
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| 2,104.4 |
| 50 |
| 2,013.6 |
| 50 |
| 1,566.5 |
| 53 |
| 1,211.7 |
| 56 |
| 1,037.8 |
| 53 |
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Consumer |
| 650.7 |
| 17 |
| 369.6 |
| 13 |
| 285.5 |
| 14 |
| 314.8 |
| 16 |
| 345.5 |
| 17 |
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| 691.8 |
| 17 |
| 650.7 |
| 17 |
| 369.6 |
| 13 |
| 285.5 |
| 14 |
| 314.8 |
| 16 |
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Total loans |
| $ | 3,988.6 |
| 100 | % | $ | 2,956.5 |
| 100 | % | $ | 2,142.2 |
| 100 | % | $ | 1,961.6 |
| 100 | % | $ | 2,007.1 |
| 100 | % |
| $ | 4,180.5 |
| 100 | % | $ | 3,988.6 |
| 100 | % | $ | 2,956.5 |
| 100 | % | $ | 2,142.2 |
| 100 | % | $ | 1,961.6 |
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Allowance for loan losses |
| (33.2 | ) |
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| (32.4 | ) |
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| (31.9 | ) |
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| (31.8 | ) |
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| (22.9 | ) |
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| (33.3 | ) |
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| (33.2 | ) |
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| (32.4 | ) |
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Net loans |
| $ | 3,955.4 |
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| $ | 2,924.1 |
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| $ | 2,110.3 |
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| $ | 1,929.8 |
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| $ | 1,984.2 |
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| $ | 4,147.2 |
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| $ | 3,955.4 |
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| $ | 2,924.1 |
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| $ | 2,110.3 |
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| $ | 1,929.8 |
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Residential Mortgages. The Bank offers fixed-rate and adjustable-rate residential mortgage loans with maturities of up to 30 years that are fully amortizing with monthly loan payments. Residential mortgages are generally underwritten according to the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Association (“Freddie Mac”) guidelines for loans they designate as “A” or “A-” (these are referred to as “conforming loans”). Private mortgage insurance is generally required for loans with loan-to-value ratios in excess of 80%. The Bank also originates loans above conforming loan amount limits, referred to as “jumbo loans,” which are generally conforming to secondary market guidelines for these loans. The Bank does not offer subprime mortgage lending programs.
The Bank generally sells most of its newly originated fixed rate mortgages. It also monitors its interest rate risk position and sometimes may decide to purchase or sell seasoned mortgage loans in the secondary mortgage market. The Bank is approved as a direct seller to Fannie Mae, retaining the servicing rights. Beginning in 2012, the Bank sells the majority of its mortgages to national institutional secondary market investors on a servicing released basis. Sales of mortgages generally involve customary representations and warranties and are nonrecourse in the event of borrower default. The Bank is also an approved originator of loans for sale to the Federal Housing Administration (“FHA”), U.S. Department of Veteran Affairs (“VA”), and state housing agency programs.
The Bank offers adjustable rate (“ARM”) mortgages which do not contain interest-only or negative amortization features. After an initial term of six months to ten years, the rates on these loans generally reset every year based upon a contractual spread or margin above the average yield on U.S. Treasury securities. ARM loan interest rates may rise as interest rates rise, thereby increasing the potential for default. At year-end 2012,2013, the Bank’s adjustable rate mortgage portfolio totaled $363$401 million. The Bank also originates loans to individuals for the construction and acquisition of personal residences. These loans generally provide fifteen-month construction periods followed by a permanent mortgage loan, and follow the Bank’s normal mortgage underwriting guidelines.
Commercial Mortgages. The Bank originates commercial mortgages on properties used for business purposes such as small office buildings, industrial, healthcare, lodging, recreation, or retail facilities. This portfolio also includes commercial 1-4 family and multifamily properties. Loans may generally be made with amortizations of up to 25 years and with interest rates that adjust periodically (primarily from short-term to five years). Most commercial mortgages are originated with final maturities of ten years or less. The Bank generally requires that borrowers have debt service coverage ratios (the ratio of available cash flows before debt service to debt service) of at least 1.25 times. Loans at origination may be made up to 80% of appraised value. Generally, commercial mortgages require personal guarantees by the principals. Credit enhancements in the form of additional collateral or guarantees are normally considered for start-up businesses without a qualifying cash flow history. As part of its business activities, the Bank also enters into commercial loan participations with regional banks and purchases and sells commercial loans in its footprint.
Commercial mortgages generally involve larger principal amounts and a greater degree of risk than residential mortgages. They also often provide higher lending spreads. Because repayment is often dependent on the successful operation or management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks through strict adherence to its underwriting standards and portfolio management processes.
The Bank offers interest rate swaps to certain larger commercial mortgage borrowers. These swaps allow the Bank to originate a mortgage based on short-term LIBOR rates and allow the borrower to swap into a longer term fixed rate. The Bank simultaneously sells an offsetting back-to-back swap to an investment grade national bank so that it does not retain this fixed-rate risk. The Bank also records fee income on these interest rate swaps based on the terms of the offsetting swaps with the bank counterparties.
The Bank originates construction loans to builders and commercial borrowers in and around its markets. Construction loans finance the acquisition and/or improvement of commercial and residential properties. The maximum loan to value limits for construction loans follow FDIC supervisory limits, up to a maximum of 80%. The Bank commits to provide the permanent mortgage financing on most of ourits construction loans on income-producing property. Advances on construction loans are made in accordance with a schedule reflecting the cost of the improvements. Construction loans include land acquisition loans up to a maximum 65% loan to value on raw land. Construction loans may have greater credit risk than permanent loans. In many cases, the loan’s repayment is dependent on the completion of construction and other real estate improvements, which entails risk that construction permits may be delayed or may not be received, or that there may be delays or cost overruns during construction. Repayment is also often dependent on the sale or rental of the improved property, which depends on market conditions and the availability of permanent financing. Developers and contractors may also encounter liquidity risks or other risks related to other projects which are not being financed.
Commercial Business Loans. The Bank offers secured commercial term loans with repayment terms which are normally limited to the expected useful life of the asset being financed, generally not exceeding seven years. The Bank also offers revolving loans, lines of credit, letters of credit, time notes and Small Business Administration guaranteed loans. Business lines of credit have adjustable rates of interest and are payable on demand, subject to annual review and renewal. Commercial business loans are generally secured by a variety of collateral such as accounts receivable, inventory and equipment, and are generally supported by personal guarantees. Loan to value ratios depend on the collateral type and generally do not exceed 95% of the liquidation value of the collateral. Some commercial loans may also be secured by liens on real estate. The Bank generally does not make unsecured commercial loans.
The Asset Based Lending Group serves the commercial middle market in New England, as well as the Bank’s market in northeastern New York. This group expands the Bank’s business lending offerings to include revolving lines of credit and term loans secured by accounts receivable, inventory, and other assets to manufacturers, distributors and select service companies experiencing seasonal working capital needs, rapid sales growth, a turnaround, buyout or recapitalization with credit needs ranging from $2 to $25 million. Asset based lending involves monitoring loan collateral so that outstanding balances are always properly secured by business assets.
In the fourth quarter of 2011, the Bank recruited an experiencedThe Bank’s commercial lending team to servein Central/Eastern Massachusetts serves the commercial middle market in Central/Eastern Massachusetts. This team also haswith expertise in health care and education financing. Additionally, the Bank has reorganized its small business lending function to expand this important business financing capability and includes the retail division in the origination of conforming small business loans in order to provide the best service to community based small businesses.
Commercial loans are of higher risk and are made primarily on the basis of the borrower’s ability to make repayment from the cash flows of its business. Further, any collateral securing such loans may depreciate over time, may be difficult to monitor and appraise and may fluctuate in value. The Bank gives additional consideration to the borrower’s credit history and the guarantor’s capacity to help mitigate these risks.
Consumer Loans. The Bank’s consumer loans consist principally of home equity lines of credit, together with second mortgage loans and automobile loans. The Bank’s home equity lines of credit are typically secured by first or second mortgages on borrowers’ residences. Home equity lines have an initial revolving period up to fifteen years, followed by an amortizing term up to twenty years. These loans are normally indexed to the prime rate. Home equity loans also include amortizing fixed-rate second mortgages with terms up to fifteen years. Lending policies for combined debt service and collateral coverage are similar to those used for residential first mortgages, although underwriting verifications are more streamlined. The maximum combined loan-to-value is 80%. Home equity line credit risks are similar to those of adjustable-rate first mortgages, although these loans may be more sensitive to losses when interest rates are rising due to increased sensitivity to rate changes. Additionally, there may be possible compression of collateral coverage on second lien home equity lines. The Bank also includes all other consumer loans in this portfolio total, including personal secured and unsecured loans and overdraft protection facilities. The acquired Beacon operations include direct and indirect automobile loan portfolios. Beacon originated indirect automobile loans through established relationships with a number of automobile dealers in Central New York.portfolios are growing. For new automobiles, the amount financed could be up to 100% of the value of the vehicle, plus applicable taxes and dealer charges (i.e., warranty and insurance charges). For used automobiles, the amount of the loan was limited to the “loan value” of the vehicle, as established by industry guides.
Maturity and Sensitivity of Loan Portfolio. The following table shows contractual final maturities of selected loan categories at year-end 2012.2013. The contractual maturities do not reflect premiums, discounts, deferred costs, and prepayments.
Item 1 - Table 2 - Loan Contractual Maturity -Scheduled Loan Amortizations are not included in the maturities presented.
Contractual Maturity |
| One Year |
| More than One |
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| More than One |
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(In thousands) |
| or Less |
| to Five Years |
| Five Years |
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| to Five Years |
| Five Years |
| Total |
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Construction mortgage loans: |
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Residential |
| $ | 6,870 |
| $ | 19,849 |
| $ | — |
| $ | 26,719 |
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| $ | 5,773 |
| $ | 17,397 |
| $ | — |
| $ | 23,170 |
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Commercial |
| 64,752 |
| 103,073 |
| — |
| 167,825 |
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| 39,514 |
| 99,503 |
| — |
| 139,017 |
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Commercial business loans |
| 171,817 |
| 326,681 |
| 101,628 |
| 600,126 |
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| 207,164 |
| 356,694 |
| 123,435 |
| 687,293 |
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Total |
| $ | 243,439 |
| $ | 449,603 |
| $ | 101,628 |
| $ | 794,670 |
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| $ | 252,451 |
| $ | 473,594 |
| $ | 123,435 |
| $ | 849,480 |
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For the $551$597 million of loans above which mature in more than one year, $162$105 million of these loans are fixed-rate and $388$492 million are variable rate.
Loan Administration. Lending activities are governed by a loan policy approved by the Board’s Risk Management Committee. Internal staff perform and monitor post-closing loan documentation review, quality control, and commercial loan administration. The lending staff assigns a risk rating to all commercial loans. Management primarily relies on internal risk management staff to review the risk ratings of the majority of commercial loan balances.
The Bank’s lending activities follow written, non-discriminatory underwriting standards and loan origination procedures established by the Risk Management Committee and Management. The Bank’s loan underwriting is based
on a review of certain factors including risk ratings, recourse, loan-to-value ratios and material policy exceptions. The
Risk Management Committee has established individual and combined loan limits and lending approval authorities. Management’s Executive Loan Committee is responsible for commercial and residential loan approvals in accordance with these standards and procedures. Generally, commercial lending management has the authority to approve pass rated secured loans up to $2 million and in conjunction with the Senior Credit Officer up to $7.5 million (or $5 million in the case of material policy exceptions). The Executive Loan Committee approves secured loans over these amounts (and over $1 million unsecured).
The Bank’s lending activities are conducted by its salaried and commissioned loan personnel. Designated salaried branch staff originate conforming residential mortgages and receive bonuses based on overall performance. Additionally, the Bank employs commissioned residential mortgage originators. Commercial lenders receive salaries and are eligible for bonuses based on overall performance. From time to time, the Bank will purchase whole loans or participations in loans. These loans are underwritten according to the Bank’s underwriting criteria and procedures and are generally serviced by the originating lender under terms of the applicable participation agreement. The Bank routinely sells newly originated fixed rate residential mortgages in the secondary market. Customer rate locks are offered without charge and rate locked applications are generally committed for forward sale or hedged with derivative financial instruments to minimize interest rate risk pending delivery of the loans to the investors. The Bank sells a limited number of commercial loan participations on a non-recourse basis. The Bank issues loan commitments to its prospective borrowers conditioned on the occurrence of certain events. Loan origination commitments are made in writing on specified terms and conditions and are generally honored for up tosixty days from approval; some commercial commitments are made for longer terms.
The loan policy sets certain limits on concentrations of credit and requires periodic reporting of concentrations to the Risk Management Committee. Loans outstanding to the ten largest relationships averaged $23$26 million each, or 5.1%5.3% of total risk based capital. Total year-end commercial construction loans outstanding were 37%29% of the Bank’s risk based capital at year-end, and total commercial mortgage outstandings (including certain owner-occupied loans) were estimated at 272% of risk based capital.year-end. The Bank’s portfolio management objective has been to reduce these concentrations. The FDIC has established monitoring guidelines of 100% and 300% for these ratios, respectively.this ratio. Above these guidelines, additional monitoring and risk management controls are required.
Problem Assets. The Bank prefers to work with borrowers to resolve problems rather than proceeding to foreclosure. For commercial loans, this may result in a period of forbearance or restructuring of the loan, which is normally done at current market terms and does not result in a “troubled” loan designation. For residential mortgage loans, the Bank generally follows FDIC guidelines to attempt a restructuring that will enable owner-occupants to remain in their home. However, if these processes fail to result in a performing loan, then the Bank generally will initiate foreclosure or other proceedings no later than the 90th day of a delinquency, as necessary, to minimize any potential loss. Management reports delinquent loans and non-performing assets to the Board quarterly. Loans are generally removed from accruing status when they reach 90 days delinquent, except for certain loans which are well secured and in the process of collection. Delinquent automobile loans are maintained on accrual until they reach 120 days delinquent, and then they are generally charged-off.
Real estate acquired by the Bank as a result of loan collections is classified as real estate owned until sold. When property is acquired it is recorded at fair market value less estimated selling costs at the date of foreclosure, establishing a new cost basis. Holding costs and decreases in fair value after acquisition are expensed. Interest income that would have been recorded for 20122013 if nonaccruing loans had been current according to their original terms, amounted to $1.5$1.3 million. Included in the amount is $19$34 thousand related to troubled debt restructurings. The amount of interest income on those loans that was recognized in net income in 20122013 was $0.3$0.7 million. Included in this amount is $43 thousand
is $101 thousand related to troubled debt restructurings. Interest income on accruing troubled debt restructurings totaled $0.1$0.4 million for 2012.2013. The total carrying value of troubled debt restructurings was $4.6$10.8 million at year-end.
The following table sets forth additional information on year-end problem assets and accruing troubled debt restructurings (“TDR”). Due to accounting standards for business combinations, non-accrual loans of acquired banks are recorded as accruing on the acquisition date. Therefore, measures related to accruing and non-accruing loans reflect these standards and may not be comparable compared to prior periods.
Item 1 - Table 3 - Problem Assets and Accruing TDR
(In thousands) |
| 2012 |
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Non-accruing loans: |
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Residential mortgages |
| $ | 7,466 |
| $ | 7,010 |
| $ | 2,173 |
| $ | 3,304 |
| $ | 1,646 |
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| $ | 7,868 |
| $ | 7,466 |
| $ | 7,010 |
| $ | 2,173 |
| $ | 3,304 |
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Commercial mortgages |
| 12,617 |
| 14,280 |
| 9,488 |
| 31,917 |
| 7,738 |
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| 13,739 |
| 12,617 |
| 14,280 |
| 9,488 |
| 31,917 |
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Commercial business |
| 3,681 |
| 990 |
| 1,305 |
| 3,115 |
| 1,921 |
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| 2,355 |
| 3,681 |
| 990 |
| 1,305 |
| 3,115 |
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Consumer |
| 1,748 |
| 1,954 |
| 746 |
| 364 |
| 866 |
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| 3,493 |
| 1,748 |
| 1,954 |
| 746 |
| 364 |
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Total non-performing loans |
| 25,512 |
| 24,234 |
| 13,712 |
| 38,700 |
| 12,171 |
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| 27,455 |
| 25,512 |
| 24,234 |
| 13,712 |
| 38,700 |
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Real estate owned |
| 1,929 |
| 1,900 |
| 3,386 |
| 30 |
| 498 |
|
| 2,758 |
| 1,929 |
| 1,900 |
| 3,386 |
| 30 |
| ||||||||||
Total non-performing assets |
| $ | 27,441 |
| $ | 26,134 |
| $ | 17,098 |
| $ | 38,730 |
| $ | 12,669 |
|
| $ | 30,213 |
| $ | 27,441 |
| $ | 26,134 |
| $ | 17,098 |
| $ | 38,730 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Troubled debt restructurings (accruing) |
| $ | 3,641 |
| $ | 1,263 |
| $ | 7,829 |
| $ | 17,818 |
| $ | 7,456 |
|
| $ | 8,344 |
| $ | 3,641 |
| $ | 1,263 |
| $ | 7,829 |
| $ | 17,818 |
|
Accruing loans 90+ days past due |
| $ | 18,977 |
| $ | 10,184 |
| $ | 1,054 |
| $ | 91 |
| $ | 923 |
|
| $ | 9,223 |
| $ | 18,977 |
| $ | 10,184 |
| $ | 1,054 |
| $ | 91 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Total non-performing loans/total loans |
| 0.64 | % | 0.82 | % | 0.64 | % | 1.97 | % | 0.61 | % |
| 0.66 | % | 0.64 | % | 0.82 | % | 0.64 | % | 1.97 | % | ||||||||||
Total non-performing assets/total assets |
| 0.52 | % | 0.65 | % | 0.59 | % | 1.43 | % | 0.48 | % |
| 0.53 | % | 0.52 | % | 0.65 | % | 0.59 | % | 1.43 | % |
Asset Classification and Delinquencies. The Bank performs an internal analysis of its commercial loan portfolio and assets to classify such loans and assets in a manner similar to that employed by the federal banking regulators. There are four classifications for loans with higher than normal risk: Loss, Doubtful, Substandard and Special Mention. Normally an asset classified as Loss is fully charged-off. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. Assets that do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated Special Mention. Please see the additional discussion of non-accruing and potential problem loans in Item 7 and additional information about loans by risk rating in the Loans Note to the consolidated financial statements.
Allowance for Loan Losses. The Bank’s loan portfolio is regularly reviewed by management to evaluate the adequacy of the allowance for loan losses. The allowance represents management’s estimate of inherent losses that are probable and estimable as of the date of the financial statements. The allowance includes a specific component for impaired loans (a “specific loan loss reserve”) and a general component for portfolios of all outstanding loans (a “general loan loss reserve”). There isAt the time of acquisition, no allowance for loan losses is assigned at the time of acquisition to loans acquired in business combinations whichcombinations. These loans are carried at fair value, including the impact of expected losses, as of the acquisition date. An allowance on such loans is established subsequent to the acquisition date through the provision for loan losses based on an analysis of factors including environmental factors. The loan loss allowance is discussed further in the Note about Significant Accounting Policies in the consolidated financial statements.
For loans covered by the loan loss allowance, management assesses specific loan loss reserves when it deems that it is probable that the Bank will be unable to collect all amounts due according to the contractual terms stipulated in the loan agreement. Management weighs various factors in its assessment, including but not limited to, its review of the borrower’s payment history and the borrower’s future ability to service the debt, the current value of any pledged collateral, and the strength of any guarantor support. Generally non-accruing commercial loans are deemed impaired and evaluated for specific valuation allowances. Confirmed loan losses are charged-off directly to the allowance. Losses are deemed confirmed when upon review of all the available evidence, any portion of the loan balance is deemed uncollectible. Subsequent recoveries, if any, are credited to the allowance.
For loans from business activities covered by the loan loss allowance, management estimates general loan loss reserves when it is probable that there would be credit losses in portfolios of loans with similar characteristics. Management has identified four primary loan portfolios: residential mortgages, commercial mortgages, commercial business, and consumer loans. Sub-portfolios within these primary loan portfolios are also evaluated in order to arrive at a more precise general loan loss allowance. The methodology includes a historical loss component and an environmental factors component. The historical loss component is based on the Bank’s risk rating system in combination with the attribution of loss factors based on corporate default and recovery rates in the industry. The environmental factors component assesses loss potential as it may be affected by economic business conditions, lending policies and procedures, portfolio characteristics, management and staff changes, problem loan trends, and credit concentration trends. While the general loss reserve is analyzed according to the various subportfolios, the general loss reserve in aggregate is available to cover all losses in all components of the loan portfolio.
Management believes that it uses the best information available to establish the allowance for loan losses. However, future adjustments to the allowance for loan losses may be necessary, and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making its determinations. Because the estimation of inherent losses cannot be made with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loan or loan portfolio category deteriorate as a result of the factors discussed above. Additionally, the regulatory agencies, as an integral part of their examination process, also periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to make additional provisions for estimated losses based upon judgments different from those of management. Any material increase in the allowance for loan losses may adversely affect the Bank’s financial condition and results of operations.
The following table presents an analysis of the allowance for loan losses for the years indicated.
Item 1 - Table 4 - Allowance for Loan Loss
(In thousands) |
| 2012 |
| 2011 |
| 2010 |
| 2009 |
| 2008 |
|
| 2013 |
| 2012 |
| 2011 |
| 2010 |
| 2009 |
| ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Balance at beginning of year |
| $ | 32,444 |
| $ | 31,898 |
| $ | 31,816 |
| $ | 22,908 |
| $ | 22,116 |
|
| $ | 33,208 |
| $ | 32,444 |
| $ | 31,898 |
| $ | 31,816 |
| $ | 22,908 |
|
Charged-off loans: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Residential mortgages |
| 2,647 |
| 1,322 |
| 409 |
| 2,016 |
| 143 |
|
| 2,426 |
| 2,647 |
| 1,322 |
| 409 |
| 2,016 |
| ||||||||||
Commercial mortgages |
| 4,229 |
| 4,046 |
| 6,403 |
| 27,596 |
| 1,384 |
|
| 5,026 |
| 4,229 |
| 4,046 |
| 6,403 |
| 27,596 |
| ||||||||||
Commercial business |
| 697 |
| 1,443 |
| 2,685 |
| 5,945 |
| 884 |
|
| 2,917 |
| 697 |
| 1,443 |
| 2,685 |
| 5,945 |
| ||||||||||
Consumer |
| 1,877 |
| 885 |
| 1,188 |
| 3,586 |
| 2,031 |
|
| 2,467 |
| 1,877 |
| 885 |
| 1,188 |
| 3,586 |
| ||||||||||
Total charged-off loans |
| 9,450 |
| 7,696 |
| 10,685 |
| 39,143 |
| 4,442 |
|
| 12,836 |
| 9,450 |
| 7,696 |
| 10,685 |
| 39,143 |
| ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Recoveries on charged-off loans: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Residential mortgages |
| 103 |
| 231 |
| 213 |
| — |
| — |
|
| 399 |
| 103 |
| 231 |
| 213 |
| — |
| ||||||||||
Commercial mortgages |
| 52 |
| 189 |
| 794 |
| 22 |
| 100 |
|
| 549 |
| 52 |
| 189 |
| 794 |
| 22 |
| ||||||||||
Commercial business |
| 96 |
| 109 |
| 1,094 |
| 64 |
| 290 |
|
| 211 |
| 96 |
| 109 |
| 1,094 |
| 64 |
| ||||||||||
Consumer |
| 373 |
| 150 |
| 140 |
| 235 |
| 264 |
|
| 414 |
| 373 |
| 150 |
| 140 |
| 235 |
| ||||||||||
Total recoveries |
| 624 |
| 679 |
| 2,241 |
| 321 |
| 654 |
|
| 1,573 |
| 624 |
| 679 |
| 2,241 |
| 321 |
| ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Net loans charged-off |
| 8,826 |
| 7,017 |
| 8,444 |
| 38,822 |
| 3,788 |
|
| 11,263 |
| 8,826 |
| 7,017 |
| 8,444 |
| 38,822 |
| ||||||||||
Allowance attributed to loans acquired by merger |
| — |
| — |
| — |
| — |
| — |
|
| — |
| — |
| — |
| — |
| — |
| ||||||||||
Provision for loan losses |
| 9,590 |
| 7,563 |
| 8,526 |
| 47,730 |
| 4,580 |
|
| 11,378 |
| 9,590 |
| 7,563 |
| 8,526 |
| 47,730 |
| ||||||||||
Transfer of commitment reserve |
| — |
| — |
| — |
| — |
| — |
|
| — |
| — |
| — |
| — |
| — |
| ||||||||||
Balance at end of year |
| $ | 33,208 |
| $ | 32,444 |
| $ | 31,898 |
| $ | 31,816 |
| $ | 22,908 |
|
| $ | 33,323 |
| $ | 33,208 |
| $ | 32,444 |
| $ | 31,898 |
| $ | 31,816 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Ratios: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Net charge-offs/average loans |
| 0.26 | % | 0.27 | % | 0.42 | % | 1.96 | % | 0.19 | % |
| 0.29 | % | 0.26 | % | 0.27 | % | 0.42 | % | 1.96 | % | ||||||||||
Recoveries/charged-off loans |
| 6.60 |
| 8.82 |
| 20.97 |
| 0.82 |
| 14.72 |
|
| 12.25 |
| 6.60 |
| 8.82 |
| 20.97 |
| 0.82 |
| ||||||||||
Net loans charged-off/allowance for loan losses |
| 26.58 |
| 21.63 |
| 26.47 |
| 109.81 |
| 14.77 |
|
| 33.80 |
| 26.58 |
| 21.63 |
| 26.47 |
| 109.81 |
| ||||||||||
Allowance for loan losses/total loans |
| 0.83 |
| 1.10 |
| 1.49 |
| 1.62 |
| 1.14 |
|
| 0.80 |
| 0.83 |
| 1.10 |
| 1.49 |
| 1.62 |
| ||||||||||
Allowance for loan losses/non-accruing loans |
| 130.17 |
| 133.88 |
| 232.63 |
| 82.21 |
| 188.22 |
|
| 121.37 |
| 130.17 |
| 133.88 |
| 232.63 |
| 82.21 |
|
The following tables present year-end data for the approximate allocation of the allowance for loan losses by loan categories at the dates indicated (including an apportionment of any unallocated amount). The first table shows for each category the amount of the allowance allocated to that category as a percentage of the outstanding loans in that category. The second table shows the allocated allowance together with the percentage of loans in each category to total loans. Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance to each category is not indicative of future losses and does not restrict the use of any of the allowance to absorb losses in any category. Due to the impact of accounting standards for acquired loans, data in the accompanying tables may not be comparable between accounting periods.
Item 1 - Table 5A - Allocation of Allowance for Loan Loss by Category
|
| 2012 |
| 2011 |
| 2010 |
| 2009 |
| 2008 |
|
| 2013 |
| 2012 |
| 2011 |
| 2010 |
| 2009 |
| ||||||||||||||||||||||||||||||
|
|
|
| Percent of |
|
|
| Percent of |
|
|
| Percent of |
|
|
| Percent of |
|
|
| Percent of |
|
|
|
| Percent of |
|
|
| Percent of |
|
|
| Percent of |
|
|
| Percent of |
|
|
| Percent of |
| ||||||||||
|
|
|
| Amount Allocated |
|
|
| Amount Allocated |
|
|
| Amount Allocated |
|
|
| Amount Allocated |
|
|
| Amount Allocated |
|
|
|
| Amount Allocated |
|
|
| Amount Allocated |
|
|
| Amount Allocated |
|
|
| Amount Allocated |
|
|
| Amount Allocated |
| ||||||||||
|
|
|
| to Total |
|
|
| to Total |
|
|
| to Total |
|
|
| to Total |
|
|
| to Total |
|
|
|
| to Total |
|
|
| to Total |
|
|
| to Total |
|
|
| to Total |
|
|
| to Total |
| ||||||||||
|
| Amount |
| Loans in Each |
| Amount |
| Loans in Each |
| Amount |
| Loans in Each |
| Amount |
| Loans in Each |
| Amount |
| Loans in Each |
|
| Amount |
| Loans in Each |
| Amount |
| Loans in Each |
| Amount |
| Loans in Each |
| Amount |
| Loans in Each |
| Amount |
| Loans in Each |
| ||||||||||
(Dollars in thousands) |
| Allocated |
| Category |
| Allocated |
| Category |
| Allocated |
| Category |
| Allocated |
| Category |
| Allocated |
| Category |
|
| Allocated |
| Category |
| Allocated |
| Category |
| Allocated |
| Category |
| Allocated |
| Category |
| Allocated |
| Category |
| ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Residential mortgages |
| $ | 6,444 |
| 0.49 | % | $ | 3,420 |
| 0.34 | % | $ | 3,200 |
| 0.50 | % | $ | 3,169 |
| 0.52 | % | $ | 2,006 |
| 0.30 | % |
| $ | 7,562 |
| 0.55 | % | $ | 6,444 |
| 0.49 | % | $ | 3,420 |
| 0.34 | % | $ | 3,200 |
| 0.50 | % | $ | 3,169 |
| 0.52 | % |
Commercial mortgages |
| 19,275 |
| 1.36 |
| 22,176 |
| 1.92 |
| 19,923 |
| 2.15 |
| 19,659 |
| 2.31 |
| 13,539 |
| 1.68 |
|
| 16,112 |
| 1.13 |
| 19,275 |
| 1.36 |
| 22,176 |
| 1.92 |
| 19,923 |
| 2.15 |
| 19,659 |
| 2.31 |
| ||||||||||
Commercial business |
| 5,707 |
| 0.95 |
| 4,566 |
| 1.11 |
| 6,498 |
| 2.27 |
| 6,099 |
| 3.28 |
| 4,184 |
| 2.34 |
|
| 5,770 |
| 0.85 |
| 5,707 |
| 0.95 |
| 4,566 |
| 1.11 |
| 6,498 |
| 2.27 |
| 6,099 |
| 3.28 |
| ||||||||||
Consumer |
| 1,782 |
| 0.27 |
| 2,282 |
| 0.62 |
| 2,277 |
| 0.80 |
| 2,889 |
| 0.92 |
| 3,179 |
| 0.92 |
|
| 3,879 |
| 0.56 |
| 1,782 |
| 0.27 |
| 2,282 |
| 0.62 |
| 2,277 |
| 0.80 |
| 2,889 |
| 0.92 |
| ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Total |
| $ | 33,208 |
| 0.83 | % | $ | 32,444 |
| 1.10 | % | $ | 31,898 |
| 1.49 | % | $ | 31,816 |
| 1.62 | % | $ | 22,908 |
| 1.14 | % |
| $ | 33,323 |
| 0.80 | % | $ | 33,208 |
| 0.83 | % | $ | 32,444 |
| 1.10 | % | $ | 31,898 |
| 1.49 | % | $ | 31,816 |
| 1.62 | % |
Item 1 - Table 5B - Allocation of Allowance for Loan Loss
|
| 2012 |
| 2011 |
| 2010 |
| 2009 |
| 2008 |
|
| 2013 |
| 2012 |
| 2011 |
| 2010 |
| 2009 |
| ||||||||||||||||||||||||||||||
|
|
|
| Percent of |
|
|
| Percent of |
|
|
| Percent of |
|
|
| Percent of |
|
|
| Percent of |
|
|
|
| Percent of |
|
|
| Percent of |
|
|
| Percent of |
|
|
| Percent of |
|
|
| Percent of |
| ||||||||||
|
|
|
| Loans in Each |
|
|
| Loans in Each |
|
|
| Loans in Each |
|
|
| Loans in Each |
|
|
| Loans in Each |
|
|
|
| Loans in Each |
|
|
| Loans in Each |
|
|
| Loans in Each |
|
|
| Loans in Each |
|
|
| Loans in Each |
| ||||||||||
|
| Amount |
| Category |
| Amount |
| Category |
| Amount |
| Category |
| Amount |
| Category |
| Amount |
| Category |
|
| Amount |
| Category |
| Amount |
| Category |
| Amount |
| Category |
| Amount |
| Category |
| Amount |
| Category |
| ||||||||||
(Dollars in thousands) |
| Allocated |
| to Total Loans |
| Allocated |
| to Total Loans |
| Allocated |
| to Total Loans |
| Allocated |
| to Total Loans |
| Allocated |
| to Total Loans |
|
| Allocated |
| to Total Loans |
| Allocated |
| to Total Loans |
| Allocated |
| to Total Loans |
| Allocated |
| to Total Loans |
| Allocated |
| to Total Loans |
| ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Residential mortgages |
| $ | 6,444 |
| 33.20 | % | $ | 3,420 |
| 34.51 | % | $ | 3,200 |
| 30.11 | % | $ | 3,169 |
| 31.05 | % | $ | 2,006 |
| 33.74 | % |
| $ | 7,562 |
| 33.11 | % | $ | 6,444 |
| 33.20 | % | $ | 3,420 |
| 34.51 | % | $ | 3,200 |
| 30.11 | % | $ | 3,169 |
| 31.05 | % |
Commercial mortgages |
| 19,275 |
| 35.44 |
| 22,176 |
| 39.11 |
| 19,923 |
| 43.21 |
| 19,659 |
| 43.42 |
| 13,539 |
| 40.13 |
|
| 16,112 |
| 41.26 |
| 19,275 |
| 35.44 |
| 22,176 |
| 39.11 |
| 19,923 |
| 43.21 |
| 19,659 |
| 43.42 |
| ||||||||||
Commercial business |
| 5,707 |
| 15.05 |
| 4,566 |
| 13.88 |
| 6,498 |
| 13.35 |
| 6,099 |
| 9.48 |
| 4,184 |
| 8.92 |
|
| 5,770 |
| 9.08 |
| 5,707 |
| 15.05 |
| 4,566 |
| 13.88 |
| 6,498 |
| 13.35 |
| 6,099 |
| 9.48 |
| ||||||||||
Consumer |
| 1,782 |
| 16.31 |
| 2,282 |
| 12.50 |
| 2,277 |
| 13.33 |
| 2,889 |
| 16.05 |
| 3,179 |
| 17.21 |
|
| 3,879 |
| 16.55 |
| 1,782 |
| 16.31 |
| 2,282 |
| 12.50 |
| 2,277 |
| 13.33 |
| 2,889 |
| 16.05 |
| ||||||||||
|
| �� |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Total |
| $ | 33,208 |
| 100.00 | % | $ | 32,444 |
| 100.00 | % | $ | 31,898 |
| 100.00 | % | $ | 31,816 |
| 100.00 | % | $ | 22,908 |
| 100.00 | % |
| $ | 33,323 |
| 100.00 | % | $ | 33,208 |
| 100.00 | % | $ | 32,444 |
| 100.00 | % | $ | 31,898 |
| 100.00 | % | $ | 31,816 |
| 100.00 | % |
INVESTMENT SECURITIES ACTIVITIES
The securities portfolio provides cash flow to protect the safety of customer deposits and as a potential source of liquidity for funding loan commitments. The portfolio is also used to manage interest rate risk and to earn a reasonable return on investment. Decisions are made in accordance with the Company’s investment policy and include consideration of risk, return, duration, and portfolio concentrations. Day-to-day oversight of the portfolio rests with the Chief Financial Officer and the Treasurer. The Asset/Liability Committee meets monthly and reviews investment strategies. The Risk Management Committee reviews all securities transactions and provides general oversight of the investment function.
The Company has historically maintained a high-quality portfolio of limited duration mortgage-backed securities, together with a portfolio of municipal bonds including national and local issuers and local economic development bonds issued to non-profit organizations. Nearly all of the mortgage-backed securities are issued by Ginnie Mae, Fannie Mae or Freddie Mac, and they generally have an average duration of twothree to fourfive years. They principally consist of collateralized mortgage obligations (generally consisting of planned amortization class bonds). Other than securities issued by the above agencies, no other issuer concentrations exceeding 10% of stockholders’ equity existed at year-end 2012.2013. The municipal portfolio provides tax-advantaged yield, and the local economic development bonds were originated by the Company to area borrowers. Nearly all of the Company’s available for sale municipal securities are investment grade rated and most of the portfolio carries credit enhancement protection. The Company also invests in equity securities of local financial institutions for a variety of reasons, particularly if it concludes the financial institution is undervalued or if the Company might consider partnering with the financial institution in the future. The Company owns restricted equity in the Federal Home Loan Bank of Boston (“FHLBB”) based on its operating relationship with the FHLBB. The Company owns an interest rate swap against a tax advantaged economic development bond issued to a local not-for-profit organization, and as a result this security is carried as a trading
account security. The Bank did not record any material losses or write-downs of investment securities during the year and none of the Company’s investment securities were other-than-temporarily impaired at year-end.
The following tables present the amortized cost and fair value of the Company’s securities, by type of security, for the years indicated.
Item 1 - Table 6A - Amortized Cost and Fair Value of Securities
|
| 2012 |
| 2011 |
| 2010 |
|
| 2013 |
| 2012 |
| 2011 |
| ||||||||||||||||||||||||
|
| Amortized |
| Fair |
| Amortized |
| Fair |
| Amortized |
| Fair |
|
| Amortized |
| Fair |
| Amortized |
| Fair |
| Amortized |
| Fair |
| ||||||||||||
(In thousands) |
| Cost |
| Value |
| Cost |
| Value |
| Cost |
| Value |
|
| Cost |
| Value |
| Cost |
| Value |
| Cost |
| Value |
| ||||||||||||
Securities available for sale |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Municipal bonds and obligations |
| $ | 79,498 |
| $ | 84,757 |
| $ | 73,436 |
| $ | 77,854 |
| $ | 79,292 |
| $ | 79,906 |
|
| $ | 77,852 |
| $ | 77,671 |
| $ | 79,498 |
| $ | 84,757 |
| $ | 73,436 |
| $ | 77,854 |
|
Mortgage-backed securities |
| 318,245 |
| 321,685 |
| 289,084 |
| 292,707 |
| 170,294 |
| 172,883 |
|
| 610,326 |
| 601,429 |
| 318,245 |
| 321,685 |
| 289,084 |
| 292,707 |
| ||||||||||||
Other bonds and obligations |
| 35,241 |
| 34,436 |
| 30,702 |
| 28,186 |
| 40,931 |
| 38,548 |
|
| 61,123 |
| 58,975 |
| 35,241 |
| 34,436 |
| 30,702 |
| 28,186 |
| ||||||||||||
Marketable equity securities |
| 22,467 |
| 25,291 |
| 20,236 |
| 21,009 |
| 15,756 |
| 18,905 |
|
| 20,041 |
| 21,973 |
| 22,467 |
| 25,291 |
| 20,236 |
| 21,009 |
| ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Total securities available for sale |
| $ | 455,451 |
| $ | 466,169 |
| $ | 413,458 |
| $ | 419,756 |
| $ | 306,273 |
| $ | 310,242 |
|
| $ | 769,342 |
| $ | 760,048 |
| $ | 455,451 |
| $ | 466,169 |
| $ | 413,458 |
| $ | 419,756 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||||||||||||||
Securities held to maturity |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Municipal bonds and obligations |
| $ | 8,295 |
| $ | 8,295 |
| $ | 10,349 |
| $ | 10,349 |
| $ | 7,069 |
| $ | 7,069 |
|
| $ | 4,244 |
| $ | 4,244 |
| $ | 8,295 |
| $ | 8,295 |
| $ | 10,349 |
| $ | 10,349 |
|
Mortgage-backed securities |
| 76 |
| 83 |
| 79 |
| 83 |
| 83 |
| 86 |
|
| 73 |
| 75 |
| 76 |
| 83 |
| 79 |
| 83 |
| ||||||||||||
Tax advantaged economic development bonds |
| 41,678 |
| 43,137 |
| 47,869 |
| 49,348 |
| 48,861 |
| 50,016 |
|
| 40,260 |
| 41,101 |
| 41,678 |
| 43,137 |
| 47,869 |
| 49,348 |
| ||||||||||||
Other bonds and obligations |
| 975 |
| 975 |
| 615 |
| 615 |
| 423 |
| 423 |
|
| 344 |
| 344 |
| 975 |
| 975 |
| 615 |
| 615 |
| ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Total securities held to maturity |
| $ | 51,024 |
| $ | 52,490 |
| $ | 58,912 |
| $ | 60,395 |
| $ | 56,436 |
| $ | 57,594 |
|
| $ | 44,921 |
| $ | 45,764 |
| $ | 51,024 |
| $ | 52,490 |
| $ | 58,912 |
| $ | 60,395 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Trading account security |
| $ | 13,610 |
| $ | 16,893 |
| $ | 14,096 |
| $ | 17,395 |
| $ | 14,560 |
| $ | 16,155 |
|
| $ | 13,096 |
| $ | 14,840 |
| $ | 13,610 |
| $ | 16,893 |
| $ | 14,096 |
| $ | 17,395 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Restricted equity securities |
| $ | 39,785 |
| $ | 39,785 |
| $ | 37,118 |
| $ | 37,118 |
| $ | 23,120 |
| $ | 23,120 |
|
| $ | 50,282 |
| $ | 50,282 |
| $ | 39,785 |
| $ | 39,785 |
| $ | 37,118 |
| $ | 37,118 |
|
Item 1 - Table 6B - Amortized Cost and Fair Value of Securities
|
| 2012 |
| 2011 |
| 2010 |
|
| 2013 |
| 2012 |
| 2011 |
| ||||||||||||||||||||||||
|
| Amortized |
| Fair |
| Amortized |
| Fair |
| Amortized |
| Fair |
|
| Amortized |
| Fair |
| Amortized |
| Fair |
| Amortized |
| Fair |
| ||||||||||||
(In thousands) |
| Cost |
| Value |
| Cost |
| Value |
| Cost |
| Value |
|
| Cost |
| Value |
| Cost |
| Value |
| Cost |
| Value |
| ||||||||||||
U.S. Treasuries,other Government agencies and corporations |
| $ | 340,789 |
| $ | 347,058 |
| $ | 309,399 |
| $ | 313,799 |
| $ | 186,133 |
| $ | 191,874 |
|
| $ | 630,442 |
| $ | 623,478 |
| $ | 340,789 |
| $ | 347,058 |
| $ | 309,399 |
| $ | 313,799 |
|
Municipal bonds and obligations |
| 143,080 |
| 153,082 |
| 145,750 |
| 154,946 |
| 149,782 |
| 153,146 |
|
| 135,451 |
| 137,855 |
| 143,080 |
| 153,082 |
| 145,750 |
| 154,946 |
| ||||||||||||
Other bonds and obligations |
| 76,001 |
| 75,197 |
| 68,435 |
| 65,919 |
| 64,474 |
| 62,091 |
|
| 111,749 |
| 109,601 |
| 76,001 |
| 75,197 |
| 68,435 |
| 65,919 |
| ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Total Securites |
| $ | 559,870 |
| $ | 575,337 |
| $ | 523,584 |
| $ | 534,664 |
| $ | 400,389 |
| $ | 407,111 |
|
| $ | 877,642 |
| $ | 870,934 |
| $ | 559,870 |
| $ | 575,337 |
| $ | 523,584 |
| $ | 534,664 |
|
The schedule includes available-for-sale and held-to-maturity securities as well as the trading security and restricted equity securities.
The following table summarizes year-end 20122013 amortized cost, weighted average yields and contractual maturities of debt securities. A significant portion of the mortgage-based securities are planned amortization class bonds. Their expected durations are 2-43-5 years at current interest rates, but the contractual maturities shown reflect the underlying maturities of the collateral mortgages. Additionally, the mortgage-based securities maturities shown below are based on final maturities and do not include scheduled amortization.
Item 1 - Table 7 - Weighted Average Yield
|
|
|
| More than One |
| More than Five Years |
|
|
|
|
|
|
|
|
|
| More than One |
| More than Five Years |
|
|
|
|
|
|
|
|
| ||||||||||||||||||||||||
|
| One Year or Less |
| Year to Five Years |
| to Ten Years |
| More than Ten Years |
| Total |
|
| One Year or Less |
| Year to Five Years |
| to Ten Years |
| More than Ten Years |
| Total |
| ||||||||||||||||||||||||||||||
|
|
|
| Weighted |
|
|
| Weighted |
|
|
| Weighted |
|
|
| Weighted |
|
|
| Weighted |
|
|
|
| Weighted |
|
|
| Weighted |
|
|
| Weighted |
|
|
| Weighted |
|
|
| Weighted |
| ||||||||||
|
| Amortized |
| Average |
| Amortized |
| Average |
| Amortized |
| Average |
| Amortized |
| Average |
| Amortized |
| Average |
|
| Amortized |
| Average |
| Amortized |
| Average |
| Amortized |
| Average |
| Amortized |
| Average |
| Amortized |
| Average |
| ||||||||||
(In millions) |
| Cost |
| Yield |
| Cost |
| Yield |
| Cost |
| Yield |
| Cost |
| Yield |
| Cost |
| Yield |
|
| Cost |
| Yield |
| Cost |
| Yield |
| Cost |
| Yield |
| Cost |
| Yield |
| Cost |
| Yield |
| ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Municipal bonds and obligations |
| $ | 4.6 |
| 1.26 | % | $ | 4.5 |
| 4.97 | % | $ | 17.1 |
| 6.38 | % | $ | 61.7 |
| 6.38 | % | $ | 87.8 |
| 6.04 | % |
| $ | 1.1 |
| 1.69 | % | $ | 4.5 |
| 4.92 | % | $ | 18.9 |
| 6.30 | % | $ | 57.6 |
| 5.66 | % | $ | 82.1 |
| 5.71 | % |
Mortgage-backed securities |
| 0.0 |
| 5.34 |
| 7.8 |
| 2.88 |
| 22.9 |
| 2.01 |
| 287.7 |
| 1.43 |
| 318.3 |
| 1.51 |
|
| 0.0 |
| 6.04 |
| 11.3 |
| 3.19 |
| 10.5 |
| 2.02 |
| 588.6 |
| 2.18 |
| 610.4 |
| 2.20 |
| ||||||||||
Other bonds and obligations |
| 0.6 |
| 1.96 |
| 9.0 |
| 4.46 |
| 29.6 |
| 5.63 |
| 38.7 |
| 5.33 |
| 77.9 |
| 5.32 |
|
| 3.0 |
| 5.22 |
| 6.1 |
| 3.14 |
| 62.3 |
| 4.30 |
| 30.3 |
| 5.01 |
| 101.7 |
| 4.47 |
| ||||||||||
Total |
| $ | 5.2 |
| 1.34 | % | $ | 21.3 |
| 3.99 | % | $ | 69.6 |
| 4.62 | % | $ | 388.1 |
| 2.60 | % | $ | 484.0 |
| 2.94 | % |
| $ | 4.1 |
| 4.26 | % | $ | 21.9 |
| 3.53 | % | $ | 91.7 |
| 4.45 | % | $ | 676.5 |
| 2.60 | % | $ | 794.2 |
| 2.85 | % |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS
Deposits are the major source of funds for the Bank’s lending and investment activities. Deposit accounts are the primary product and service interaction with the Bank’s customers. The Bank serves personal, commercial, non-profit, and municipal deposit customers. Most of the Bank’s deposits are generated from the areas surrounding its branch offices. The Bank offers a wide variety of deposit accounts with a range of interest rates and terms. The Bank also periodically offers promotional interest rates and terms for limited periods of time. The Bank’s deposit accounts consist of interest-bearing checking, noninterest-bearing checking, regular savings, money market savings and time certificates of deposit. The Bank emphasizes its transaction deposits — checking and NOW accounts for personal accounts and checking accounts promoted to businesses. These accounts have the lowest marginal cost to the Bank and are also often a core account for a customer relationship. The Bank offers a courtesy overdraft program to improve customer service, and also provides debit cards and other electronic fee producing payment services to transaction account customers. The Bank is promoting remote deposit capture devices so that commercial accounts can make deposits from their place of business. Money market accounts have increased in popularity due to their interest rate structure. Savings accounts include traditional passbook and statement accounts. The Bank’s time accounts provide maturities from three months to ten years. Additionally, the Bank offers a variety of retirement deposit accounts to personal and business customers. Deposit service fee income also includes other miscellaneous transaction and convenience services sold to customers through the branch system as part of an overall service relationship.
The Bank offers 100% insurance on all deposits as a result of a combination of insurance from the FDIC and the Massachusetts Depositors Insurance Fund, a mutual insurance fund sponsored by Massachusetts-chartered savings banks.
The following table presents information concerning average balances and weighted average interest rates on the Bank’s interest-bearing deposit accounts for the years indicated. Deposit amounts in the following tables include balances associated with discontinued operations.
Item 1 - Table 8 - Average Balance and Weighted Average Rates for Deposits
|
| 2012 |
| 2011 |
| 2010 |
|
| 2013 |
| 2012 |
| 2011 |
| |||||||||||||||||||||||||||||||||
|
|
|
| Percent |
|
|
|
|
| Percent |
|
|
|
|
| Percent |
|
|
|
|
|
| Percent |
|
|
|
|
| Percent |
|
|
|
|
| Percent |
|
|
| |||||||||
|
|
|
| of Total |
| Weighted |
|
|
| of Total |
| Weighted |
|
|
| of Total |
| Weighted |
|
|
|
| of Total |
| Weighted |
|
|
| of Total |
| Weighted |
|
|
| of Total |
| Weighted |
| |||||||||
|
| Average |
| Average |
| Average |
| Average |
| Average |
| Average |
| Average |
| Average |
| Average |
|
| Average |
| Average |
| Average |
| Average |
| Average |
| Average |
| Average |
| Average |
| Average |
| |||||||||
(In millions) |
| Balance |
| Deposits |
| Rate |
| Balance |
| Deposits |
| Rate |
| Balance |
| Deposits |
| Rate |
|
| Balance |
| Deposits |
| Rate |
| Balance |
| Deposits |
| Rate |
| Balance |
| Deposits |
| Rate |
| |||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||
Demand |
| $ | 870.1 |
| 21 | % |
| — | % | $ | 377.9 |
| 14 | % |
| — | % | $ | 279.2 |
| 14 | % |
| — | % |
| $ | 655.7 |
| 17 | % | — | % | $ | 529.0 |
| 15 | % | — | % | $ | 377.9 |
| 14 | % | — | % |
NOW |
| 368.4 |
| 9 |
| 0.2 |
| 244.2 |
| 9 |
| 0.4 |
| 199.3 |
| 10 |
| 0.4 |
|
| 355.2 |
| 9 |
| 0.1 |
| 304.1 |
| 9 |
| 0.2 |
| 244.2 |
| 9 |
| 0.4 |
| |||||||||
Money market |
| 1,396.2 |
| 33 |
| 0.4 |
| 833.3 |
| 31 |
| 0.7 |
| 597.3 |
| 29 |
| 0.9 |
|
| 1,389.2 |
| 35 |
| 0.9 |
| 1,189.1 |
| 34 |
| 0.4 |
| 833.3 |
| 31 |
| 0.7 |
| |||||||||
Savings |
| 480.1 |
| 11 |
| 0.1 |
| 369.6 |
| 13 |
| 0.2 |
| 224.3 |
| 11 |
| 0.3 |
|
| 442.2 |
| 11 |
| 0.1 |
| 390.8 |
| 11 |
| 0.1 |
| 369.6 |
| 13 |
| 0.2 |
| |||||||||
Time |
| 1,077.5 |
| 26 |
| 1.6 |
| 902.6 |
| 33 |
| 1.8 |
| 749.2 |
| 36 |
| 2.6 |
|
| 1,085.8 |
| 28 |
| 1.2 |
| 1,056.0 |
| 31 |
| 1.6 |
| 902.6 |
| 33 |
| 1.8 |
| |||||||||
Total |
| $ | 4,192.3 |
| 100 | % | 0.6 | % | $ | 2,727.6 |
| 100 | % | 0.9 | % | $ | 2,049.3 |
| 100 | % | 1.3 | % |
| $ | 3,928.1 |
| 100 | % | 0.5 | % | $ | 3,469.0 |
| 100 | % | 0.6 | % | $ | 2,727.6 |
| 100 | % | 0.9 | % |
At year-end 2012,2013, the Bank had time deposit accounts in amounts of $100 thousand or more maturing as follows:
Item 1 - Table 9 - Maturity of Deposits > $100,000
|
|
|
| Weighted |
|
|
|
| Weighted |
| ||
|
|
|
| Average |
|
|
|
| Average |
| ||
Maturity Period |
| Amount |
| Rate |
|
| Amount |
| Rate |
| ||
(In thousands) |
|
|
|
|
|
|
|
|
|
| ||
Three months or less |
| $ | 91,591 |
| 1.13 | % |
| $ | 74,379 |
| 1.49 | % |
Over 3 months through 6 months |
| 76,007 |
| 0.89 |
|
| 66,935 |
| 1.04 |
| ||
Over 6 months through 12 months |
| 143,394 |
| 1.38 |
|
| 88,193 |
| 1.03 |
| ||
Over 12 months |
| 310,702 |
| 1.74 |
|
| 281,239 |
| 1.48 |
| ||
Total |
| $ | 621,694 |
| 1.46 | % |
| $ | 510,746 |
| 1.34 | % |
The Company also uses borrowings from the FHLBB as an additional source of funding, particularly for daily cash management and for funding longer duration assets. FHLBB advances also provide more pricing and option alternatives for particular asset/liability needs. The FHLBB functions as a central reserve bank providing credit for member institutions. As an FHLBB member, the Company is required to own capital stock of the FHLBB. FHLBB borrowings are secured by a blanket lien on most of the Bank’s mortgage loans and mortgage-related securities, as well as certain other assets. Advances are made under several different credit programs with different lending standards, interest rates, and range of maturities. The Company has a $15 million trust preferred obligation outstanding and in September 2012 issued $75 million in senior subordinated notes. Subject to certain limitations, the Company can also choose to issue common stock in public stock offerings and can also potentially obtain privately placed common and preferred stock, and subordinated, and senior debt from institutional and private investors.
DERIVATIVE FINANCIAL INSTRUMENTS
The Company uses interest rate swap instruments for its own account andto fix the interest rate on some of its borrowings, most of which are designated as cash flow hedges. The Company also offers them for saleinterest rate swaps to commercial loan customers forwho wish to fix the interest rates on their own accounts, normally in conjunction with commercial loans, offered by the Bank to these customers. At year-end 2012,and the Company held derivative financial instrumentsbacks these swaps with a total notional amountoffsetting swaps with national bank counterparties. These swaps are designated as economic hedges. Additionally the Company’s mortgage banking activities also result in derivatives. Interest rate lock commitments are provided on applications for residential mortgages intended for resale and are accounted for as non-hedging derivatives. The Company arranges offsetting forward sales commitments for most of $1.31 billion, including $488 million in interest rate contractsthese rate-locks with its retail and commercial customers. national bank counterparties, which are designated as economic hedges.
The Company has a policy for managing its derivative financial instruments, and the policy and program activity are overseen by the Risk Management Committee. Derivative financial instruments with counterparties which are not customers are limited to a select number of national financial institutions. Collateral may be required based on financial condition tests. The Company works with a third-party firmfirms which assistsassist in marketing swapderivative transactions, documentingexecuting transactions, and providing information for bookkeeping and accounting purposes.
At year-end 2013, the Company held derivative financial instruments with a total notional amount of $905 million, including cash flow hedges consisting of interest rate swaps on Federal Home Loan Bank borrowings totaling $410 million. In conjunction with the New York branch acquisition, the Company terminated these cash flow hedges in the first quarter of 2014, and recorded an after-tax charge of approximately $5.1 million which had no significant effect on stockholders’ equity since the after-tax unrealized loss on these hedges was already recorded in other comprehensive income in stockholders’ equity. Also during the first quarter of 2014, the Company entered into $300 million of new cash flow hedges based on an analysis of its current interest rate sensitivity.
WEALTH MANAGEMENT SERVICES
The Company’s Wealth Management Group provides consultative investment management and trust relationships to individuals, businesses, and institutions, with an emphasis on personal investment management. The Wealth Management Group has built a track record over more than a decade with its dedicated in-house investment management team. In 2011,2012, the Wealth Management business line expanded with the integration of the Renaissance Investment Group in the Legacy merger. At year-end 2012,2013, assets under management totaled $1.3 billion (including custodial and investment accounts) totaled $1.05 billion.. Wealth Management services include investment management, trust administration, estate planning, and private banking. The Bank also provides a full line of investment products, financial planning, and brokerage services utilizing Commonwealth Financial Network as the broker/dealer. The Group’s principal operations are in Western New England and it is expanding its services in the Company’s other regions.
INSURANCE
As an independent insurance agent, the Berkshire Insurance Group represents a carefully selected group of financially sound, reputable insurance companies offering attractive coverage at competitive prices. The Insurance Group offers a full line of personal and commercial property and casualty insurance. It also offers employee benefits insurance and a full line of personal life, health, and financial services insurance products. Berkshire Insurance Group operates a focused cross-sell program of insurance and banking products through all offices and branches of the Bank with some of the Group’s offices located within the Bank’s branches. The Group’s principal operations are in Western New England, and it is expanding its services in the Company’s other regions.
PERSONNEL
At year-end 2012,2013, the Company had 1,012939 full time equivalent employees. Total employees increaseddecreased from 7601,012 at the start of the year (excluding employees assigned to discontinued operations which were divested in January, 2012). The increase was primarily due to business combinations during the year.merger integration and restructuring initiatives. Berkshire continues to develop its staffing, including staff for new branches and hires related to team development. The Company has also developed staff with targeted skills to deepen the Company’s infrastructure. The Company’s employees are not represented by a collective bargaining unit.
SUBSIDIARY ACTIVITIES
The Company wholly-owns two active consolidated subsidiaries: the Bank and Berkshire Insurance Group. The Bank is a Massachusetts-chartered savings bank. One of the Bank’s subsidiaries is Berkshire Bank Municipal Bank, which is chartered in the state of New York. Berkshire Insurance Group is incorporated in Massachusetts.
The Company also owns all of the common stock of a Delaware statutory business trust, Berkshire Hills Capital Trust I. The capital trust was organized under Delaware law to facilitate the issuance of trust preferred securities and is not consolidated into the Company’s financial results. Its only activity has been the issuance of the $15 million trust preferred security related to the junior subordinated debentures reported in the Company’s consolidated financial statements.
Additional information about the subsidiaries is contained in Exhibit 21 to this report.
SEGMENT REPORTING
The Company has two reportable operating segments, banking and insurance. Banking includes the activities of the Bank and its subsidiaries, which provide commercial and retail banking services. Insurance includes the activities of Berkshire Insurance Group, which provides commercial and consumer insurance services. The only other consolidated financial activity of the Company is that of the Company’s role as parent of the Bank and Berkshire Insurance Group. For more information about the Company’s reportable operating segments, see the related note in the consolidated financial statements.
REGULATION AND SUPERVISION
General
Berkshire Hills BancorpThe Company is a Delaware corporation and savings and loan holding company registered with the Federal Reserve Board. The Bank’s deposits are insured up to applicable limits by the FDIC and by the Depositors Insurance Fund of Massachusetts for amounts in excess of the FDIC insurance limits. The Bank is subject to extensive regulation by the Massachusetts Commissioner of Banks (the “Commissioner”) as its chartering agency, and by the FDIC, as its deposit insurer. The Bank is required to file reports with the Commissioner and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other savingsdepository institutions or branches of other institutions. The Commissioner and the FDIC conduct periodic examinations to test the Bank’s safety and soundness and compliance with various regulatory requirements. As a savings and loan holding company, Berkshire Hills Bancorpthe Company is required by federal law to file reports with, and otherwise comply with the rules and regulations of, the Federal Reserve Board. The regulatory structure gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies,
whether by the Commissioner, the Massachusetts legislature, the FDIC, the Federal Reserve Board or Congress, could have a material adverse impact on Berkshire Hills Bancorp,the Company, the Bank and their operations.
The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) made extensive changes in the regulation of insured depository institutions. Under the Dodd-Frank Act, the Office of Thrift Supervision (“OTS”), the previous federal regulator of Berkshire Hills Bancorp,the Company, was eliminated. At the same time, responsibility for the regulation and supervision of savings and loan holding companies, such as Berkshire Hills Bancorp,the Company, was transferred
to the Federal Reserve Board, which also supervises bank holding companies. The transfer took place as of July 21, 2011.
Additionally, the Dodd-Frank Act created a new Consumer Financial Protection Bureau as an independent bureau of the Federal Reserve Board. The Consumer Financial Protection Bureau assumed responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations, a function previously assigned to prudential regulators, and has authority to impose new requirements. However, institutions of less than $10 billion in assets, such as the Bank, will continue to be examined for compliance with consumer protection and fair lending laws and regulations by, and be subject to the primary enforcement authority of their prudential regulator rather than the Consumer Financial Protection Bureau.
In addition, the Dodd-Frank Act directed changes in the way that institutions are assessed for deposit insurance, mandated the imposition of consolidated capital requirements on savings and loan holding companies such as Berkshire Hills Bancorp, requiredthe Company, mandated regulations requiring originators of certain securitized loans to retain a percentage of the risk for the transferred loans, stipulated regulatory rate-setting for certain debit card interchange fees, repealed restrictions on the payment of interest on commercial demand deposits and contained a number of reforms related to mortgage originations.
The Consumer Financial Protection Bureau has finalized the rule implementing the “Ability to Pay” requirements of the Dodd-Frank Act. The regulations generally require creditors to make a reasonable, good faith determination as to a borrower’s ability to repay most residential mortgage loans. The final rule establishes a safe harbor for certain “Qualified Mortgages,” which contain certain features deemed less risky and omit certain other characteristics considered to enhance risk. The Ability to Repay final rules were effective January 10, 2014.
Many of the provisions of the Dodd-Frank Act are subject to delayed effective dates and/or require the issuance of implementing regulations. TheirThe regulatory process is ongoing and the impact on operations cannot yet be fully assessed. However, there is a significant possibility that the Dodd-Frank Act will, at a minimum, result in increased regulatory burden, compliance costs and interest expense for the Company and the Bank.
Certain regulatory requirements applicable to the Company, including certain changes made by the Dodd-Frank Act, are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on the Company and is qualified in its entirety by reference to the actual laws and regulations.
Massachusetts Banking Laws and Supervision
General. As a Massachusetts-chartered savings bank,depository institution, the Bank is subject to supervision, regulation and examination by the Commissioner and to various Massachusetts statutes and regulations which govern, among other things, investment powers, lending and deposit-taking activities, borrowings, maintenance of surplus and reserve accounts, distribution of earnings and payment of dividends. In addition, the Bank is subject to Massachusetts consumer protection and civil rights laws and regulations. The approval of the Commissioner is required for a
Massachusetts-chartered bankinstitution to establish or close branches, merge with other financial institutions, organize a holding company, issue stock and undertake certain other activities.
Massachusetts regulations generally allow Massachusetts banksinstitutions to engage in activities permissible for federally chartered banks or banks chartered by another state. The Commissioner has adopted procedures reducing regulatory burdens and expense and expediting branching by well-capitalized and well-managed banks.
Dividends. A Massachusetts stock bankinstitution may declare cash dividends from net profits not more frequently than quarterly and non-cash dividends at any time. No dividends may be declared, credited or paid if the bank’sinstitution’s capital stock is impaired. The approval of the Commissioner is required if the total of all dividends declared in any calendar year exceeds the total of its net profits for that year combined with its retained net profits of the preceding two years. Net profits for this purpose means the remainder of all earnings from current operations plus actual recoveries on loans and
investments and other assets after deducting from the total thereof all current operating expenses, actual losses, accrued dividends on preferred stock, if any, and all federal and state taxes.
Loans to One Borrower Limitations. Massachusetts banking law grants broad lending authority. However, with certain limited exceptions, total obligations of one borrower to a bankan institution may not exceed 20.0% of the total of the bank’sinstitution’s capital, which is defined under Massachusetts law as the sum of the bank’sinstitution’s capital stock, surplus account and undivided profits.
Loans to a Bank’s Insiders. Massachusetts banking laws prohibit any executive officer, director or trustee from borrowing from or otherwise becoming indebted or becoming liable for a loan or other extension of credit by such bank to, any other person,their institution, except for any of the following loans or extensions of credit: (i) loans or extensions of credit, secured or unsecured, to an officer of the bankinstitution in an amount not exceeding $100,000; (ii) loans or extensions of credit intended or secured for educational purposes to an officer of the bank in an amount not exceeding $200,000; (iii) loans or extensions of credit secured by a mortgage on residential real estate to be occupied in whole or in part by the officer to whom the loan or extension of credit is made, in an amount not exceeding $750,000; and (iv) loans or extensions of credit to a director or trustee of the bank who is not also an officer of the bankinstitution in an amount permissible under the bank’sinstitution’s loan to one borrower limit.
The loans listeddescribed above require approval of the majority of the members of the Bank’sinstitution’s Board of Directors, excluding any member involved in the loan or extension of credit. No such loan or extension of credit may be granted with an interest rate or other terms that are preferential in comparison to loans granted to persons not affiliated with the savings bank.institution.
Investment Activities. In general, Massachusetts-chartered savings banksinstitutions may invest in preferred and common stock of any corporation organized under the laws of the United States or any state provided such investments do not involve control of any corporation and do not, in the aggregate, exceed 4.0% of the bank’s deposits. Massachusetts-chartered savings banksinstitutions may in additionalso invest an amount equal to 1.0% of their deposits in stocks of Massachusetts corporations or companies with substantial employment in Massachusetts which have pledged to the Commissioner that such monies will be used for further development within the Commonwealth. However, these powers are constrained by federal law.
Regulatory Enforcement Authority. Any Massachusetts-chartered bankinstitution that does not operate in accordance with the regulations, policies and directives of the Commissioner may be sanctioned for non-compliance, including seizure of the property and business of the bankinstitution and suspension or revocation of its charter. The Commissioner may, under certain circumstances, suspend or remove officers or directors who have violated the law, conducted the bank’sinstitution’s business in a manner which is unsafe, unsound or contrary to the depositors interests or been negligent in
the performance of their duties. In addition, upon finding that a bankinstitution has engaged in an unfair or deceptive act or practice, the Commissioner may issue an order to cease and desist and impose a fine on the bankinstitution concerned. Finally, Massachusetts consumer protection and civil rights statutes applicable to the Bank permit private individual and class action lawsuits and provide for the rescission of consumer transactions, including loans, and the recovery of statutory and punitive damage and attorney’s fees in the case of certain violations of those statutes.
Depositors Insurance Fund. All Massachusetts-chartered savings banks are required to be members of the Depositors Insurance Fund (“DIF”), a corporation that insures savings bank deposits in excess of federal deposit insurance coverage. The DIF is a private, industry-sponsored insurance company and is not backed by the federal government or the Commonwealth of Massachusetts. The DIF is authorized to charge savings banks an annual assessment for its coverage. Such assessments may vary based on the risk classification assigned to the institution.
The combination of FDIC and DIF insurance provides customers of Massachusetts-chartered savings banks with full deposit insurance on all their deposit accounts.has recently advised the Bank that its excess deposits covered by the DIF insurance coverage requires no applications or special forms.
Depositors automatically receive this added insurance benefit at no cost whenever they make a deposithave grown to a newsize at which DIF policy requires that the Bank either secure a substantial reinsurance policy, with the DIF as loss payee, or existing account atwithdraw from the DIF. The Bank is evaluating its options and may withdraw from the DIF. The withdrawal from the DIF would not affect the Bank’s federal deposit insurance. Under Massachusetts law, withdrawal from the DIF will require the Bank to convert from a DIF member bank.Massachusetts savings bank to a Massachusetts trust company charter. The DIF is examined annually byCompany believes that the powers of a Massachusetts Divisiontrust company and a Massachusetts savings bank are generally similar. The charter conversion would have some regulatory consequences for the Bank, such as the loss of Banks and audited by an independent auditor.grandfathered authority under federal law to invest in certain equity securities (although the Company itself can continue to make such investments). On balance, however, the Company does not believe that the Bank’s change in charter, should it occur, will have a material impact on its business.
Massachusetts has other statutes or regulations that are similar to the federal provisions discussed below.
Federal Regulations
Capital Requirements. Under FDIC regulations, federally insured state-chartered banks that are not members of the Federal Reserve System (“state non-member banks”), such as the Bank, are required to comply with minimum leverage capital requirements. For an institution determined by the FDIC to not be anticipating or experiencing significant growth and to be in general a strong banking organization, rated composite 1 under the Uniform Financial Institutions Rating System established by the Federal Financial Institutions Examination Council, the minimum capital leverage requirement is a ratio of Tier 1 capital to total average assets (as defined) of 3%. For all other institutions, the minimum leverage capital ratio is not less than 4%. Tier 1 capital is the sum of common stockholders’ equity, noncumulative perpetual preferred stock (including any related surplus) and minority investments in certain subsidiaries, less intangible assets (except for certain servicing rights and credit card relationships) and certain other items.
The Bank must also comply with the FDIC risk-based capital guidelines. The FDIC guidelines require state non-member banks to maintain certain levels of regulatory capital in relation to regulatory risk-weighted assets. Risk-based capital ratios are determined by allocating assets and specified off-balance sheet items to four risk-weighted categories ranging from 0% to 100%, with higher levels of capital being required for the categories perceived as representing greater risk.
State non-member banks must maintain a minimum ratio of total capital to risk-weighted assets of at least 8%, of which at least one-half must be Tier 1 capital. Total capital consists of Tier 1 capital plus Tier 2 or supplementary capital items, which include allowances for loan losses in an amount of up to 1.25% of risk-weighted assets,
cumulative preferred stock, a portion of the net unrealized gain on equity securities and other capital instruments. The includable amount of Tier 2 capital cannot exceed the amount of the institution’s Tier 1 capital.
As a savings and loan holding company, the Company is not currently subject to any separate regulatory capital requirements, although this is expected to change in the future. The Bank’s regulatory capital is included in the Stockholders’ Equity note of the Company’s financial statements in Item 8 of this report. At year-end 2012, the Bank met each of its capital requirements.
On June 6, 2012,In July 2013, the FDIC and the other federal bank regulatory agencies issued a series of proposed rulesfinal rule that wouldwill revise their leverage and risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The proposed rules would apply to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more and top-tier savings and loan holding companies. Among other things, the proposed rules establishrule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets) and; sets the leverage ratio at a higheruniform 4% of total assets; increases the minimum Tier 1 capital to risk-based assets requirement (6%(from 4% to 6% of risk-weighted assets) ; and assignassigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The proposed rulesfinal rule also requirerequires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements.requirements unless a one-time opt-out is exercised. The proposed rules limitrule limits a banking organization’s capital distributions and certain discretionary bonus payments to executive officers if the banking organization does not hold a “capital conservation buffer”
consisting of a specified amount2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The proposed rules indicatedfinal rule also implements the Dodd-Frank Act’s directive to apply to savings and loan holding companies consolidated capital requirements that theare not less stringent than those applicable to their subsidiary institutions. The final rules would becomerule is effective on January 1, 2013, and the changes set forth in the final rules2015. The “capital conservation buffer” will be phased in from January 1, 2013 through2016 to January 1, 2019. However,2019, when the agencies have recently indicatedfull capital conservation buffer will be effective.
As a savings and loan holding company, the Company is not currently subject to any separate regulatory capital requirements, although that due to the volumewill change as of public comments received, the final rule has been delayed past January 1, 2013.2015, as is described in a subsequent section. The Bank’s regulatory capital is included in the Stockholders’ Equity note of the Company’s financial statements in Item 8 of this report. At year-end 2013, the Bank met each of its capital requirements.
Interstate Banking and Branching. Federal law permits a bank,an institution, such as the Bank, to acquire ananother institution by merger in a state other than Massachusetts unless the other state has opted out. Federal law, as amended by the Dodd-Frank Act, authorizes de novo branching into another state to the extent that the target state allows its state chartered banks to establish branches within its borders. The Bank operates branches in New York, Vermont, Connecticut and Connecticut,Tennessee, as well as Massachusetts. At its interstate branches, the Bank may conduct any activity that is authorized under Massachusetts law that is permissible either for a savings bankan institution chartered in that state (subject to applicable federal restrictions) or a branch in that state of an out-of-state national bank. The New York State Superintendent of Banks, the Vermont Commissioner of Banking and Insurance, and the Connecticut Commissioner of Banking and the Tennessee Commissioner of Financial Institution may exercise certain regulatory authority over the Bank’s New York, Vermont, and Connecticut branches.branches in their respective states.
Prompt Corrective Regulatory Action. Federal law requires, among other things, that federal bank regulatory authorities take “prompt corrective action” with respect to banks that do not meet minimum capital requirements. For these purposes, the law establishes three categories of capital deficient institutions: undercapitalized, significantly undercapitalized and critically undercapitalized.
An institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a leverage ratio of 5% or greater. An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater and generally a leverage ratio of 4% or greater. An institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital ratio of less than 4%, or generally a leverage ratio of less than 4% (3%
or less for institutions with the highest examination rating). An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, or a leverage ratio of less than 3%. An institution is considered to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2%. At year-end 2012, the Bank met the conditions to be classified as a “well capitalized” institution.
“Undercapitalized” banks must adhere to growth, capital distribution (including dividend) and other limitations and are required to submit a capital restoration plan. No institution may make a capital distribution, including payment as a dividend, if it would be “undercapitalized” after the payment. A bank’s compliance with such plans is required to be guaranteed by its parent holding company in an amount equal to the lesser of 5% of the institution’s total assets when deemed “undercapitalized” or the amount needed to comply with regulatory capital requirements. If an “undercapitalized” bank fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.” “Significantly undercapitalized” banks must comply with one or more of a number of additional restrictions, including but not limited to an order by the FDIC to sell sufficient voting stock to become “adequately capitalized”, requirements to reduce assets and cease receipt of deposits from correspondent banks or dismiss directors or officers, and restrictions on interest rates paid on deposits, compensation of executive officers and capital distributions by the parent holding company. “Critically undercapitalized” institutions must comply with additional sanctions including, subject to a narrow exception, the appointment of a receiver or conservator within 270 days after it obtains such status.
The recently proposed rules that would increase regulatory capital requirements would adjustAt December 31, 2013, the Bank met the criteria for being considered “well-capitalized” as defined in the prompt corrective action categories accordingly.regulations.
TableIn connection with the final capital rule described earlier, the federal banking agencies have adopted revisions to the prompt corrective action framework, effective January 1, 2015. Under the revised prompt corrective action requirements, insured depository institutions would be required to meet the following in order to qualify as “well capitalized:” (1) a common equity Tier 1 risk-based capital ratio of Contentsat least 6.5%; (2) a Tier 1 risk-based capital ratio of at least 8% (increased from 6%); (3) a total risk-based capital ratio of at least 10% (unchanged) and (4) a Tier 1 leverage ratio of 5% or greater (unchanged).
Transactions with Affiliates.Transactions between depository institutions and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. In a holding company context, at a minimum, the parent holding company of a savings bankan institution and any companies which are controlled by such parent holding company are affiliates of the savings bank.institution. Generally, Section 23A limits the extent to which the savings bankinstitution or its subsidiaries may engage in “covered transactions,” such as loans, with any one affiliate to 10% of such savings bank’sinstitution’s capital stock and surplus, and contains an aggregate limit on all such transactions with all affiliates to 20% of capital stock and surplus. Loans to affiliates and certain other specified transactions must comply with specified collateralization requirements. Section 23B requires that transactions with affiliates be on terms that are no less favorable to the savings bankinstitution or its subsidiary as similar transactions with non-affiliates.
Further, federal law restricts an institution with respect to loans to directors, executive officers, and principal stockholders (“insiders”). Loans to insiders and their related interests may not exceed, together with all other outstanding loans to such persons and affiliated entities, the institution’s total capital and surplus. Loans to insiders above specified amounts must receive the prior approval of the Board of Directors. Further, loans to insiders must be made on terms substantially the same as offered in comparable transactions to other persons, except that such insiders may receive preferential loans made under a benefit or compensation program that is widely available to the Bank’sinstitution’s employees and does not give preference to the insider over the employees. Federal law places additional limitations on loans to executive officers.
Enforcement. The FDIC has extensive enforcement authority over insured savings banks,institutions, including the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease and desist orders and to remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and unsafe or unsound practices. The FDIC has authority under federal law to appoint a conservator or receiver for an insured bankinstitution under certain circumstances.
Insurance of Deposit Accounts. The Bank’s deposit accounts are insured by the Deposit Insurance Funddeposit insurance fund of the FDIC up to applicable legal limits, and, as discussed above under “Massachusetts Banking Laws and Supervision—Depositors Insurance Fund,” by the Massachusetts Depositors Insurance Fund for amounts in excess of federal deposit insurance coverage.
limits. The FDIC insures deposits up to the standard maximum deposit insurance amount (“SMDIA”) of $250 thousand.$250,000. The deposit insurance limit was increased in response to the Dodd-Frank Act, which, among other provisions, made permanent the increase in the SMDIA from $100 thousand$100,000 to $250 thousand. Additionally, in November 2010, pursuant to the$250,000. The Dodd-Frank Act the FDIC issued a final rule to provide separateprovided for temporary coverage for noninterest-bearing transaction accounts. The final rule indicates that all funds held in noninterest-bearing transaction accounts were fully insured, without limit, and that this unlimited coverage was separate from, and in addition to, the coverage provided to depositors with respect to other accounts held at an insured depository institution, such as the Bank. This provision for non-interestof certain noninterest bearing transaction accounts, became effective December 31, 2010 and terminatedbut such unlimited coverage expired on December 31, 2012.
The FDIC has adopted a risk-based insurance assessment system. The FDIC assigns an institution to one of four risk categories based on the institution’s financial condition and supervisory ratings. An institution’s assessment rate depends on the capital category and supervisory category to which it is assigned based on a final rule which became effectiveand certain adjustments set forth in April 2011. UnderFDIC regulations. Institutions deemed to present higher risk to the final rule, banks in Risk Category 1 have a base assessment rate of 5-9 basis points and those in Risk Category 2 have a rate of 14 basis points, subject to adjustment based on certain risk additional risk factors specified by the FDIC.insurance fund pay higher assessments. The overall assessment range, including prospective adjustments, is 2.5 to 45 basis points.
Assessment rates are scheduled to decline as the FDIC Reserve Ratiofund reserve ratio improves. As required by the Dodd-Frank Act, FDIC assessments are now based on each institution’s total assets less Tier 1 capital, rather than deposits, as was previously the case. The FDIC has stated that nearly all of the 7,600-plus institutions with assets less than $10 billion will pay smaller assessments as a result of this final rule.
In the fourth quarter of 2009, due to stress on the insurance fund, the FDIC voted to require insured institutions to prepay thirteen quarters of estimated insurance assessments. The estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011, and 2012 were paid by the Bank on December 30, 2009.
In addition, FDIC insured institutions are also required to pay assessments to the Federal Deposit Insurance CorporationFDIC to fund interest payments on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize a predecessor to deposit insurance fund. These assessments will continue until the Financing Corporation bonds mature in 2017 through 2019. The assessment rate is adjusted quarterly to reflect changes in the assessment basesbase of the fund based on quarterly Call Report and Thrift Financial Report submissions and forfund. For the quarter ended December 31, 20122013, the Financing Corporation assessment amounted to .660.64 basis points of total assets less Tier 1 capital.
Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by a regulator. Management does not know of any practice, condition or violation that might lead to termination of FDIC deposit insurance.
The Dodd-Frank Act increased the minimum target DIFfederal deposit insurance fund ratio from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits. The FDIC must seek to achieve the 1.35% ratio by September 30, 2020. Insured institutions with assets of $10 billion or more are supposed to fund the increase. The Dodd-Frank Act eliminated the 1.50% maximum fund ratio, instead leaving it to the discretion of the FDIC. The FDIC has recently exercised that discretion by establishing a long range fund ratio of 2.00%.
The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank system, which consists of 12 regional Federal Home Loan Banks that provide a central credit facility primarily for member institutions. The Bank, as a member, is required to acquire and hold shares of capital stock in the FHLBB.
The Federal Home Loan Banks are required to provide funds for certain purposes including contributing funds for affordable housing programs. These requirements, and general financial results, could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. Historically, the FHLBB paid dividends to member banks based on money market interest rates. Due to losses initially reported in the fourth quarter of 2008, the FHLBB suspended its dividend to members in the first quarter of 2009. The dividend remained suspended through year-end 2010, but was restored to a nominal amount in the first quarter of 2011 and2011. It has improved marginally in subsequent quarters, though it is still much lower than 2008 levels.
Holding Company Regulation
General. Federal law allows a state savings bank that qualifies as a “Qualified Thrift Lender,” discussed below, to elect to be treated as a savings association for purposes of the savings and loan holding company provisions of federal law. Such election, which was made by the Bank, allows itsthe parent holding company to be regulated as a savings and loan holding company, by the Federal Reserve Board rather than as a bank holding company by the Federal Reserve Board under the federal Bank Holding Company Act. As such, the ParentCompany is registered as a savings and loan holding company with the Federal Reserve Board and must adhere to the Federal Reserve Board’s regulations and reporting requirements. In addition, the Federal Reserve Board, may examine, supervise and take enforcement action against the ParentCompany and its non-savings institution subsidiaries. Among other things, this authority permits the Federal Reserve Board to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution. By regulation, the Federal Reserve Board may restrict or prohibit the Bank from paying dividends. The Federal Reserve Board generally exercises its regulatory authority over the Company through the Federal Reserve Bank of Boston.
The Dodd-Frank Act provided for the elimination of the OTS and transferred its authority over and responsibilities forFederal law authorizes unitary savings and loan holding companies to the Federal Reserve Board. That transfer was effective July 21, 2011. The Gramm-Leach-Bliley Act of 1999 provided that unitary savings and loan holding companies may engage in activities permitted tofor a financial holding company under that legislationfederal law and those permitted for multiple savings and loan holding companies. A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance and activities that are incidental or complementary to financial activities. The Dodd-Frank Act added that any savings and loan holding company that engages in activities permissible for a financial holding company must meet the qualitative requirements for a bank holding company to be a financial holding company and conduct the activities in accordance with the requirements that would apply to a financial holding company’s conduct of the activity. A multiple savings and loan holding company is generally limited to activities permissible for bank holding companies under Section 4(c)-(8) of the Bank Holding Company Act and certain additional activities authorized by Federal Reserve Board regulations, subject to the prior approval of the Federal Reserve Board. Certain activities require prior Federal Reserve Board approval.regulations.
Federal law prohibits a savings and loan holding company from, directly or indirectly, acquiring more than 5% of the voting stock of another savings association or savings and loan holding company or from acquiring such an institution or company by merger, consolidation or purchase of its assets, without prior written approval of the Federal Reserve Board. In evaluating applications by holding companies to acquire savings associations, the Federal Reserve Board considers factors such as the financial and managerial resources and future prospects of the Company and the institution involved, the effect of the acquisition on the risk to the insurance fund, the convenience and needs of the community and competitive factors.
To be regulated as a savings and loan holding company (rather than as a bank holding company), the bankBank must qualify as a Qualified Thrift Lender. To qualify asbe a Qualified Thrift Lender, the bankBank must maintain compliance with the test for a “domestic building and loan association,” as defined in the Internal Revenue Code, or with a Qualified Thrift Lender Test. Under the Qualified Thrift Lender Test (the “QLT Test”), a savingsan institution is required to maintain at least 65% of its “portfolio assets” (total assets less: (1) specified liquid assets up to 20% of total assets; (2) intangibles,
including goodwill; and (3) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities) in at least 9 months out of each 12-month period. At year-end 2012,2013, the Bank maintained at least 65% of its portfolio assets in qualified thrift investments and met the QTL Test for the year.Test.
Savings and loan holding companies have historically not historically been subjected to consolidated regulatory capital requirements. However, theThe Dodd-Frank Act, requireshowever, required the Federal Reserve Board to set, for all depository institution
holding companies, minimumpromulgate consolidated capital levels that are as stringent as those required for the insured depository institution subsidiaries. The components of Tier 1 capital must be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions. That would exclude from Tier 1 capital such instruments as trust preferred securities and cumulative preferred stock that are currently permittedrequirements for bank holding companies. The Dodd-Frank Act provides that instruments issued before May 19, 2010 will be grandfathered for companies with consolidated assets of $15 billion or less. The Dodd-Frank Act further provides that holding companies that were not regulated by the Federal Reserve Board as of May 19, 2010 (which would include mostand savings and loan holding companies)companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to their subsidiary depository institutions. Instruments such as cumulative preferred stock and trust-preferred securities, which are currently includable within Tier 1 capital, within certain limits by bank holding companies, would no longer be includable as Tier 1 capital, subject to a five-year transition period from the July 21, 2010 date of enactment ofcertain grandfathering. The previously discussed final rule regarding regulatory capital requirements implements the Dodd-Frank Act before suchAct’s directives as to holding company capital requirements. Consolidated regulatory capital requirements apply. The proposedidentical to those applicable to the subsidiary depository institutions will apply to holding companies as of January 1, 2015. As is the case with institutions themselves, the capital rules discussed earlier would implement the consolidated capital requirements for savingsconservation buffer will be phased in between 2016 and loan holding companies. However, the proposed rules did not incorporate the referenced grandfather for instruments issued before May 19, 2010 or the transition period, notwithstanding the Dodd-Frank statutory language, so it is uncertain whether any final rule will do so.
2019. The Dodd-Frank Act also extended the “source of strength” doctrine, which has long applied to bank holding companies, to savings and loan holding companies.companies as well. The regulatory agencies must promulgateFederal Reserve Board has promulgated regulations implementing the “source of strength” policy, which requires holding companies to act as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial distress. Further, the Federal Reserve Board has issued a policy statement regarding the payment of dividends by bank holding companies that it has suggested is also applicable to savings and loan holding companies as well.companies. In general, the policy provides that dividends should be paid only out of current earnings and if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Regulatory guidance provides for regulatory consultation as to capital distributions in certain circumstances such as where the company’s net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a savings and loan holding company to pay dividends may be restricted if a subsidiary bankdepository institution becomes undercapitalized. In addition, a subsidiary savings associationinstitution of a saving and loan holding company must file prior notice with and receive the nonobjection of, the Federal Reserve Board, and receive its nonobjection, before paying dividends to theirthe parent savings and loan holding company. Federal Reserve Board guidance also provides for regulatory review of certain stock redemption and repurchase proposals. These regulatory policies could affect the ability of Berkshire Hills Bancorpthe Company to pay dividends, engage in stock redemptions or repurchases or otherwise engage in capital distributions.
As noted previously, the Bank may withdraw from the DIF and such withdrawal would trigger the Bank’s conversion from a Massachusetts savings bank to a Massachusetts trust company charter. The charter conversion would cause the Company to become a bank holding company, rather than a savings and loan company, which requires the prior approval of the Federal Reserve Board. The Company contemplates that it would elect financial holding company status upon becoming a bank holding company in order to allow it to engage in a broader range of nonbanking activities. The most significant regulatory consequence of becoming a bank holding company is that the Federal Reserve Board’s bank holding company consolidated regulatory capital requirements would become immediately applicable. The Company believes that it currently meets the bank holding company capital requirements and expects that becoming a bank holding company would not materially impact its business. With the Company as a bank holding company, rather than a savings and loan holding company, the Bank would no longer need to comply with the QTL Test.
Acquisition of the Company. Under the Federal Change in Bank Control Act, a notice must be submitted to the Federal Reserve Board if any person (including a company), or group acting in concert, seeks to acquire “control” of a savingsdepository institution and loan holding company. A change in control may occur, and prior notice is required, upon the acquisition of 10% or more of the Company’s outstanding voting stock, unless the Federal Reserve Board has found that the acquisition will not result in a change of control of the Company.
Massachusetts Holding Company Regulation. In addition to the federal holding company regulations, a bank holding company organized or doing business in Massachusetts must comply with regulations under Massachusetts law. Approval of the Massachusetts regulatory authorities would be required for the Company to acquire 25% or more of the voting stock of another depository institution. Similarly, prior regulatory approval would be necessary for any person or company to acquire 25% or more of the voting stock of the Company. The term “bank holding company,” for the purpose of Massachusetts law, is defined generally to include any company which, directly or indirectly, owns, controls or holds with power to vote more than 25% of the voting stock of each of two or more banking institutions, including commercial banks and state co-operative banks, savings banks and savings and loan association and national banks, federal savings banks and federal savings and loan associations. In general, a holding company controlling, directly or indirectly, only one banking institution will not be deemed to be a bank holding company for the purposes of
Massachusetts law. Under Massachusetts law, the prior approval of the Board of Bank Incorporation is required before any of the following: any company becoming a bank holding company; any bank holding company acquiring direct or indirect ownership or control of more than 5% of the voting stock of, or all or substantially all of the assets of, a banking institution; or any bank holding company merging with another bank holding company. Although Berkshire Hills Bancorpthe Company is not a bank holding company for purposes of Massachusetts law, any future acquisition of ownership, control, or the power to vote 25% or more of the voting stock of another banking institution or bank holding company would cause it to become such.
Legislation. The U.S. Congress, state lawmaking bodies and federal and state regulatory agencies continue to consider a number of wide-ranging and comprehensive proposals for altering the structure, regulation and competitive relationships of the nation’s financial institutions. The Federal Reserve Board in coordination withAny such legislation may impact the Departmentbusiness of the Treasury, the Office of the Comptroller of the Currency,Company and the FDIC, have proposed implementation of new risk-based capital guidelines incorporating policies outlined by the Basel Committee. The Company is in the process of assessing the impact of the changes proposed by this rulemaking and cannot predict the extent to which the Company may be affected thereby.Bank.
Berkshire Bank Municipal Bank
Berkshire Bank Municipal Bank is a state-chartered limited purpose commercial bank in New York, established to accept deposits of municipalities and other governmental entities in the State of New York. Berkshire Bank Municipal Bank is subject to extensive regulation, examination and supervision by the New York State Superintendent of Banks, as its primary regulator, and the FDIC, as the deposit insurer. It is also subject to regulation as to certain matters by the Federal Reserve Board. As of year-end 2012,2013, Berkshire Bank Municipal Bank met all of its capital requirements and met the capital conditions to be classified as a “well capitalized” institution.
Other Regulations
Consumer Protection Laws. The Bank is subject to federal and state consumer protection statuesstatutes and regulations applicable to depository institutions including, but not limited to, the following:
·Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
· Home Mortgage Disclosure Act, requiring financial institutions to provide certain information about home mortgage and refinance loans;
· Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
· Fair Credit Reporting Act, governing the provision of consumer information to credit reporting agencies and the use of consumer information;
· Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and
· Electronic Funds Transfer Act, governing automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.
The Bank also is subject to federal laws protecting the confidentiality of consumer financial records, and limiting the ability of the institution to share non-public personal information with third parties.
The Community Reinvestment Act (“CRA”) establishes a requirement for federal banking agencies that, in connection with examinations of financialdepository institutions within their jurisdiction, the agencies evaluate the record of the financialdepository institutions in meeting the credit needs of their local communities, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or new facility. Under the CRA, institutions are assigned a rating of “outstanding,” “satisfactory,” “needs to improve,” or “substantial non-compliance.” A less than “satisfactory” rating would result in the suspension of any growth of the Bank through acquisitions or opening de novo branches until the rating is improved. As of the most recent CRA examination by the FDIC, the Bank’s CRA rating was “satisfactory.”
Anti-Money Laundering Laws. The Bank is subject to extensive anti-money laundering provisions and requirements, which require the institution to have in place a comprehensive customer identification program and an anti-money laundering program and procedures. These laws and regulations also prohibit financialdepository institutions from engaging in business with foreign shell banks; require financialdepository institutions to have due diligence procedures and, in some cases, enhanced due diligence procedures for foreign correspondent and private banking accounts; and improve information sharing between financialdepository institutions and the U.S. government. The Bank has established policies and procedures intended to comply with these provisions.
TAXATION
The Company reports its income on a calendar year basis using the accrual method of accounting. This discussion of tax matters is only a summary and is not a comprehensive description of the tax rules applicable to the Company and its subsidiaries. Further discussion of income taxation is contained in the income taxes note to the consolidated financial statements.
Federal
The federal income tax laws apply to the Company in the same manner as to other corporations with some exceptions. CorporationsThe Company may exclude from income 100% of dividends received from the Bank and from Berkshire Insurance Group as members of the same affiliated group of corporations. For federal income tax purposes, corporations may carry back net operating losses to the preceding two taxable years and forward to the succeeding twenty taxable years, subject to certain limitations.
State
The Company reports income on a calendar year basis to the Commonwealth of Massachusetts. The Massachusetts income tax rate for financial institutions was 9.0% in 2013 and 9.5% in 2011 and declined to 9.0% in 2012 and thereafter.2012. The Company’s taxable income under Massachusetts tax law includes gross income as defined under the Internal Revenue Code, plus interest from non-Massachusetts municipal obligations, less deductions, but not the credits, allowable under the provisions of the Internal Revenue Code. Carry forwards and carry backs of net operating losses are not allowed under Massachusetts tax law. Also no deduction is allowed for bonus depreciation or state income taxes paid.
Massachusetts tax law generally permits special tax treatment for a qualifying limited purpose “securities corporation.” The Bank’s three securities corporations all qualify for this treatment, and are taxed at a 1.3% rate on their gross income.
The Company also pays certain franchise taxes annually in the states of Vermont, New York, and Connecticut. These taxes were immaterial to the Company’s results.
The risks set forth below, in addition to the other risks described in this Annual Report on Form 10-K, may adversely affect our business, financial condition and operating results. In addition to the risks set forth below and the other risks described in this annual report, there may also be additional risks and uncertainties that are not currently known to us or that we currently deem to be immaterial that could materially and adversely affect our business, financial condition or operating results. As a result, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods. Further, to the extent that any of the information contained in this Annual Report on Form 10-K constitutes forward-looking statements, the risk factors set forth below also are cautionary statements identifying important factors that could cause our actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of us.
Overall Business Risks
The Company’s Business May Be Adversely Affected by Conditions in the Financial Markets and Economic Conditions Generally and LocallyLocally.
National and local conditions reflectmarkets generally exhibit low growth conditions and heightened uncertainty relatedstubbornly high unemployment. Federal monetary policy continues to public policy. Stubbornly high unemploymentbe unusually stimulative, which has leddistorted financial markets and contributed to sustained monetary stimulus by theongoing low interest rates and record stock market prices. Federal Reserve Bank. Repetitive federalpolicy gridlock, uncertainties about presidential initiatives, and state and local fiscal and treasury deadlineschallenges contribute to uncertainty and the potential for market disruption. Private sector growth has been substantially offset by public sector austerity.business planning uncertainties. Private sector liquidity has grown and investment has been modest, while public sector leverage has increased due to long term imbalances in taxing and spending. Regulation of the financial system continues to evolve and add to uncertainty and operating burdens. Real estate markets have improved from the lows reached after the 2008 decline, and recovery is uneven across U.S. regional markets.recessionary lows. A deterioration of business and economic conditions, particularly in our local markets, could adversely affect the credit quality of the Company’s loans, results of operations and financial condition.
Lending
Continued and Prolonged Deterioration in the Housing Sector, Commercial Real Estate, and Related Markets May Adversely Affect Our Business and Financial Results.
Commercial and residential real estate markets have been impacted by the broader economic conditions previously discussed. Real estate lending is a major business activity for the Company. Real estate market conditions affect the value and marketability of this real estate collateral, and they also affect the cash flows, liquidity, and net worth of many borrowers whose operations and finances depend on real estate market conditions. Adverse conditions in our market areas could reduce our growth rate, affect the ability of our customers to repay their loans and generally affect our financial condition and results of operations.
Our Emphasis on Commercial Lending May Expose Us to Increased Lending Risks, Which Could Hurt Our Profits.
We plan to continue to emphasize the origination of commercial loans, which generally exposes us to a greater risk of nonpayment and loss because repayment of such loans often depends on the successful operations and income stream of the borrowers. Commercial loans are historically more sensitive to economic downturns. Such sensitivity includes potentially higher default rates and possible reduction of collateral values. Commercial lending involves larger loan sizes and larger relationship exposures, which can have a greater impact on profits in the event of adverse loan performance. The majority of the Company’s commercial loans is secured by real estate and subject to the previously discussed real
estate risk factors. Commercial lending sometimes involves construction or other development financing, which is dependent on the future success of new operations. The Company’s commercial lending activities have extended across wider parts of its New England and New York markets into areas where the Company has less business experience. The Company’s commercial lending includes asset based lending, which depends on the Company’s processes for monitoring and being able to liquidate collateral on which these loans rely. Commercial loans may increase as a percentage of total loans, and commercial lending may continue to expose the company to increased risks.
Our Allowance for Loan Losses May Prove to be Insufficient to Absorb Losses in Our Loan Portfolio.
Like all financial institutions, we maintain an allowance for loan losses which is our estimate of the probable losses that are inherent in the loan portfolio as of the financial statement date. However, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially and adversely affect our operating results. The accounting measurements related to impairment and the loan loss allowance require significant estimates which are subject to uncertainty and changes relating to new information and changing circumstances. Additionally, the allowance can only reflect those losses which are reasonably estimable, and there are constraints in our ability to estimate losses in this period of unusual economic and financial stress. This is particularly relevant for our estimates of losses for pools of loans. Accordingly, at any time, there may be probable losses inherent in the portfolio but which we are not reasonably able to estimate until additional information emerges which can form the basis for a reasonable estimate.
State and federal regulators, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs, net of recoveries. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations.
Our Estimates of Discounts onRelated to Accounting for Acquired Loans With Deteriorated Credit Quality May Be Inadequate.Differ From Actual Results.
Under generally accepted principles for business combinations, there is no loan loss allowance recorded for acquired loans, which are recorded at net fair value on the acquisition date. This net fair value generally includes embedded loss estimates for acquired loans with deteriorated credit quality. These estimates are based on projections of expected cash flows for these problem loans, which in many cases rely on estimates deriving from the liquidation of collateral. If the projections are inadequate, the fair value estimates may exceed the actual collectability of the balances, and this may result in the related loans being considered impaired, which would result in a reduction in interest income. If fair value estimates differ from actual collectability, then tangible book value of the Company will have been recorded incorrectly at the time of the acquisition, and subsequent earnings will differ from original estimates. Measures of tangible book value and earnings impacts of business combinations are frequently used in evaluating the merits and value of business combinations. In 2013, the Company recorded significant income resulting from collections of acquired impaired loans which exceeded the fair value estimates originally established. Additionally, accounting for acquired loans involves ongoing assessments of the timing and amount of expected loan collections. Numerous
assumptions and estimates are integral to purchased loan accounting, and actual results could be different from prior estimates.
New regulations could restrict our ability to originate and sell mortgage loans.
The CFPB has issued a rule designed to clarify for lenders how they can avoid monetary damages under the Dodd-Frank Act, which would hold lenders accountable for ensuring a borrower’s ability to repay a mortgage. Loans that meet this “qualified mortgage” definition will be presumed to have complied with the new ability-to-repay standard. Under the CFPB’s rule, a “qualified mortgage” loan must not contain certain specified features, including:
·excessive upfront points and fees (those exceeding 3% of the total loan amount, less “bona fide discount points” for prime loans);
·interest-only payments;
·negative-amortization; and
·terms longer than 30 years.
Also, to qualify as a “qualified mortgage,” a borrower’s total debt-to-income ratio may not exceed 43%. Lenders must also verify and document the income and financial resources relied upon to qualify the borrower for the loan and underwrite the loan based on a fully amortizing payment schedule and maximum interest rate during the first five years, taking into account all applicable taxes, insurance and assessments. The CFPB’s rule on qualified mortgages could limit our ability or desire to make certain types of loans or loans to certain borrowers, or could make it more expensive/and or time consuming to make these loans, which could limit our growth or profitability.
Operating
Our Expansion, Growth, and Acquisitions Could Negatively Impact Earnings If Not Successful.
We plan to achieve significant growth organically, by geographic expansion, through business line expansion, and through acquisitions. We have recently expanded into new geographic markets and anticipate that we will continue to expand into additional geographic markets as we grow as a regional bank. The success of this expansion depends on our ability to continue to maintain and develop an infrastructure appropriate to support and integrate such growth. Also, our success
depends on the acceptance by customers of us and our services in these new markets and, in the case of expansion through acquisitions, our success depends on many factors, including the long-term recruitment and retention of key personnel and acquired customer relationships. The profitability of our expansion strategy also depends on whether the income we generate in the new markets will offset the increased expenses of operating a larger entity with increased personnel, more branch locations and additional product offerings. In 2013, revenues decreased in the second half of the year due to changes related to loans and operations acquired in the prior two years.
We continue to identify and evaluate opportunities to expand through acquisition of banks, insurance agencies, and wealth management firms. Some of these opportunities could result in further geographic expansion. Merger and acquisition activities are subject to a number of risks, including lending, operating, and integration risks. Growth through acquisition requires careful due diligence, evaluation of risks, and projections of future operations and financial conditions. Actual results may differ from our expectations and could have a material adverse effect on our financial condition and results of operations. Growth through acquisition also often involves the negotiation and execution of extensive merger agreements. Such agreements may give rise to litigation, constrain us in certain ways, or expose us to other risks beyond our normal operating risks.
The Company negotiated the purchase of 20 branches in Central New York in 2013, and completed this acquisition shortly after year-end 2013. The amount of deposits acquired was significantly below the amount at the time of the purchase agreement. If there is continued attrition of deposit balances or difficulties in integrating the acquired operations, the expected benefits of this acquisition may not be realized.
The Company’s recruitment of new executive and commercial lending management has in several cases brought in new management who previously worked at larger institutions. These individuals have often served larger customers than the Company has historically serviced, and they have had the benefit of larger capital and administrative resources than are present in the Company’s current structure. The success of this recruitment may depend on the successful integration of these individuals into the Company and may expose the Company to lending and operating losses related to large new customers in newer markets. The Company’s commercial banking strategy has particularly focused on taking market share from larger national institutions and in many cases these new accounts are larger than the Company’s historic accounts. Additionally, the Company’s ability to service these accounts may in some cases involve arranging loan participations and syndications. These activities can expose the Company to additional lending, administrative, and liquidity risks. The Company also actively recruits in other business lines, including private banking and wealth management. This activity can give the Company additional access to large customers in its markets in order to expand our business. Such recruitment can affect the retention of new and old business, and can also be affected by competitive reactions and other relationship risks in retaining accounts.
Operations acquired in business combinations have frequently been subject to bank regulations prior to the merger date. Related regulatory examinations may result in the identification of certain operating matters requiring remediation, undisclosed deficiencies related to regulatory compliance, deficiencies that arise as a result of integration of acquired operations and operating activities conducted by those operations subsequent to the merger date, or impacts on existing business operations which are being integrated with the acquired operations. Any identified deficiencies related to regulatory compliance may result in changes that affect operating revenues and costs, including the scope or scale of business activities.activities and/or potential future expansion initiatives.
Competition From Financial Institutions and Other Financial Service Providers May Adversely Affect Our Growth and Profitability.
Competition in the banking and financial services industry is intense. We compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Larger banking institutions have substantially greater resources and lending limits and may offer certain services that we do not. Local competitors with excess capital may accept lower returns on new business. There is increased competition by out-of-market competitors through the internet. Federal regulations and financial support programs may in some cases favor competitors or place
us at an economic disadvantage. Our profitability depends on our continued ability to successfully compete and grow profitably in our market areas.
We are Subject to Security and Operational Risks Relating to Our Use of Technology that Could Damage Our Reputation and Our Business.
Security breaches of confidential information in our internet banking activities could expose us to possible liability and damage our reputation. Any compromise of our data security could also deter customers from using our internet banking services. We rely on industry standard internet security systems to provide the security and authentication necessary to effect secure transmission of data. These precautions may not protect our security systems from compromises or breaches and could result in damage to our reputation and our business. We utilize third party core banking software and for some systems we have outsourced our data processing to a third party. If our third party providers encounter difficulties or if we have difficulty in communicating with such third parties, it could significantly affect our ability to adequately process and account for customer transactions, which could significantly affect our business operations. We utilize file encryption in designated internal systems and networks and are subject to certain state and federal regulations regarding how we manage data security. Natural disasters and disaster recovery risks could affect our operating systems, which could affect our reputation. Potential problems with the management of technology security and operational risks may affect regulatory compliance, which could affect operating costs and expansion plans.
Financial and Operating Counterparties Expose Us to Risks.
We have increased our use of derivative financial instruments, primarily interest rate swaps, which exposes us to financial and contractual risks with counterparty banks. We maintain correspondent bank relationships, manage certain loan participations, engage in securities transactions, and engage in other activities with financial counterparties that are customary to our industry. We also utilize services from major vendors of technology, telecommunications, and other essential operating services. There is financial and operating risk in these relationships, which we seek to manage through internal controls and procedures, but there are no assurances that we will not experience loss or interruption of our business as a result of unforeseen events with these providers. Our expanded mortgage lending and mortgage banking operations have also exposed us to more counterparty transactions including the use of third parties to participate in the management
of interest rate risk and mortgage sales and hedging. Financial and operational risks are inherent in these counterparty relationships.
We May Not Be Able to Attract and Retain Skilled People.
Our success depends, in large part, on our ability to attract new employees, retain and motivate our existing employees, and continue to compensate employees competitively. Competition for the best people in our industry can be intense and we may not be able to hire or retain appropriately qualified individuals. As a result of recent revenue declines and expense restructuring activities, the Company could experience changes in the retention of existing employees.
Management Changes Could Affect Operations.
In 2013, there were changes in executive and senior management, including vacancy periods during times of transition. Existing senior managers were promoted to executive management positions with the expectation that there would be better focus on core competencies. Transitions in the management team introduce control risks in the oversight of operating activities and in the planning and execution of strategic objectives.
Our Controls and Procedures May Fail or Be Circumvented.
Management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.
New MortgageRetail Lending Operations In Eastern Massachusetts Expose Us to New Operating Risks.
In 2012, the Bank acquired the business assets of an established residential mortgage origination company in Eastern Massachusetts. UnderThe acquired mortgage operations have been integrated and expanded in the agreement the Bank has employed the former employeesBank’s footprint. Following record business volumes in 2012, mortgage business volumes contracted substantially in 2013 which affected mortgage banking profitability and necessitated a restructuring of this companyexpenses and is utilizing itsoperations.
business name and operating procedures to originate residential mortgages in Eastern Massachusetts as well as in other areas of Massachusetts and surrounding markets. The volume of mortgage originations has exceeded the Bank’s existing mortgage originations volume, and involves lending in a new market area with new staff and new processes.2012. The Bank has assimilated these operations into the Bank’s risk management program. There has been turnover in the position of the senior manager ofcentralized its franchise consumer lending who overseesin these acquired Syracuse operations, including indirect automobile lending and the Bank has utilizedhome equity lending. The Company views these acquired consumer lending operations as a third party financial accounting resourcesignificant opportunity to assist in the accounting of these operations.expand its franchise consumer lending.
These changes expose us to operating risks. The conduct of these new activities exposesalso expose the Bank to the risk of loan losses, losses related to interest rate risk management, compliance, litigation, and other risks common in mortgage bankingconsumer lending operations.
Derivatives and Counterparty Risks Have Increased Due to the Expanded Mortgage Operations.Increased.
The total notional amount of derivative financial instruments more than doubled in 2012, largely due to the expanded mortgage operations. The increase includes customer interest rate lock commitments on applications for mortgages that Berkshire intends to sell, and forward sales of securities intended to hedge the interest rate risk of these rate lock commitments until the loans are closed and sold. These activities involve new derivative instruments and new broker/dealer counterparties, as well as the utilization of a new vendor responsible for managing the hedging position. Additionally, Berkshire sells closed loans on a servicing released basis under mandatory and best efforts contracts to institutional secondary market purchasers which are new counterparties for Berkshire. Berkshire could experience losses if there are failures in the controls or accounting for these activities or if there are performance failures by any of these new counterparties. The risk of loss is increased ifwhen interest rates change suddenly and if the intended hedging objectives are not achieved as a result of market or counterparty behaviors. The sudden change in interest rates in 2013 contributed to lower mortgage banking profitability in 2013.
The Bank expanded its use of interest rate swaps in 2013 related to hedging its borrowings and providing commercial loan customers with fixed interest rate payment options. Following the completion of the New York branch acquisition shortly after year-end 2013, all outstanding interest rate swaps related to Federal Home Loan Bank loans were terminated and new borrowings and interest rate swaps were entered into based on an analysis of the current interest rate profile and objectives. These terminations in hedge management were due to changed circumstances and the Company’s ability to utilize its hedge accounting methods depends on its ability to forecast related economic and financial factors which could limit its ability to utilize these methods in the event of future unforeseen events.
The Planned Core Bank Processing System Conversion Exposes Us to Operating and Financial Risks.
In 2012, the Bank converted its core bank processing system to a new system and a new vendor. This system was changed from primarily an “in-house” system run on the Bank’s own computers to one that is primarily a “service bureau” solution running on the provider’s computers and relying on long distance telecommunications. Core systems conversions involve extensive planning and operational changes that affect bank account records, customer service delivery, internal procedures, technology risk management, and other significant operating activities. The changes expose the Bank to new risks with new systems and new vendors. The Bank has worked closely with third parties to manage the related operating and financial risks. Potential problems with new systems could involve regulatory compliance risk, potentially resulting in higher operating costs or limitations on operating activities. The new systems involve new costs with the new vendor, which could exceed expectations and impact profitability and future vendor relations.
Liquidity
Our Wholesale Funding Sources May Prove Insufficient to Replace Deposits at Maturity and Support Our Operations and Future Growth.
We must maintain sufficient funds to respond to the needs of depositors and borrowers. As a part of our liquidity management, we use a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. These sources include Federal Home Loan Bank advances, proceeds from the sale of loans, and liquidity resources at the holding company. Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable costs. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our operating margins and profitability would be adversely affected. Turbulence in the capital and credit markets may adversely affect our liquidity and financial condition and the willingness of certain counterparties and customers to do business with us. The
Company’s long term plan anticipates asset growth at a faster rate than deposit growth, which may result in increased reliance on wholesale or nontraditional funding sources. If deposits in new markets do not remain at planned levels, this could increase the possible reliance on wholesale or nontraditional funding sources.
The Company Has Exceeded Certain Massachusetts Depositors Insurance Fund Size Thresholds, Which May Result In Changes in Deposit Insurance May Affect Demand for Deposits.to the Company and the Bank’s Operations.
AtDue to ongoing growth, the endCompany has exceeded certain Massachusetts Depositors Insurance Fund size thresholds and is evaluating its alternatives. Should Berkshire Bank determine to withdraw from participation in the Depositors Insurance Fund, the Bank would be required, under Massachusetts law, to convert from a Massachusetts savings bank to a Massachusetts trust company and, under federal law, the Company would be required to convert from a savings and loan holding company to a bank holding company. Such a charter conversion and holding company change would affect the overall powers and obligations of 2012,the Company and the Bank. The Bank is considering available alternatives to a charter conversion. None of these issues would affect the Bank’s federal deposit insurance coverage by the FDIC terminated unlimitedand a potential withdrawal from the DIF supplemental insurance program would be expected to include a notice and transition time period for currently insured accounts. Withdrawal from DIF could have negative impact to future deposit insurance for transaction accounts. Dueacquisition or retention. The Company expects that any related charter changes, would be managed in an orderly manner without significant impact to its growth, the Bank is also evaluating alternative structures of deposit protection which might be utilized differently from its historic offering of DIF insurance. Changes to deposit protection may affect demand for deposits.business operations.
Our Ability to Service Our Debt, Pay Dividends and Otherwise Pay Our Obligations as They Come Due Is Substantially Dependent on Capital Distributions from the Bank, and These Distributions Are Subject to Regulatory Limits and Other Restrictions.
A substantial source of our holding company income is the receipt of dividends from the Bank, from which we service our debt, pay our obligations, and pay shareholder dividends. The availability of dividends from the Bank is limited by various statutes and regulations. It is possible, depending upon the financial condition of the Bank and other factors, that the applicable regulatory authorities could assert that payment of dividends or other types of payments are an unsafe or unsound practice. If the Bank is unable to pay dividends to us, we may not be able to service our debt, pay our obligations or pay dividends on our common stock. The inability to receive dividends from the Bank would adversely affect our business, financial condition, results of operations and prospects.
New Subordinated Debt May Affect the Company’s Future Profitability and Ability to Service Its Obligations and Provide Dividends to Shareholders.
The Company issued $75 million in subordinated debt at the parent level in the most recent quarter. Proceeds from this debt were primarily used as partial consideration for the Beacon merger on October 19, 2012. The merger of Beacon into Berkshire Bank is expected to produce earnings accretion, which will provide additional cash flow to service the new subordinated debt. The Company relies primarily on payments from Berkshire Bank, which could be interrupted in the future due to economic or regulatory changes. The additional leverage at the parent could affect its access to other sources of funds and the general adequacy of its liquidity.
Interest Rates
Changes in Interest Rates Could Adversely Affect Our Results of Operations and Financial Condition.
Net interest income is our largest source of income. Changes in interest rates can affect the level of net interest income. The Company’s interest rate sensitivity is discussed in more detail in Item 7A of this report. WeThe Company principally managemanages interest rate risk by managing ourits volume and mix of our earning assets and funding liabilities. In a changing interest rate environment, wethe Company may not be able to manage this risk effectively. If we arethe Company is unable to manage interest rate risk effectively, ourits business, financial condition and results of operations could be materially harmed. Changes in interest rates can also affect the demand for ourthe Company’s products and services, and the supply conditions in the U.S. financial and capital markets. Changes in the level of interest rates may negatively affect ourthe Company’s ability to originate real estate loans, the value of ourits assets and ourits ability to realize gains from the sale of our assets, all of which ultimately affect our earnings. In 2013, factors related to market interest rates affected the retention of bank loans and mortgage banking revenues acquired in recent business combinations.
Securities Market Values
Declines in the Value of Certain Investment Securities Could Require Write-Downs, Which Would Reduce Our Earnings.
Unrealized losses on investment securities result from changes in credit spreads and liquidity issues in the marketplace, along with changes in the credit profile of individual securities issuers. We haveThe Company concluded that, as of year-end 2012,2013, any unrealized losses are temporary in nature, and we haveit has the intent and ability to hold these investments for a time necessary to recover ourits cost or stated maturity (at which time, full payment is expected). However, a continued decline in the value of these securities or other factors could result in an other-than-temporary impairment write-down which would reduce our earnings. Some of the Company’s securities are locally originated economic development bonds. These securities could become impaired due to economic and real estate market conditions which also affect loan risk. We haveThe Company has an investment in the stock of the Federal Home Loan Bank of Boston, which recently reinstitutedcurrently provides a modest dividend after a period when the dividend was suspended. If the capitalization of a Federal Home Loan Bank, including the FHLBB, became substantially diminished it could result in a write-down which would reduce our earnings. At year-end 2013, the initial promulgation of a regulatory change known as “the Volker Rule” would have required the write-down of a pooled trust preferred security in the Bank’s portfolio. This promulgation was modified, eliminating any potential accounting impacts for the Company. Future regulatory pronouncements could affect the securities portfolio and its carrying value.
Regulatory
Legislative and Regulatory Initiatives May Affect our Business Activities and Increase Operating Costs.
The potential exists for additional federal or state laws and regulations regarding lending, funding practices, capital, and liquidity standards. Bank regulatory agencies are expected to be more active in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement orders. In addition, new laws, regulations, and other regulatory changes may also increase our compliance costs and affect our business and operations. Moreover, the FDIC sets the cost of our FDIC insurance premiums, which can affect our profitability.
We areThe Company is required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. Regulatory capital requirements and their impact on the Company may change. WeIt may need to raise additional capital in the future to support our operations and continued growth. Our ability to raise capital, if needed, will depend on conditions in the capital markets at that time, which are outside of our control, and on our financial performance. If we cannot raise additional capital when needed, it could affect our operations and our ability to execute ourthe execution of the strategic plan, which includes further expanding our operations through internal growth and acquisitions.
The Dodd-Frank Act made extensive changes in the regulation of insured depository institution.institutions. In addition to eliminating the OTS and creating the Consumer Financial Protection Bureau, the Dodd-Frank Act, among other things, directs changes in the way that institutions are assessed for deposit insurance, mandates the imposition of consolidated capital requirements on savings and loan holding companies, requires originators of certain securitized loans to retain a percentage of the risk for the transferred loans, stipulates regulatory rate-setting for certain debit card interchange fees, repeals restrictions on the payment of interest on commercial demand deposits and contains a number of reforms related to mortgage originations. The impact of many of the provisions of the Dodd-Frank Act cannot yet be fully assessed. However, there is a significant possibility that the Dodd-Frank Act will, at a minimum, result in increased regulatory burden, compliance costs and interest expense for the Company.
New laws, regulations, and other regulatory changes, along with negative developments in the financial industry and the domestic and international credit markets, may significantly affect the markets in which we do business, the markets for
and value of our loans and investments, and our ongoing operations, costs and profitability. For more information, see “Regulation and Supervision”in Item 1 of this report.
Proposed New Federal Bank Capital Rules May Affect the Company’s Future Condition and Performance.
On June 12, 2012,In July 2013, the Office of the Comptroller of the Currency (“OCC”), Board of Governors of the Federal Reserve System (“FRB”), and the Federal Deposit Insurance Corporation (“FDIC”) announced that they are seeking comment on three noticesthe adoption of proposed rulemakingnew rules that would revise and replace the agencies’ current capital rules as these federal agencies move forward with implementing capital requirements consistent within response to agreements reached by the Basel Committee on Banking Supervision (“Basel III”). The proposed rules are currently preliminary and the Company will beis assessing the potential impact of these rules, including the proposed and final rules. Please see the further discussion of bank regulationimpact on capital sources and capital rules in Item I in this Form 10-K.returns.
Provisions of Our Certificate of Incorporation, Bylaws and Delaware Law, as Well as State and Federal Banking Regulations, Could Delay or Prevent a Takeover of Us by a Third Party.
Provisions in our certificate of incorporation and bylaws, the corporate law of the State of Delaware, and state and federal regulations could delay, defer or prevent a third party from acquiring us, despite the possible benefit to our stockholders, or otherwise adversely affect the price of our common stock. These provisions include: limitations on voting rights of beneficial owners of more than 10% of our common stock; supermajority voting requirements for certain business combinations; the election of directors to staggered terms of three years; and advance notice requirements for nominations for election to our Board of Directors and for proposing matters that stockholders may act on at stockholder meetings. In addition, we are subject to Delaware laws, including one that prohibits us from engaging in a business combination with any interested stockholder for a period of three years from the date the person became an interested stockholder unless certain conditions are met. These provisions may discourage potential takeover attempts, discourage bids for our common stock at a premium over market price or adversely affect the market price of, and the voting and other rights of the holders of, our common stock. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors other than the candidates nominated by our Board.
Goodwill and Other Intangible Assets
Our Acquisitions Have Resulted in Significant Goodwill, Which if it Becomes Impaired Would be Required to be Written Down, Resulting in a Negative Impact on Earnings.
The initial recording and subsequent impairment testing of goodwill and other intangible assets requires subjective judgments about the estimates of the fair value of assets acquired. Factors that may significantly affect the estimates include specific industry or market sector conditions, changes in revenue growth trends, customer behavior, competitive forces, cost structures and changes in discount rates. It is possible that future impairment testing could result in an impairment of the value of goodwill or intangible assets, or both. If we determine impairment exists at a given point in time, our earnings and the book value of the related intangible asset(s) will be reduced by the amount of the impairment. Notwithstanding the foregoing, the results of impairment testing on goodwill and core deposit intangible assets have no impact on our tangible book value or regulatory capital levels. These are non-GAAP financial measures. They are not a substitute for GAAP measures and should only be considered in conjunction with the Company’s GAAP financial information.
Trading of our Common Stock
The Trading History of Our Common Stock Is Characterized By Low Trading Volume. The Value of Your Investment May be Subject To Sudden Decreases Due To the Volatility of the Price of Our Common Stock.
Our common stock trades on the New York Stock Exchange and was transferred from the NASDAQ Global Select Market in 2012. The level of interest and trading in ourthe Company’s stock depends on many factors beyond our control. The market price of our common stock may be highly volatile and subject to wide fluctuations in response to numerous factors, including, but not limited to, the factors discussed in other risk factors and the following: actual or anticipated fluctuations in our operating results; changes in interest rates; changes in the legal or regulatory environment in which we operate;environment; press releases, announcements or publicity relating to usthe Company or ourits competitors or relating to trends in ourits industry; changes in expectations as to our future financial performance, including financial estimates or recommendations by securities analysts and investors; future sales of our common stock; changes in economic conditions in our marketplace, general conditions in the U.S. economy, financial markets or the banking industry; and other developments affecting our competitors or us. These factors may adversely affect the trading price of our common stock, regardless of our actual operating performance, and could prevent our stockholders from selling their common stock at a desirable price.
In the past, stockholders have brought securities class action litigation against a company following periods of volatility in the market price of their securities. We could be the target of similar litigation in the future, which could result in substantial costs and divert management’s attention and resources.
Recent Mergers
Recent Mergers May Create Unforeseen Risks For the Bank and the Company.
The Company reported risk factors in the stock registration and proxy/prospectus forms filed with the SEC related to the CBT and Beacon acquisitions. While the CBT, Greenpark, and Beacon business combinations have been completed, the Company continues to recognize the risks related to integration, regulation, and management of the acquired operations which were previously identified in the subject SEC filings. Similarly, the Company completed the conversion of its core processing system in the third quarter of 2012. In the near term, the Company recognizes the risks related to the utilization, integration, and internal control of its new systems related to the integration of the CBT systems in the final quarter of 2012, and related to the integration of the Beacon systems with the new core banking system, which is planned for the first quarter of 2013. Unforeseen difficulties in managing these conversions and subsequent business operations could negatively impact customer service, account retention, revenues, costs, and earnings.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
The Company’s headquarters are located in owned and leased facilities located in Pittsfield, Massachusetts. The Company also owns or leases other facilities within its primary market areas: Berkshire County, Massachusetts; Pioneer Valley (Springfield area), Massachusetts; Southern Vermont; the Capital Region; NortheasternRegion (Albany area), New York and now, Northern Connecticut andYork; Central New York.York; Northern Connecticut; and Central/Eastern Massachusetts. The Company has 7792 full-service banking offices. branches in Massachusetts, New York, Connecticut, and Vermont (including one branch in Tennessee held for sale following a bank acquisition).
The Company’s Asset Based Lending Group operates from a leased facilityCompany also has 7 regional headquarters. The 7 regional locations are full-service commercial offices located in Woburn, MassachusettsPittsfield, Massachusetts; Springfield, Massachusetts; Albany, New York; Syracuse, New York; Hartford, Connecticut; Westborough, Massachusetts; and itsBurlington, Massachusetts. In addition, the Company has 5 residential mortgage lending locations in Central/Eastern, Massachusetts Commercial Banking Team operates from a leased facility in Westborough, Massachusetts.
During 2012, the Company acquired The Connecticut Bank and Trust Company and Beacon Federal Bancorp, Inc, which significantly expanded its owned and leased facilities. Berkshire utilizes the former headquarters facilities at acquired banks and may identify and reduce excess facilities capacity over time. CBT added eight Hartford area branches in the second quarter of 2012, while Beacon added an additional four branches in New York, one branch in Eastern Massachusetts, and two branches in Tennessee to the Company’s total in the fourth quarter. The Company divested several Legacy Berkshire County branches in accordance with its merger agreement, in January, 2012. In selected other locations, the Company may combine or relocate other branches over time based on market conditions. During 2012, Berkshire consolidated and relocated most of its headquarters operations in buildings currently owned and/or leased in Pittsfield.
The addition of Beacon also brought an additional Insurance Agency, Beacon Comprehensive. With this addition, Berkshire Insurance Group operates from 12 locations in both Western Massachusetts and Syracuse, New York in both standalone premises as well as in rented space located in the Bank’s premises and now in Syracuse, NY.premises.
For several years, allIn January 2014, Berkshire completed the acquisition of 20 New York branches from Bank of America, reaching more communities between Albany and Syracuse. As part of the acquisition, two branches were consolidated in Central New York. Berkshire continues to look to consolidate to decrease operating expenses where appropriate and consolidated its commercial banking team into a new regional headquarters in Burlington, Massachusetts. The
Company also opened a new office in Loudonville, New York in January 2014, as part of its ongoing organic expansion.
In 2013, the Company identified five branches that were consolidated as part of the Company’s ongoing initiative to reduce operating costs and achieve greater efficiency following its acquisitions. These locations are in communities in and around the Company’s existing footprint and were consolidated due to the proximity with other locations and other business strategies.
Berkshire branch locations have been based aroundcontinues to expand its new retail branch design which eliminates traditional teller counters and provides an interactive customer service environment through “pod” stations which include automated cash handling technology. Berkshire currently has 14 branches based on this design. In many cases, this branch design also includes a multimedia community room which is offered for use by nonprofit community groups. Berkshire is also remodeling certain existing branches with this design over time. Berkshire currently has 12 offices configured based on this new branch design, including all of the de novo branch offices opened in recent years. Berkshire’s presence in Albany has mostly resulted from de novo branch expansion. In 2012, the Company opened four branch offices in this market, bringing the total branch count to 17 as it progresses towards its goal of 20 or more branch offices in this area.
In 2012, Berkshire expanded significantly in Eastern Massachusetts, including the acquisition of the operations of Greenpark Mortgage Corporation, including its eight mostly rented lending offices. This brings Berkshire’s total lending office count to ten in Eastern Massachusetts. The Company has acquired property to construct a branch and regional headquarters in Westborough in 2013. With the Beacon acquisition, the Company has also acquired its first Eastern Massachusetts bank branch in Chelmsford.
At December 31, 2012,2013, neither the Company nor the Bank was involved in any pending legal proceedings believed by management to be material to the Company’s financial condition or results of operations. Periodically, there have been various claims and lawsuits involving the Bank, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Bank’s business. However, neither the Company nor the Bank is a party to any pending
legal proceedings that it believes, in the aggregate, would have a material adverse effect on the financial condition or operations of the Company.
ITEM 4. MINE SAFETY DISCLOSURES
Not Applicable.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
The common shares of the Company trade on the New York Stock Exchange under the symbol “BHLB”. The following table sets forth the quarterly high and low closing sales price information and dividends declared per share of common stock in 20122013 and 2011.2012.
|
| High |
| Low |
| Dividends |
| |||||||||||||
2013 |
|
|
|
|
|
|
| |||||||||||||
First quarter |
| $ | 26.01 |
| $ | 23.38 |
| $ | 0.18 |
| ||||||||||
Second quarter |
| 27.84 |
| 24.62 |
| 0.18 |
| |||||||||||||
Third quarter |
| 29.38 |
| 24.34 |
| 0.18 |
| |||||||||||||
Fourth quarter |
| 27.86 |
| 24.50 |
| 0.18 |
| |||||||||||||
|
| High |
| Low |
| Dividends |
|
|
|
|
|
|
|
| ||||||
2012 |
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||
First quarter |
| $ | 24.49 |
| $ | 21.03 |
| $ | 0.17 |
|
| $ | 24.49 |
| $ | 21.03 |
| $ | 0.17 |
|
Second quarter |
| 23.49 |
| 20.15 |
| 0.17 |
|
| 23.49 |
| 20.15 |
| 0.17 |
| ||||||
Third quarter |
| 23.66 |
| 21.19 |
| 0.17 |
|
| 23.66 |
| 21.19 |
| 0.17 |
| ||||||
Fourth quarter |
| 24.26 |
| 20.89 |
| 0.18 |
|
| 24.26 |
| 20.89 |
| 0.18 |
| ||||||
2011 |
|
|
|
|
|
|
| |||||||||||||
First quarter |
| $ | 22.92 |
| $ | 20.68 |
| $ | 0.16 |
| ||||||||||
Second quarter |
| 22.85 |
| 20.45 |
| 0.16 |
| |||||||||||||
Third quarter |
| 24.14 |
| 17.11 |
| 0.16 |
| |||||||||||||
Fourth quarter |
| 22.50 |
| 17.56 |
| 0.17 |
|
Holders
The Company had approximately 3,5083,420 holders of record of common stock at March 14, 2013.7, 2014.
Dividends
The Company intends to pay regular cash dividends to common stockholders; however, there can be no assurance as to future dividends because they are dependent on the Company’s future earnings, capital requirements, financial condition, and regulatory environment. Dividends from the Bank have been a source of cash used by the Company to pay its dividends, and these dividends from the Bank are dependent on the Bank’s future earnings, capital requirements, and financial condition. Further information about dividend restrictions is provided in the Stockholders’ Equity note in the consolidated financial statements.
Recent Sales of Unregistered Securities; Use of Proceeds Fromfrom Registered Securities
On September 28, 2012, the Company issued $75.0 million principal amount of fixed to floating rate unregistered subordinated notes through a private placement to institutional investors in accordance with Rule 506 of Regulation D. The notes are due in 2027 and are redeemable at par by the Company during the final five years. The notes bear interest at a fixed rate of 6.875% for the first ten years and convert to a variable rate of interest in the final five years. The proceeds were used for Beacon merger consideration and other corporate purposes. There have been no other sales of registered or unregistered securities within the last three years.
Purchases of Equity Securities by the Issuer and Affiliated Purchases
There were no purchases of equity securities during the fourth quarter of 20122013 made by or on behalf of the Company or any “affiliated purchaser”, as defined by Section 240.10b-18(a)(3) of the Securities and Exchange Act of 1934, of shares of the Company’s common stock. On December 14, 2007,March 26, 2013, the Company authorized the purchase of up to 300500 thousand shares, from time to time, subject to market conditions. The repurchase plan will continue until it is completed or terminated by the Board of Directors. The Company has no intentions to terminate this plan or to cease any potential future purchases. As of year-end 2012,2013, there were 98118 thousand shares that remain unpurchased under this plan.
The following table sets forth information regarding the activity during the fourth quarter of 2012:
|
|
|
|
|
| Total number of shares |
| Maximum number of |
| |
|
|
|
|
|
| purchased as part of |
| shares that may yet |
| |
|
| Total number of |
| Average price |
| publicly announced |
| be purchased under |
| |
Period |
| shares purchased (1) |
| paid per share |
| plans or programs |
| the plans or programs |
| |
October 1-31, 2012 |
| 9,661 |
| $ | 24.12 |
| — |
| 97,993 |
|
November 1-30, 2012 |
| — |
| — |
| — |
| 97,993 |
| |
December 1-31, 2012 |
| — |
| — |
| — |
| 97,993 |
| |
Total |
| 9,661 |
| $ | 24.12 |
| — |
| 97,993 |
|
(1) Shares represent common stock withheld by the Company to satisfy tax withholding requirements on the vesting of shares under the Company’s benefit plans.
Total number of shares | Maximum number of | |||||||||
purchased as part of | shares that may yet | |||||||||
Total number of | Average price | publicly announced | be purchased under | |||||||
Period | shares purchased | paid per share | plans or programs | the plans or programs | ||||||
October 1-31, 2013 | — | $ | — | — | 118,113 | |||||
November 1-30, 2013 | — | — | — | 118,113 | ||||||
December 1-31, 2013 | — | — | — | 118,113 | ||||||
Total | — | $ | — | — | 118,113 |
Common Stock Performance Graph
The performance graph compares the Company’s cumulative stockholder return on its common stock over the last five years to the cumulative return of the NYSE Composite Index and the KBW Regional Bank Index, the NASDAQ Composite Index, and the SNL Bank and Thrift Index. Total stockholder return is measured by dividing total dividends (assuming dividend reinvestment) for the measurement period plus share price change for a period by the share price at the beginning of the measurement period. The Company’s cumulative stockholder return over a five-year period is based on an initial investment of $100 on December 31, 2007.
We have chosen to change the comparison indexes this year. The NYSE Composite was chosen to replace the Nasdaq composite because the Company moved its stock listing to the NYSE in 2012 and feels the diversity and breadth of the index makes it a more accurate broad market indicator. The KBW Regional Bank Index (KRX) was chosen to replace the SNL Bank and Thrift Index because the Company has grown and feels the KRX more accurately reflects its peers. The index is also more widely available to the public. All four indices are represented in the chart below.2008.
Information used on the graph and table was obtained from a third party provider, a source believed to be reliable, but the Company is not responsible for any errors or omissions in such information.
|
| Period Ending |
|
| Period Ending |
| ||||||||||||||||||||
Index |
| 12/31/07 |
| 12/31/08 |
| 12/31/09 |
| 12/31/10 |
| 12/31/11 |
| 12/31/12 |
|
| 12/31/08 |
| 12/31/09 |
| 12/31/10 |
| 12/31/11 |
| 12/31/12 |
| 12/31/13 |
|
Berkshire Hills Bancorp, Inc. |
| 100.00 |
| 121.62 |
| 83.92 |
| 92.70 |
| 95.95 |
| 106.37 |
|
| 100.00 |
| 69.00 |
| 76.22 |
| 78.89 |
| 87.46 |
| 102.79 |
|
NASDAQ Composite |
| 100.00 |
| 60.02 |
| 87.24 |
| 103.08 |
| 102.26 |
| 120.42 |
| |||||||||||||
SNL Bank and Thrift |
| 100.00 |
| 57.51 |
| 56.74 |
| 63.34 |
| 49.25 |
| 66.14 |
| |||||||||||||
NYSE Composite Index |
| 100.00 |
| 59.11 |
| 73.77 |
| 81.76 |
| 76.76 |
| 86.69 |
|
| 100.00 |
| 124.80 |
| 138.34 |
| 129.88 |
| 146.66 |
| 180.65 |
|
PHLX KBW Regional Banking Index |
| 100.00 |
| 78.34 |
| 59.36 |
| 70.18 |
| 65.17 |
| 71.99 |
|
| 100.00 |
| 75.78 |
| 89.58 |
| 83.19 |
| 91.89 |
| 132.00 |
|
In accordance with the rules of the SEC, this section captioned “Common Stock Performance Graph,” shall not be incorporated by reference into any of our future filings made under the Securities Exchange Act of 1934 or the Securities Act of 1933. The Common Stock Performance Graph, including its accompanying table and footnotes, is not deemed to be soliciting material or to be filed under the Exchange Act or the Securities Act.
ITEM 6. SELECTED FINANCIAL DATA
The following summary data is based in part on the consolidated financial statements and accompanying notes, and other schedules appearing elsewhere in this Form 10-K. Historical data is also based in part on, and should be read in conjunction with, prior filings with the SEC.
|
| At or For the Years Ended December 31, |
|
| At or For the Years Ended December 31, |
| ||||||||||||||||||||||||||
(In thousands, except per share data) |
| 2012 |
| 2011 |
| 2010 |
| 2009 |
| 2008 |
|
| 2013 |
| 2012 |
| 2011 |
| 2010 |
| 2009 |
| ||||||||||
|
|
|
|
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|
|
|
|
|
|
|
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|
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|
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|
|
|
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| ||||||||||
Selected Financial Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Total assets |
| $ | 5,296,809 |
| $ | 3,992,257 |
| $ | 2,882,298 |
| $ | 2,700,991 |
| $ | 2,666,729 |
|
| $ | 5,672,799 |
| $ | 5,296,809 |
| $ | 3,992,257 |
| $ | 2,882,298 |
| $ | 2,700,991 |
|
Securities |
| 573,871 |
| 533,181 |
| 405,953 |
| 420,966 |
| 341,516 |
|
| 870,091 |
| 573,871 |
| 533,181 |
| 405,953 |
| 420,966 |
| ||||||||||
Loans |
| 3,988,654 |
| 2,956,570 |
| 2,142,162 |
| 1,961,658 |
| 2,007,152 |
|
| 4,180,523 |
| 3,988,654 |
| 2,956,570 |
| 2,142,162 |
| 1,961,658 |
| ||||||||||
Allowance for loan losses |
| (33,208 | ) | (32,444 | ) | (31,898 | ) | (31,816 | ) | (22,908 | ) |
| (33,323 | ) | (33,208 | ) | (32,444 | ) | (31,898 | ) | (31,816 | ) | ||||||||||
Goodwill and intangibles |
| 274,258 |
| 223,364 |
| 173,079 |
| 176,100 |
| 178,830 |
|
| 270,662 |
| 274,258 |
| 223,364 |
| 173,079 |
| 176,100 |
| ||||||||||
Deposits |
| 4,100,409 |
| 3,101,175 |
| 2,204,441 |
| 1,986,762 |
| 1,829,580 |
|
| 3,848,529 |
| 4,100,409 |
| 3,101,175 |
| 2,204,441 |
| 1,986,762 |
| ||||||||||
Borrowings and subordinated debentures |
| 448,088 |
| 237,402 |
| 260,301 |
| 306,668 |
| 374,621 |
| |||||||||||||||||||||
Borrowings and subordinated notes |
| 1,064,107 |
| 448,088 |
| 237,402 |
| 260,301 |
| 306,668 |
| |||||||||||||||||||||
Total stockholders’ equity |
| 667,265 |
| 551,808 |
| 387,323 |
| 385,148 |
| 408,425 |
|
| 678,062 |
| 667,265 |
| 551,808 |
| 387,323 |
| 385,148 |
| ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Selected Operating Data: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Total interest and dividend income |
| $ | 175,939 |
| $ | 138,260 |
| $ | 112,277 |
| $ | 115,476 |
| $ | 133,211 |
|
| $ | 203,741 |
| $ | 175,939 |
| $ | 138,260 |
| $ | 112,277 |
| $ | 115,476 |
|
Total interest expense |
| 32,551 |
| 31,740 |
| 35,330 |
| 45,880 |
| 57,471 |
|
| 34,989 |
| 32,551 |
| 31,740 |
| 35,330 |
| 45,880 |
| ||||||||||
Net interest income |
| 143,388 |
| 106,520 |
| 76,947 |
| 69,596 |
| 75,740 |
|
| 168,752 |
| 143,388 |
| 106,520 |
| 76,947 |
| 69,596 |
| ||||||||||
Service charges and fee income |
| 51,265 |
| 33,727 |
| 29,859 |
| 28,181 |
| 30,334 |
|
| 50,525 |
| 51,265 |
| 33,727 |
| 29,859 |
| 28,181 |
| ||||||||||
All other non-interest income (loss) |
| 2,791 |
| 2,076 |
| (108 | ) | (3,004 | ) | 1,261 |
|
| 7,707 |
| 2,791 |
| 2,076 |
| (108 | ) | (3,004 | ) | ||||||||||
Total net revenue |
| 197,444 |
| 142,323 |
| 106,698 |
| 94,773 |
| 107,335 |
|
| 226,984 |
| 197,444 |
| 142,323 |
| 106,698 |
| 94,773 |
| ||||||||||
Provision for loan losses |
| 9,590 |
| 7,563 |
| 8,526 |
| 47,730 |
| 4,580 |
|
| 11,378 |
| 9,590 |
| 7,563 |
| 8,526 |
| 47,730 |
| ||||||||||
Total non-interest expense |
| 140,806 |
| 116,442 |
| 82,137 |
| 78,571 |
| 71,699 |
|
| 157,359 |
| 140,806 |
| 116,442 |
| 82,137 |
| 78,571 |
| ||||||||||
Income tax expense (benefit) - continuing operations |
| 13,223 |
| 1,884 |
| 2,420 |
| (15,597 | ) | 8,812 |
|
| 17,104 |
| 13,223 |
| 1,884 |
| 2,420 |
| (15,597 | ) | ||||||||||
Net income from discontinued operations |
| (637 | ) | 914 |
| — |
| — |
| — |
| |||||||||||||||||||||
Net (loss) income from discontinued operations |
| — |
| (637 | ) | 914 |
| — |
| — |
| |||||||||||||||||||||
Net income (loss) |
| $ | 33,188 |
| $ | 17,348 |
| $ | 13,615 |
| $ | (15,931 | ) | $ | 22,244 |
|
| $ | 41,143 |
| $ | 33,188 |
| $ | 17,348 |
| $ | 13,615 |
| $ | (15,931 | ) |
Less: Cumulative preferred stock dividend and accretion |
| — |
| — |
| — |
| 1,030 |
| — |
|
| — |
| — |
| — |
| — |
| 1,030 |
| ||||||||||
Less: Deemed dividend from preferred stock repayment |
| — |
| — |
| — |
| 2,954 |
| — |
|
| — |
| — |
| — |
| — |
| 2,954 |
| ||||||||||
Net income (loss) available to common stockholders |
| $ | 33,188 |
| $ | 17,348 |
| $ | 13,615 |
| $ | (19,915 | ) | $ | 22,244 |
|
| $ | 41,143 |
| $ | 33,188 |
| $ | 17,348 |
| $ | 13,615 |
| $ | (19,915 | ) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Dividends per common share |
| $ | 0.69 |
| $ | 0.65 |
| $ | 0.64 |
| $ | 0.64 |
| $ | 0.63 |
|
| $ | 0.72 |
| $ | 0.69 |
| $ | 0.65 |
| $ | 0.64 |
| $ | 0.64 |
|
Basic earnings per common share |
| 1.49 |
| 0.97 |
| 0.98 |
| (1.51 | ) | 2.08 |
|
| 1.66 |
| 1.49 |
| 0.97 |
| 0.98 |
| (1.51 | ) | ||||||||||
Diluted earnings per common share |
| 1.49 |
| 0.97 |
| 0.98 |
| (1.51 | ) | 2.06 |
|
| 1.65 |
| 1.49 |
| 0.97 |
| 0.98 |
| (1.51 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
Weighted average common shares outstanding - basic |
| 22,201 |
| 17,885 |
| 13,862 |
| 13,189 |
| 10,700 |
|
| 24,802 |
| 22,201 |
| 17,885 |
| 13,862 |
| 13,189 |
| ||||||||||
Weighted average common shares outstanding - diluted |
| 22,329 |
| 17,952 |
| 13,896 |
| 13,189 |
| 10,791 |
|
| 24,965 |
| 22,329 |
| 17,952 |
| 13,896 |
| 13,189 |
|
(1) For the years 2011 and 2010, the above schedule has been adjusted for prior year lease adjustments.
|
| At or For the Years Ended December 31, |
| |||||||||||||
|
| 2013 |
| 2012 |
| 2011 |
| 2010 |
| 2009 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Selected Operating Ratios and Other Data: |
|
|
|
|
|
|
|
|
|
|
| |||||
Share Data: |
|
|
|
|
|
|
|
|
|
|
| |||||
Book value per share |
| $ | 27.08 |
| $ | 26.53 |
| $ | 26.09 |
| $ | 27.52 |
| $ | 27.68 |
|
Market price at year end |
| $ | 27.27 |
| $ | 23.86 |
| $ | 22.19 |
| $ | 22.11 |
| $ | 20.68 |
|
|
|
|
|
|
|
|
|
|
|
|
| |||||
Performance Ratios: |
|
|
|
|
|
|
|
|
|
|
| |||||
Return on average assets |
| 0.78 | % | 0.73 | % | 0.50 | % | 0.50 | % | (0.74 | )% | |||||
Return on average equity |
| 6.09 |
| 5.66 |
| 3.64 |
| 3.55 |
| 4.83 |
| |||||
Interest rate spread |
| 3.47 |
| 3.47 |
| 3.38 |
| 3.01 |
| 2.61 |
| |||||
Net interest margin |
| 3.63 |
| 3.62 |
| 3.57 |
| 3.28 |
| 3.00 |
| |||||
Non-interest income/total net revenue |
| 25.65 |
| 27.38 |
| 27.16 |
| 27.88 |
| 26.57 |
| |||||
Non-interest expense/average assets |
| 2.97 |
| 3.11 |
| 3.34 |
| 2.99 |
| 2.93 |
| |||||
Dividend payout ratio |
| 41.57 |
| 46.31 |
| 67.01 |
| 65.16 |
| N/M |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Growth Ratios: |
|
|
|
|
|
|
|
|
|
|
| |||||
Total loans |
| 4.81 |
| 34.91 |
| 38.02 |
| 9.20 |
| (2.27 | ) | |||||
Total deposits |
| (6.14 | ) | 32.22 |
| 40.68 |
| 10.96 |
| 8.59 |
| |||||
Total net revenues |
| 14.96 |
| 38.73 |
| 33.39 |
| 12.58 |
| (8.15 | ) | |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Asset Quality Ratios: |
|
|
|
|
|
|
|
|
|
|
| |||||
Net loans charged-off/average total loans |
| 0.29 |
| 0.26 |
| 0.27 |
| 0.42 |
| 1.96 |
| |||||
Allowance for loan losses/total loans |
| 0.80 |
| 0.83 |
| 1.10 |
| 1.49 |
| 1.62 |
| |||||
Net loans charged-off - Business activities/average total loans- Business activities |
| 0.24 |
| 0.34 |
| 0.32 |
| 0.42 |
| 1.96 |
| |||||
Allowance for loan losses - Business activities/total loans - Business Activities |
| 0.93 |
| 1.21 |
| 1.41 |
| 1.49 |
| 1.62 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Capital Ratios: |
|
|
|
|
|
|
|
|
|
|
| |||||
Tier 1 capital to average assets - bank |
| 7.99 |
| 7.46 |
| 8.41 |
| 8.04 |
| 7.86 |
| |||||
Total capital to risk-weighted assets - bank |
| 11.62 |
| 11.79 |
| 11.29 |
| 10.61 |
| 10.71 |
| |||||
Stockholders’ equity/total assets |
| 11.95 |
| 12.60 |
| 13.82 |
| 13.44 |
| 14.26 |
| |||||
Tangible common stockholders’ equity to tangible assets (1) |
| 7.54 |
| 7.82 |
| 8.71 |
| 7.91 |
| 8.29 |
|
(1)All performance ratios are based on average balance sheet amounts where applicable.
(2)N/M = Not Meaningful
(3)Tangible common stockholders’ equity to tangible assets exclude goodwill and other intangibles. This is a non-GAAP financial measure that the Company believes provide investors with information that is useful in understanding our financial performance and condition.
(4)Generally accepted accounting principles require that loans acquired in a business combination be recorded at fair value, whereas loans from business activities are recorded at cost. The fair value of loans acquired in a business combination includes expected loan losses, and there is no loan loss allowance recorded for these loans at the time of acquisition. Accordingly, the ratio of the loan loss allowance to total loans is reduced as a result of the existence of such loans, and this measure is not directly comparable to prior periods. Similarly, net loan charge-offs are normally reduced for loans acquired in a business combination since these loans are recorded net of expected loan losses. Therefore, the ratio of net loan charge-offs to average loans is reduced as a result of the existence of such loans, and this measure is not directly comparable to prior periods. Other institutions may have loans acquired in a business combination, and therefore there may be no direct comparability of these ratios between and among other institutions.
(5) For the years 2011 and 2010, the above schedule has been adjusted for prior year lease adjustments discussed in Note 2 in the Consolidated Financial Statements.adjustments.
|
| At or For the Years Ended December 31, |
| |||||||||||||
|
| 2012 |
| 2011 |
| 2010 |
| 2009 |
| 2008 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Selected Operating Ratios and Other Data: |
|
|
|
|
|
|
|
|
|
|
| |||||
Performance Ratios: |
|
|
|
|
|
|
|
|
|
|
| |||||
Return on average assets |
| 0.73 | % | 0.50 | % | 0.50 | % | (0.74 | )% | 0.87 | % | |||||
Return on average equity |
| 5.66 |
| 3.64 |
| 3.55 |
| (4.83 | ) | 6.47 |
| |||||
Interest rate spread |
| 3.47 |
| 3.38 |
| 3.01 |
| 2.61 |
| 3.06 |
| |||||
Net interest margin |
| 3.62 |
| 3.57 |
| 3.28 |
| 3.00 |
| 3.44 |
| |||||
Non-interest income/total net revenue |
| 27.38 |
| 25.16 |
| 27.88 |
| 26.57 |
| 29.44 |
| |||||
Non-interest expense/average assets |
| 3.11 |
| 3.34 |
| 2.99 |
| 2.93 |
| 2.81 |
| |||||
Dividend payout ratio |
| 43.62 |
| 67.01 |
| 65.16 |
| N/M |
| 30.58 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Growth Ratios: |
|
|
|
|
|
|
|
|
|
|
| |||||
Total loans |
| 34.91 |
| 38.02 |
| 9.20 |
| (2.27 | ) | 3.24 |
| |||||
Total deposits |
| 32.22 |
| 40.68 |
| 10.96 |
| 8.59 |
| 0.39 |
| |||||
Total net revenues |
| 38.73 |
| 33.39 |
| 12.58 |
| (8.15 | ) | 21.19 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Capital Ratios: |
|
|
|
|
|
|
|
|
|
|
| |||||
Tier 1 capital to average assets - bank |
| 7.46 |
| 8.41 |
| 8.04 |
| 7.86 |
| 9.34 |
| |||||
Total capital to risk-weighted assets - bank |
| 11.79 |
| 11.29 |
| 10.61 |
| 10.71 |
| 12.28 |
| |||||
Stockholders’ equity/total assets |
| 12.60 |
| 18.82 |
| 13.44 |
| 14.26 |
| 15.32 |
| |||||
Tangible common stockholders’ equity to tangible assets (3) |
| 7.82 |
| 8.71 |
| 7.91 |
| 8.29 |
| 7.75 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Asset Quality Ratios: |
|
|
|
|
|
|
|
|
|
|
| |||||
Net loans charged-off/average total loans |
| 0.26 |
| 0.27 |
| 0.42 |
| 1.96 |
| 0.19 |
| |||||
Allowance for loan losses/total loans |
| 0.83 |
| 1.10 |
| 1.49 |
| 1.62 |
| 1.14 |
| |||||
Net loans charged-off - Business activities/average total loans- Business activities |
| 0.34 |
| 0.32 |
| 0.42 |
| 1.96 |
| 0.19 |
| |||||
Allowance for loan losses - Business activities/total loans - Business activities |
| 1.21 |
| 1.41 |
| 1.49 |
| 1.62 |
| 1.14 |
| |||||
|
|
|
|
|
|
|
|
|
|
|
| |||||
Share Data: |
|
|
|
|
|
|
|
|
|
|
| |||||
Book value per share |
| $ | 26.53 |
| $ | 26.09 |
| $ | 27.52 |
| $ | 27.68 |
| $ | 30.33 |
|
Market price at year end |
| $ | 23.86 |
| $ | 22.19 |
| $ | 22.11 |
| $ | 20.68 |
| $ | 30.86 |
|
|
|
|
|
|
|
|
|
|
|
Average Balances, Interest and Average Yields/Cost
The following table presents an analysis of average rates and yields on a fully taxable equivalent basis for the years presented. Tax exempt interest revenue is shown on a tax-equivalent basis for proper comparison using a statutory federal income tax rate of 35%.comparison.
Item 6 - Table 3 - Average Balance, Interest and Average Yields / Costs
|
| 2012 |
| 2011 |
| 2010 |
|
| 2013 |
| 2012 |
| 2011 |
| |||||||||||||||||||||||||||||||||||||
|
|
|
|
|
| Average |
|
|
|
|
| Average |
|
|
|
|
| Average |
|
|
|
|
|
| Average |
|
|
|
|
| Average |
|
|
|
|
| Average |
| |||||||||||||
|
| Average |
|
|
| Yield/ |
| Average |
|
|
| Yield/ |
| Average |
|
|
| Yield/ |
|
| Average |
|
|
| Yield/ |
| Average |
|
|
| Yield/ |
| Average |
|
|
| Yield/ |
| |||||||||||||
(Dollars in millions) |
| Balance |
| Interest |
| Rate |
| Balance |
| Interest |
| Rate |
| Balance |
| Interest |
| Rate |
|
| Balance |
| Interest |
| Rate |
| Balance |
| Interest |
| Rate |
| Balance |
| Interest |
| Rate |
| |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Interest-earning assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Loans: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Residential Loans |
| $ | 1,193.9 |
| $ | 52.7 |
| 4.42 | % | $ | 876.1 |
| $ | 42.5 |
| 4.85 | % | $ | 633.6 |
| $ | 32.9 |
| 5.19 | % |
| $ | 1,271.7 |
| $ | 51.5 |
| 4.05 | % | $ | 1,193.9 |
| $ | 52.7 |
| 4.42 | % | $ | 876.1 |
| $ | 42.5 |
| 4.85 | % | |
Commercial Mortgages |
| 1,271.6 |
| 69.1 |
| 5.44 |
| 1,058.0 |
| 52.9 |
| 5.00 |
| 881.9 |
| 43.3 |
| 4.91 |
|
| 1,380.8 |
| 74.3 |
| 5.38 |
| 1,271.6 |
| 69.1 |
| 5.44 |
| 1,058.0 |
| 52.9 |
| 5.00 |
| |||||||||||||
Commercial Business Loans |
| 507.9 |
| 20.4 |
| 4.01 |
| 344.3 |
| 16.5 |
| 4.79 |
| 204.0 |
| 10.5 |
| 5.15 |
|
| 637.9 |
| 29.6 |
| 4.64 |
| 507.9 |
| 20.4 |
| 4.01 |
| 344.3 |
| 16.5 |
| 4.79 |
| |||||||||||||
Consumer Loans |
| 427.5 |
| 17.8 |
| 4.17 |
| 336.7 |
| 13.4 |
| 3.98 |
| 299.9 |
| 11.7 |
| 3.90 |
|
| 654.7 |
| 29.6 |
| 4.52 |
| 427.5 |
| 17.8 |
| 4.17 |
| 336.7 |
| 13.4 |
| 3.98 |
| |||||||||||||
Total Loans |
| 3,400.9 |
| 160.0 |
| 4.71 |
| 2,615.1 |
| 125.3 |
| 4.79 |
| 2,019.4 |
| 98.4 |
| 4.87 |
|
| 3,945.1 |
| 185.0 |
| 4.69 |
| 3,400.9 |
| 160.0 |
| 4.71 |
| 2,615.1 |
| 125.3 |
| 4.79 |
| |||||||||||||
Investment securities (2) |
| 550.8 |
| 17.6 |
| 3.19 |
| 444.9 |
| 16.5 |
| 3.71 |
| 403.5 |
| 16.7 |
| 4.14 |
|
| 701.1 |
| 19.6 |
| 2.79 |
| 550.8 |
| 17.6 |
| 3.19 |
| 444.9 |
| 16.5 |
| 3.71 |
| |||||||||||||
Federal funds sold and short-term investments |
| 76.4 |
| 0.9 |
| 0.13 |
| 14.7 |
| — |
| 0.11 |
| 11.4 |
| — |
| 0.14 |
|
| 71.3 |
| 1.5 |
| 2.10 |
| 76.4 |
| 0.9 |
| 1.18 |
| 14.7 |
| — |
| 0.11 |
| |||||||||||||
Total interest-earning assets |
| 4,028.1 |
| 178.5 |
| 4.43 |
| 3,074.7 |
| 141.8 |
| 4.61 |
| 2,434.3 |
| 115.1 |
| 4.73 |
|
| 4,717.5 |
| 206.1 |
| 4.37 |
| 4,028.1 |
| 178.5 |
| 4.43 |
| 3,074.7 |
| 141.8 |
| 4.61 |
| |||||||||||||
Intangible assets |
| 241.7 |
|
|
|
|
| 207.5 |
|
|
|
|
| 174.5 |
|
|
|
|
|
| 272.2 |
|
|
|
|
| 241.7 |
|
|
|
|
| 207.5 |
|
|
|
|
| |||||||||||||
Other non-interest earning assets |
| 262.4 |
|
|
|
|
| 201.8 |
|
|
|
|
| 134.2 |
|
|
|
|
|
| 317.1 |
|
|
|
|
| 262.4 |
|
|
|
|
| 201.8 |
|
|
|
|
| |||||||||||||
Total assets |
| $ | 4,532.2 |
|
|
|
|
| $ | 3,484.0 |
|
|
|
|
| $ | 2,743.0 |
|
|
|
|
|
| $ | 5,306.8 |
|
|
|
|
| $ | 4,532.2 |
|
|
|
|
| $ | 3,484.0 |
|
|
|
|
| |||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Interest-bearing liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Deposits: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
NOW accounts |
| $ | 304.1 |
| $ | 0.9 |
| 0.30 | % | $ | 244.2 |
| $ | 0.9 |
|
| 0.4 | % | $ | 199.3 |
| $ | 0.7 |
| 0.35 | % |
| $ | 355.2 |
| $ | 0.8 |
| 0.23 | % | $ | 304.1 |
| $ | 0.9 |
| 0.30 | % | $ | 244.2 |
| $ | 0.9 |
| 0.37 | % |
Money market accounts |
| 1,189.1 |
| 5.8 |
| 0.48 |
| 833.3 |
| 5.6 |
| 0.67 |
| 597.3 |
| 5.6 |
| 0.94 |
|
| 1,389.2 |
| 5.7 |
| 0.41 |
| 1,189.1 |
| 5.8 |
| 0.48 |
| 833.3 |
| 5.6 |
| 0.67 |
| |||||||||||||
Savings accounts |
| 390.8 |
| 0.7 |
| 0.19 |
| 369.6 |
| 0.8 |
| 0.22 |
| 224.3 |
| 0.6 |
| 0.27 |
|
| 442.2 |
| 0.7 |
| 0.17 |
| 390.8 |
| 0.7 |
| 0.19 |
| 369.6 |
| 0.8 |
| 0.22 |
| |||||||||||||
Certificates of deposit |
| 1,056.0 |
| 15.1 |
| 1.43 |
| 902.6 |
| 16.3 |
| 1.81 |
| 749.2 |
| 19.4 |
| 2.59 |
|
| 1,085.8 |
| 13.6 |
| 1.25 |
| 1,056.0 |
| 15.1 |
| 1.43 |
| 902.6 |
| 16.3 |
| 1.81 |
| |||||||||||||
Total interest-bearing deposits |
| 2,940.0 |
| 22.5 |
| 0.77 |
| 2,349.7 |
| 23.6 |
| 1.00 |
| 1,770.1 |
| 26.3 |
| 1.49 |
|
| 3,272.4 |
| 20.8 |
| 0.63 |
| 2,940.0 |
| 22.5 |
| 0.77 |
| 2,349.7 |
| 23.6 |
| 1.00 |
| |||||||||||||
Borrowings and notes |
| 432.1 |
| 10.1 |
| 2.33 |
| 250.4 |
| 8.4 |
| 3.35 |
| 282.0 |
| 9.0 |
| 3.19 |
|
| 655.3 |
| 14.1 |
| 2.16 |
| 432.1 |
| 10.1 |
| 2.33 |
| 250.4 |
| 8.4 |
| 3.35 |
| |||||||||||||
Total interest-bearing liabilities |
| 3,372.1 |
| 32.6 |
| 0.97 |
| 2,600.1 |
| 32.0 |
| 1.23 |
| 2,052.1 |
| 35.3 |
| 1.72 |
|
| 3,927.7 |
| 34.9 |
| 0.89 |
| 3,372.1 |
| 32.6 |
| 0.97 |
| 2,600.1 |
| 32.0 |
| 1.23 |
| |||||||||||||
Non-interest-bearing demand deposits |
| 529.0 |
|
|
|
|
| 377.9 |
|
|
|
|
| 279.1 |
|
|
|
|
|
| 655.7 |
|
|
|
|
| 529.0 |
|
|
|
|
| 377.9 |
|
|
|
|
| |||||||||||||
Other non-interest-bearing liabilities |
| 44.8 |
|
|
|
|
| 29.8 |
|
|
|
|
| 28.7 |
|
|
|
|
|
| 48.1 |
|
|
|
|
| 44.8 |
|
|
|
|
| 29.8 |
|
|
|
|
| |||||||||||||
Total liabilities |
| 3,945.9 |
|
|
|
|
| 3,007.8 |
|
|
|
|
| 2,359.9 |
|
|
|
|
|
| 4,631.5 |
|
|
|
|
| 3,945.9 |
|
|
|
|
| 3,007.8 |
|
|
|
|
| |||||||||||||
Equity |
| 586.3 |
|
|
|
|
| 476.2 |
|
|
|
|
| 383.1 |
|
|
|
|
|
| 675.3 |
|
|
|
|
| 586.3 |
|
|
|
|
| 476.2 |
|
|
|
|
| |||||||||||||
Total liabilities and equity |
| $ | 4,532.2 |
|
|
|
|
| $ | 3,484.0 |
|
|
|
|
| $ | 2,743.0 |
|
|
|
|
|
| $ | 5,306.8 |
|
|
|
|
| $ | 4,532.2 |
|
|
|
|
| $ | 3,484.0 |
|
|
|
|
| |||||||
Net interest-earning assets |
| $ | 656.0 |
|
|
|
|
| $ | 474.6 |
|
|
|
|
| $ | 382.2 |
|
|
|
|
|
| $ | 802.4 |
|
|
|
|
| $ | 656.0 |
|
|
|
|
| $ | 474.6 |
|
|
|
|
| |||||||
Net interest income |
|
|
| $ | 145.9 |
|
|
|
|
| $ | 109.8 |
|
|
|
|
| $ | 79.8 |
|
|
|
|
|
| $ | 171.2 |
|
|
|
|
| $ | 145.9 |
|
|
|
|
| $ | 109.8 |
|
|
| |||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Supplementary data |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Total non-maturity deposits |
| $ | 2,413.0 |
|
|
|
|
| $ | 1,825.0 |
|
|
|
|
| $ | 1,300.0 |
|
|
|
|
|
| $ | 2,842.3 |
|
|
|
|
| $ | 2,413.0 |
|
|
|
|
| $ | 1,825.0 |
|
|
|
|
| |||||||
Total deposits |
| 3,469.0 |
|
|
|
|
| 2,727.6 |
|
|
|
|
| 2,049.2 |
|
|
|
|
|
| 3,928.1 |
|
|
|
|
| 3,469.0 |
|
|
|
|
| 2,727.6 |
|
|
|
|
| |||||||||||||
Fully taxable equivalent adjustment |
| 2.6 |
|
|
|
|
| 2.7 |
|
|
|
|
| 2.8 |
|
|
|
|
|
| 2.6 |
|
|
|
|
| 2.6 |
|
|
|
|
| 2.7 |
|
|
|
|
| |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| |||||||||||||
Interest rate spread |
|
|
|
|
| 3.47 | % |
|
|
|
| 3.38 | % |
|
|
|
| 3.01 | % |
|
|
|
|
| 3.48 | % |
|
|
|
| 3.47 | % |
|
|
|
| 3.38 | % | |||||||||||||
Net interest margin |
|
|
|
|
| 3.62 |
|
|
|
|
| 3.57 |
|
|
|
|
| 3.28 |
|
|
|
|
|
| 3.63 |
|
|
|
|
| 3.62 |
|
|
|
|
| 3.57 |
| |||||||||||||
Cost of funds |
|
|
|
|
| 0.84 |
|
|
|
|
| 1.08 |
|
|
|
|
| 1.52 |
|
|
|
|
|
| 0.77 |
|
|
|
|
| 0.84 |
|
|
|
|
| 1.08 |
| |||||||||||||
Cost of deposits |
|
|
|
|
| 0.65 |
|
|
|
|
| 0.87 |
|
|
|
|
| 1.28 |
|
|
|
|
|
| 0.53 |
|
|
|
|
| 0.65 |
|
|
|
|
| 0.87 |
| |||||||||||||
Interest-earning assets/interest-bearing liabilities |
|
|
|
|
| 119.45 |
|
|
|
|
| 118.25 |
|
|
|
|
| 118.62 |
|
|
|
|
|
| 120.50 |
|
|
|
|
| 119.45 |
|
|
|
|
| 118.25 |
|
Notes:
|
|
|
|
| (1) The average balances of loans include nonaccrual loans, and deferred fees and costs. (2) The average balance of investment securities is based on amortized cost. (3) The above schedule |
|
|
|
(4) The above schedule is not adjusted for prior year lease adjustments. (5) The average balances of borrowings and notes include the capital lease obligation presented under other liabilities on the consolidated balance sheet. |
RATE/VOLUME ANALYSIS
The following table presents the effects of rate and volume changes on the fully taxable equivalent net interest income. Tax exempt interest revenue is shown on a tax-equivalent basis for proper comparison using a statutory, federal income tax rate of 35%.comparison. For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to (1) changes in rate (change in rate multiplied by prior year volume), (2) changes in volume (change in volume multiplied by prior year rate) and (3) changes in volume/rate (change in rate multiplied by change in volume) have been allocated proportionately based on the absolute value of the change due to the rate and the change due to volume.
Item 6 - Table 4 - Rate Volume Analysis
|
| 2012 Compared with 2011 |
| 2011 Compared with 2010 |
|
| 2013 Compared with 2012 |
| 2012 Compared with 2011 |
| ||||||||||||||||||||||||||||
|
| Increase (Decrease) Due to |
| Increase (Decrease) Due to |
|
| Increase (Decrease) Due to |
| Increase (Decrease) Due to |
| ||||||||||||||||||||||||||||
(In thousands) |
| Rate |
| Volume |
| Net |
| Rate |
| Volume |
| Net |
|
| Rate |
| Volume |
| Net |
| Rate |
| Volume |
| Net |
| ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Interest income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Residential Loans |
| $ | (4,064 | ) | $ | 14,305 |
| $ | 10,241 |
| $ | (2,262 | ) | $ | 11,879 |
| $ | 9,617 |
|
| $ | (4,559 | ) | $ | 3,310 |
| $ | (1,249 | ) | $ | (4,064 | ) | $ | 14,305 |
| $ | 10,241 |
|
Commercial Loans |
| 4,850 |
| 11,332 |
| 16,182 |
| 861 |
| 8,796 |
| 9,657 |
|
| (1,158 | ) | 6,337 |
| 5,179 |
| 4,850 |
| 11,332 |
| 16,182 |
| ||||||||||||
Commercial Business Loans |
| (2,986 | ) | 6,885 |
| 3,899 |
| (817 | ) | 6,764 |
| 5,947 |
|
| 3,483 |
| 5,720 |
| 9,203 |
| (2,986 | ) | 6,885 |
| 3,899 |
| ||||||||||||
Consumer Loans |
| 695 |
| 3,761 |
| 4,456 |
| 232 |
| 1,457 |
| 1,689 |
|
| 1,593 |
| 10,162 |
| 11,755 |
| 695 |
| 3,761 |
| 4,456 |
| ||||||||||||
Total Loans |
| (1,505 | ) | 36,283 |
| 34,778 |
| (1,986 | ) | 28,896 |
| 26,910 |
|
| (641 | ) | 25,529 |
| 24,888 |
| (1,505 | ) | 36,283 |
| 34,778 |
| ||||||||||||
Investment securities |
| (2,505 | ) | 3,581 |
| 1,076 |
| (1,826 | ) | 1,626 |
| (200 | ) |
| (2,012 | ) | 4,013 |
| 2,001 |
| (2,505 | ) | 3,581 |
| 1,076 |
| ||||||||||||
Short-term investments |
| 35 |
| 872 |
| 907 |
| (4 | ) | 4 |
| — |
|
| 667 |
| (63 | ) | 604 |
| 35 |
| 872 |
| 907 |
| ||||||||||||
Total interest income |
| (3,975 | ) | 40,736 |
| 36,761 |
| (3,816 | ) | 30,526 |
| 26,710 |
|
| (1,986 | ) | 29,479 |
| 27,493 |
| (3,975 | ) | 40,736 |
| 36,761 |
| ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
Interest expense: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||||
NOW accounts |
| (229 | ) | 204 |
| (25 | ) | 62 |
| 169 |
| 231 |
|
| (238 | ) | 138 |
| (100 | ) | (229 | ) | 204 |
| (25 | ) | ||||||||||||
Money market accounts |
| (1,873 | ) | 1,994 |
| 121 |
| (1,774 | ) | 1,842 |
| 68 |
|
| (906 | ) | 892 |
| (14 | ) | (1,873 | ) | 1,994 |
| 121 |
| ||||||||||||
Savings accounts |
| (136 | ) | 45 |
| (91 | ) | (98 | ) | 333 |
| 235 |
|
| (70 | ) | 91 |
| 21 |
| (136 | ) | 45 |
| (91 | ) | ||||||||||||
Certificates of deposit |
| (3,685 | ) | 2,509 |
| (1,176 | ) | (6,660 | ) | 3,492 |
| (3,168 | ) |
| (1,962 | ) | 416 |
| (1,546 | ) | (3,685 | ) | 2,509 |
| (1,176 | ) | ||||||||||||
Total deposits |
| (5,923 | ) | 4,752 |
| (1,171 | ) | (8,470 | ) | 5,836 |
| (2,634 | ) |
| (3,176 | ) | 1,537 |
| (1,639 | ) | (5,923 | ) | 4,752 |
| (1,171 | ) | ||||||||||||
Borrowings |
| (3,078 | ) | 4,777 |
| 1,699 |
| 400 |
| (1,045 | ) | (645 | ) |
| (785 | ) | 4,846 |
| 4,061 |
| (3,078 | ) | 4,777 |
| 1,699 |
| ||||||||||||
Total interest expense |
| (9,001 | ) | 9,529 |
| 528 |
| (8,070 | ) | 4,791 |
| (3,279 | ) |
| (3,961 | ) | 6,383 |
| 2,422 |
| (9,001 | ) | 9,529 |
| 528 |
| ||||||||||||
Change in net interest income |
| $ | 5,026 |
| $ | 31,207 |
| $ | 36,233 |
| $ | 4,254 |
| $ | 25,735 |
| $ | 29,989 |
|
| $ | 1,975 |
| $ | 23,096 |
| $ | 25,071 |
| $ | 5,026 |
| $ | 31,207 |
| $ | 36,233 |
|
(1) The above schedule includes balances associated with discontinued operations.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
This discussion is intended to assist in understanding the financial condition and results of operations of the Company. This discussion should be read in conjunction with the consolidated financial statements and accompanying notes contained in this report.
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ACCOUNTING ESTIMATES
The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements in this Form 10-K. Please see those policies in conjunction with this discussion. The accounting and reporting policies followed by the Company conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While the Company bases estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.
The SEC defines “critical accounting policies” as those that require application of management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. Please see those policies in conjunction with this discussion. Management believes that the following policies would be considered critical under the SEC’s definition:
Allowance for Loan Losses. The allowance for loan losses represents probable credit losses that are inherent in the loan portfolio at the financial statement date and which may be estimated. Management uses historical information, as well as current economic data, to assess the adequacy of the allowance for loan losses as it is affected by changing economic conditions and various external factors, which may impact the portfolio in ways currently unforeseen. Although management believes that it uses appropriate available information to establish the allowance for loan losses, future additions to the allowance may be necessary if certain future events occur that cause actual results to differ from the assumptions used in making the evaluation. Conditions in the local economy and real estate values could require the Company to increase provisions for loan losses, which would negatively impact earnings.
Acquired Loans. Loans that the Company acquired in business combinations are initially recorded at fair value with no carryover of the related allowance for credit losses. Determining the fair value of the loans involves estimating the amount and timing of principal and interest cash flows initially expected to be collected on the loans and discounting those cash flows at an appropriate market rate of interest. Going forward, the Company continues to evaluate reasonableness of expectations for the timing and the amount of cash to be collected. Subsequent decreases in expected cash flows may result in changes in the amortization or accretion of fair market value adjustments, and in some cases may result in the loan being considered impaired. For collateral dependent loans with deteriorated credit quality, the Company estimates the fair value of the underlying collateral of the loans. These values are discounted using market derived rates of return, with consideration given to the period of time and costs associated with the foreclosure and disposition of the collateral.
Income Taxes. Significant management judgment is required in determining income tax expense and deferred tax assets and liabilities. The Company uses the asset and liability method of accounting for income taxes in which deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of the Company’s assets and liabilities. The realization of the net deferred tax asset generally depends upon future levels of taxable income and the existence of prior years’ taxable income, to which “carry back” refund claims could be made. A valuation allowance is maintained for deferred tax assets that management estimates are more likely than not to be unrealizable based on available evidence at the time the estimate is made. In determining the valuation allowance, the Company uses historical and forecasted future operating results, based upon approved business plans, including a review of the eligible carry-forward periods, tax planning opportunities and other relevant considerations. These underlying assumptions can change from period to period. For example, tax law changes or variances in future projected operating performance could result in a change in the valuation allowance. Should actual factors and
factors and conditions differ materially from those considered by management, the actual realization of the net deferred tax asset could differ materially from the amounts recorded in the financial statements. If the Company is not able to realize all or part of its net deferred tax asset in the future, an adjustment to the deferred tax asset valuation allowance would be charged to income tax expense in the period such determination is made.
Goodwill and Identifiable Intangible Assets. Goodwill and identifiable intangible assets are recorded as a result of business acquisitions and combinations. These assets are evaluated for impairment annually or whenever events or changes in circumstances indicate the carrying value of these assets may not be recoverable. When these assets are evaluated for impairment, if the carrying amount exceeds fair value, an impairment charge is recorded to income. The fair value is based on observable market prices, when practicable. Other valuation techniques may be used when market prices are unavailable, including estimated discounted cash flows and market multiples analyses. These types of analyses contain uncertainties because they require management to make assumptions and to apply judgment to estimate industry economic factors and the profitability of future business strategies. In the event of future changes in fair value, the Company may be exposed to an impairment charge that could be material.
Determination of Other-Than-Temporary Impairment of Securities. The Company evaluates debt and equity securities within the Company’s available for sale and held to maturity portfolios for other-than-temporary impairment (“OTTI”), at least quarterly. If the fair value of a debt security is below the amortized cost basis of the security, OTTI is required to be recognized if any of the following are met: (1) the Company intends to sell the security; (2) it is “more likely than not” that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) for debt securities, the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. For all impaired debt securities that the Company intends to sell, or more likely than not will be required to sell, the full amount of the depreciation is recognized as OTTI through earnings. Credit-related OTTI for all other impaired debt securities is recognized through earnings. Noncredit related OTTI for such debt securities is recognized in other comprehensive income, net of applicable taxes. In evaluating its marketable equity securities portfolios for OTTI, the Company considers its intent and ability to hold an equity security to recovery of its cost basis in addition to various other factors, including the length of time and the extent to which the fair value has been less than cost and the financial condition and near term prospects of the issuer. Any OTTI on marketable equity securities is recognized immediately through earnings. Should actual factors and conditions differ materially from those expected by management, the actual realization of gains or losses on investment securities could differ materially from the amounts recorded in the financial statements.
Fair Value of Financial Instruments. The Company uses fair value measurements to record fair value adjustments to certain financial instruments and to determine fair value disclosures. Trading assets, securities available for sale, and derivative instruments are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, or to establish a loss allowance or write-down based on the fair value of impaired assets. Further, the notes to financial statements include information about the extent to which fair value is used to measure assets and liabilities, the valuation methodologies used and its impact to earnings. For financial instruments not recorded at fair value, the notes to financial statements disclose the estimate of their fair value. Due to the judgments and uncertainties involved in the estimation process, the estimates could result in materially different results under different assumptions and conditions.
SUMMARY
Berkshire produced record net income totaling $33.2$41 million in 2013, an increase of 24% compared to $33 million in the prior year. Earnings per share for 2013 increased by 11% to $1.65 and included the impact of shares issued in 2012 for bank acquisitions. Results for 2013 benefited from ongoing expansion in Berkshire’s New England and New York
footprint, including a full year’s benefit from operations contributed through the acquisition of Beacon Federal in October 2012.
Berkshire built a larger franchise in 2013, with more capacity to increase market share in its New England/New York footprint. The Company’s achievements included:
·Entered into an agreement to purchase 20 branches in New York which wasin January 2014 added approximately 60,000 new customers and increased branch count by 24% to 92 branches.
·Integrated Beacon Federal operations and recruited experienced leadership establishing our brand in the Utica to Syracuse region of New York.
·Recruited experienced teams in commercial banking, leasing, small business banking, and mortgage banking.
·Opened/relocated two new commercial regional headquarters in Eastern Massachusetts.
·Opened/relocated three branches and consolidated five branches to strengthen the distribution system, and added new mobile banking features.
·Improved brand awareness through a 91%brand refresh and strategic media partnerships.
·Added leasing and indirect lending products, insurance products, and enhanced commercial services.
·Conducted Six Sigma process improvement projects across multiple business lines.
The year’s financial highlights included the following:
·15% increase over 2011in net revenue
·3% increase in net revenue per share
·24% increase in net income
·11% increase in net income per share
·5% increase in loans
·15% increase in commercial business loans
·4% increase in dividends per share
·2% increase in book value per share
·Increased net interest margin to 3.63%
·0.29% net loan charge-offs
·0.53% non-performing assets/assets
Additional management accomplishments included:
·Strengthened overall talent throughout the organization and utilized this talent effectively to enhance individual career progression and performance results.
·Continued focus on overall safety and soundness with ongoing balance sheet strength and improved controls in many business lines and operating functions.
·Continued to evaluate M&A opportunities while maintaining financial disciplines.
·Managed the interest rate risk profile to balance current and future earnings in light of $17.3 million. There was general improvementpotential future interest rate increases.
·Sustained community and charitable support which has resulted in national recognition.
Two external events in the first half of profitability,2013 changed the pace of the Company’s earnings growth: (1) a sharp steepening of the yield curve led to a dramatic drop in residential mortgage originations throughout the industry including at Berkshire; and measures(2) market demand for lower grade commercial debt led to accelerated outplacement of capital, asset quality, and liquidityloan balances acquired in bank
remained favorable. Berkshire continued to generate positive operating leverage in 2012; revenues grew by 39%acquisitions which was almost twice the 21% growth in expenses.
Berkshire’s earnings per share increased by 54% to $1.49 in 2012, and measured $1.98 before the $0.49 after-tax impact of merger, conversion, and nonrecurring items. In November 2012, Berkshire raised its quarterly cash dividend by 6% to $0.18 per share, mirroring a similar increase in the prior year. The total return on Berkshire stock was 10.9% in 2012, including price appreciation and dividend yield.
Berkshire believes that it significantly added to the value of its franchise in 2012, as highlighted below:
· Market share improved in targeted areas, based on the advantages of Berkshire’s positioning among the major regional banks in its marketswere not consistent with the focus, flexibility,Company’s long run balance sheet objectives. At midyear, the Company took immediate and capacityaggressive actions to gain share from national banksrespond to these market changes and smaller community banks
· Berkshire expanded its footprintabate the downturn in Eastern Massachusetts, Northern Connecticut,revenue and Central New York — all of which are large and healthy markets which offer significant long term opportunities for business development
· Revenues were diversified, with significant growth in new fee income sources and diversification of the loan portfolio both by loan type and loan geography
· A new core banking system was installed which improves distribution channels, enhances product capabilities, deepens customer relationship management, enhances scalability, improves efficiency, and provides more capabilities for data analytics to drive future profitable targeted growth
Major accomplishmentsearnings. Key actions included:
· Ongoing loanMade changes in executive and deposit growth from business development in Berkshire’s footprintsenior management to refocus on core competencies and disciplines.
· The acquisition of CBT — The Connecticut BankRestructured and Trust Company (Hartford, CT)right sized staff and Beacon Federal Bancorp (Syracuse, NY)eliminated excess premises, resulting in a 7% decrease in fourth quarter compensation/occupancy/technology costs compared to second quarter level.
· Loan production fromRefocused lending team recruitment including the new commercial team in Westborough, MA and the new mortgage banking team in Eastern Massachusetts. Recruitment also resultedoriginations, producing 16% annualized loan growth in the additionsecond half of another new seasoned commercial lending team after year-end, which is based in Eastern Massachusetts
·Four de novo branches were opened in the Albany market, bringing the total branch count to 17 as Berkshire progressed towards its goal of 20 or more offices in this market
·The insurance and wealth management business lines were enhanced, with a conversion to new insurance carriers and the consolidation of wealth management in new offices.year.
Income growthQuarterly earnings reached a high of $0.48 per share in the second quarter of 2013 and then declined to $0.33 in the third quarter and $0.42 in the fourth quarter. Earnings per share totaling $1.65 in 2013 were net of $0.22 in after-tax charges related to merger, conversion, and restructuring expenses (net of nonrecurring gains and out of period revenues). Such items contributed a credit of $0.02 per share in the final quarter of the year. The return on assets improved from 0.73% in 2012 also includedto 0.78% in 2013, ending the full year benefit of two bank acquisitions in 2011: Rome Bancorp (Rome, NY) and Legacy Bancorp (Pittsfield, MA). Berkshire’s initiatives over the past two years have resulted in an 84% increase in total assets to $5.3 billion, placing it among the 100 largest exchange traded banksat 0.77% in the U.S. Total branch offices increased by 83% to 77 offices. Annualized fourth quarter net revenue increased by 117% to $238 million. Berkshire’s office footprint extendsfinal quarter. The return on equity improved from Boston to Syracuse, and from Hartford into Vermont. Berkshire believes that its new size and reach open up new opportunities to further develop revenue and improve efficiency based on the strong leadership that it has recruited, its investment in scalable infrastructure and operating models, and its use of Six Sigma and data analytics to sharpen its product and customer management. Through its regional headquarters, it offers responsive local
market leadership across its business lines. The Company is flexibly pursuing the best opportunities for profitable growth across its geography and diversified product and service offerings.
Berkshire has managed its capital and funding sources to support its growth and the needs of its markets as the regional economy improves. Total common shares outstanding increased by 79% to $25.1 million over the last two years primarily due to shares issued as merger consideration, which contributed $247 million in new equity. In November 2012, Berkshire transferred its stock listing to the New York Stock Exchange, maintaining the “BHLB” ticker symbol. Berkshire also privately placed $75 million in subordinated debt5.7% in 2012 with institutional investors to fund6.1% in 2013, ending the cash portion of merger consideration. This placement took advantage of favorable market conditions to improve the weighted average cost of capital. Berkshire significantly expanded its relationships with national investment grade financial institutions as secondary market outlets and providers of financial derivatives to support expanded mortgage originations.
Berkshire continues to add to its senior and middle management ranks, recruiting high caliber professionals to offer products and services competitive with national banks, driving market share gainsyear at 6.2% in the retail and commercial middle markets. Financial disciplines guide pricing based on targeted profit margins and return on equity. Credit disciplines govern portfolio concentrations, credit selection, and loan structures targeted to maintain favorable momentum in credit metrics. Risk disciplines target income protection in the event of anticipated future interest rate increases, along with maintaining appropriate capital and liquidity buffers. Berkshire balances current period earnings targets with ongoing investments in strengthening its scalable infrastructure to support future growth and profitability improvement.
An important investment in 2012 was the core systems conversion in September. The Company expects this system to expand its distribution channels, enhance customer service, and improve its overall efficiency. Importantly, Berkshire expects to use this system analytically to better track customer relationships, cross sales, and product utilization, and to therefore strengthen and deepen profitability management. Management plans to use this technology together with its Six Sigma process engineering disciplines to improve data analytics and further drive smart growth. This focus will also contribute to risk management, where the Company’s focus is on continuing to maintain strong asset quality, modest credit charges, and careful interest rate management in the current challenging environment.
Berkshire recently introduced new messaging themes for its America’s Most Exciting Bank® brand, and in 2012 named Olympic gold medal and National Hall of Fame basketball coach Geno Auriemma as company spokesperson. Berkshire annually convenes AMEBU — America’s Most Exciting Bank University — to support brand and culture development companywide. The Company has an ongoing program to rebrand targeted branch offices across its region based on its redesigned branch footprint which enhances customer engagement, revenue potential, and cost management. Berkshire’s charitable foundations continue their leadership in philanthropy and community involvement in its regions. Reflecting Berkshire’s evolving governance, 2012 was the first full year for the new Capital Committee of the Board, which evaluates strategic impacts of the changing regulatory and economic factors affecting capital adequacy, capital supply, and returns on capital. At the end of the year, the Board promoted Mr. Daly to Chairman, in addition to his existing roles as President and CEO. The Board appointed Mr. Bossidy to the new role of Lead Independent Director, where he will continue to provide leadership and oversight to the Company’s governance.final quarter.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 20122013 AND 20112012
Balance Sheet Summary. Berkshire hascontinued to extend and deepen its banking footprint in 2013. Through organic growth, team recruitment, and product expansion, Berkshire increased its balance sheet significantly overloans from business activities by 21% and produced 5% total loan growth for the last two years as it has taken advantageyear. Berkshire managed run-off of opportunitiesnon-relationship deposits, with total deposits decreasing during the year prior to enlarge and strengthen its footprint in its New England and upstateincreasing with the New York markets.deposit acquisition completed shortly after year-end. Total assets increased by 7% during the year including the benefit of additional securities purchases funded with borrowings. The Company’s risk management maintained the momentum of favorable and improving asset quality while also producing significant recoveries of impaired loans which contributed to the year’s income. Berkshire’s capital metrics remained within its targets and liquidity was managed based on targets including the New York deposits acquired after year-end. Including these deposits, the Company maintained its targets for positioning its interest rate risk to benefit near term earnings from potential interest rate increases. As a result of expansion in recent years, the Company believes that it has diversified its geographicearnings sources and size positioning give it sustainable competitive advantage for gaining customer preference and increasing market and wallet share in these markets. Balancebalance sheet growth has been integral to
generating positive operating leveragerisks and improved operating profitabilityits strategic positioning for market share growth and return on equity. This growth has also improved the flexibility and diversification of revenue sources. The Company manages according to disciplines to maintain balance sheet strength including asset quality, interest rate risk, liquidity, and capital strength. Berkshire significantly increased its common shares outstanding over the last two years through merger consideration to provide appropriate capital support for this growth. Berkshire’s goal is to produce competitive long term shareholder returns and to maintain strong access to capital markets to support its deposit and loan activities in meeting the needs of the communities that it serves.
Total assets increased during 2012 by $1.3 billion (33%) to $5.3 billion. Over the last two years, total assets have increased by $2.4 billion (84%). Growth included the 2012 acquisitions of CBT, Beacon, and Greenpark Mortgage operations ($1.2 billion in total assets) and the 2011 acquisitions of Rome and Legacy ($1.2 billion in total assets). Most categories of assets and liabilities increased as a result of these acquisitions. Assets and liabilities from discontinued operations at year-end 2011 were related to four former Legacy New York branches which were divested in January 2012.
Berkshire produced a 5% increase in loans and deposits from business development in 2012, separate and distinct from the impact of the bank acquisitions. This was the product of Berkshire’s ongoing expansion in its regional markets with particular emphasis on commercial relationship growth. Commercial business development produced a 25% increase in commercial business loans and total
demand deposits increased by 27% from business development. At year-end, commercial deposits funded 64% of outstanding commercial loans, reflecting the benefit of the Company’s relationship approach to developing commercial business.
Overall measures of asset quality, capital, and liquidity remained strong through the year. Total shareholders’ equity increased by $115 million (21%) primarily due to equity issued as merger consideration. Total intangible assets increased by $51 million (23%) due primarily to merger related goodwill. Berkshire utilized additional borrowings, particularly to fund growth in residential mortgages held for sale, as well as the cash consideration used for mergers. Due to this additional leverage, the ratio of total equity to assets decreased to 12.6% from 13.8% during the year. Reflecting the higher proportion of residential mortgage related assets, the Bank’s risk based capital ratio improved to 11.8% from 11.3% during the year. The ratio of loans/deposits increased slightly to 97% from 95%. At year-end, 34% of total loans were loans acquired in business combinations which were recorded at fair value in the last two years. Total outstanding common shares increased by 19% to $25.1 million in 2012 due primarily to shares issued as merger consideration. Book value per share improved to $26.53 from $26.09 primarily due to the benefit of retained earnings.run financial results.
Investment Securities. Berkshire’s goal is to maintain a high quality portfolio consisting primarily of liquid investment securities with managed durations to limit the potential for market value declines in rising rate markets. Berkshire focuses on loan growth as the primary use of funds from deposit growth and the primary source of interest income. The investment portfolio provides additional liquidity and interest rate risk management flexibility, in addition to the capacity to generate higher earnings. The Company evaluates the portfolio within its overall objectives of producing growth in earnings per share and contributing to return on equity.
The portfolio increased in 2012 primarily due to securities acquired in bank acquisitions. There were no major changes in the structure of the portfolio during the year and the portfolio yield decreased due to the ongoing low rate environment. The Company continuously evaluates options for managing the portfolio’s size, risk, and durationduration. The Company expected to mitigateinvest in investment securities in 2014 as part of its plan for the income impactutilization of potential further yield compression withincash proceeds from the stated overall portfolio objective.acquisition of New York deposits which was completed in January 2014.
Total investment securities increased by $41$296 million (8%(52%) duringin 2013 as the year dueCompany placed increased reliance on investment income to $121 millionpartially offset a decline in investmentloan interest income following a decline in loan balances in the first half of the year. The increase in securities acquiredwas concentrated in bank acquisitions. Berkshire restructuresresidential mortgage backed securities, which also comprised the investments and borrowingsmajority of acquired banksthe portfolio at the timestart of the year. This increase included a targeted shift in the first quarter from residential mortgage loans into shorter duration mortgage backed securities to reduce interest rate risk. The Company
acquisition when these instruments are recorded at fair value. Depending on circumstances, some of this restructuring is done immediately prior to acquisition and some is done shortly after acquisition. This restructuring allows Berkshire to conform these instruments toalso increased its own policy objectives. Berkshire had liquidated portions of the recently acquired Beaconcorporate bond portfolio in the fourth quarter. Berkshire also liquidated selected existing securities positions which became uneconomical during the year as asset yields continued to decline. At year-end, the Company was in the process of evaluating alternatives for replacing some of those securities depending in part on anticipated changes in securities market yields and prices.
The increase in total securities in 2012 consisted mainly of structured U.S. agency collateralized mortgage obligations with targeted average lives in the 2 — 5 year range. Berkshire also continues to invest in dividend yieldingdecreased its equity securities as it took advantage of local financial institutions. Investment securities as a percentage of earning assets decreased modestlyprice appreciation to 12% at year-end 2012, compared to 15% at the start ofrealize $4.8 million in gains on certain community bank stocks during the year.
At year-end 2012,2013, Berkshire’s $574$870 million securities portfolio was primarily comprised of $322$602 million in mortgage-backed securities guaranteed or sponsored by the U.S. government. These securities constituted 56%69% of the portfolio at year-end, increasing slightly from 55%56% at the start of the year. Municipal securities and development bonds were little changed, totaling $135$122 million (23%(14% of the portfolio) at year-end 2012.2013. Other significant components of the portfolio at year-end included $31$56 million of corporate bonds and trust preferred securities, $25$22 million of marketable equity securities (consisting primarily of exchange traded common stock issued by community banks in the region), and $40$50 million of restricted securities which mostly consisted of Federal Home Loan bank stock. Approximately 81%87% of the total portfolio was designated as available for sale, with the primary exceptions being the restricted stock and locally issued development bonds (classified as held to maturity municipal securities except for one security classified as a trading obligation as a result of a related interest rate swap). The net unrealized gainloss on securities available for sale totaled $9.3 million, or 1.2% of cost at year-end 2013, compared to a gain of $10.7 million, or 2.4% of book valuecost at year-end 2012, compared2012. This change was primarily due to 1.5% a year earlier.the impact of higher interest rates on debt securities prices during the year. The Company’s trust preferred securities totaled $17 million at year-end 2013, including one pooled trust preferred security. New bank regulations at year-end requiring the future liquidation of certain classes of trust preferred securities were inapplicable to the Company’s portfolio, including specific exemptions published by regulatory authorities shortly after year-end.
The Company did not record any write-downs of investment securities in 20122013 and none of the Company’s investment securities were classified as other-than-temporarily impaired during the year or at year-end. Gross unrealized losses on securities with unrealized losses declinedincreased to $3$18 million from $4$3 million. Detail on these securities, including one security with a $1.7$1.4 million unrealized loss, is included in the Securities note in the consolidated financial statements. There were several downgrades of corporate bonds and single issuer trust preferred securities during 2012, due primarily to changes in the ratings environment for large financial institutions. At year-end 2012,2013, all available for sale debt securities carried at least one investment grade rating by a major rating agency except for the above security, one security called at par after year-end, and one $1.5 millionother security downgraded towith a Ba1 rating which had a 0.3% premium valuation at year-end.cost under $1 thousand . The Company’s held to maturity securities are generally unrated local securities, all of which are performing and none of which is deemed criticized according to the Company’s internal ratings systems.
The tax equivalent yield on investment securities declined to 2.8% in 2013 from 3.2% in 2012, from 3.7% in 2011, reflecting the impact of portfolio turnover and growth in the ongoing low interest rate environment. The effective duration of the debt securities portfolio at year-end 20122013 was estimated at approximately 3.04.7 years, with a year-end tax equivalent yield of approximately 2.7%. These data reflectcompared to 3.0 years and 2.7%, respectively, at the shorter duration planned amortization class bonds which comprise the majorityprior year-end. The average life of the mortgage backed securities portfolio combinedwas estimated at 5.2 years at year-end 2013 with extension risk to 6.4 years in the generally medium term durationevent of other debt securities.a 200 basis point increase in market rates due to slower prepayment speeds.
LoansLoans.. Berkshire’s focus has been on expanding and diversifyingIn 2013 Berkshire enhanced its loan portfolio to serve the credit needs oforigination activities across its marketsvarious lending functions and develop profitable financial service relationships with customers in and aroundacross its footprint. In 2012, the loan portfolio grew as a result of business combinationsCommercial lending teams were recruited in Eastern Massachusetts, Northern Connecticut,New York, and Central
New York. Berkshire hasConnecticut. The Company also recruited a new commercial leasing team and expanded its small business lending program. The Company made leadership changes focused on its core competencies and utilizing senior talent assembled in recent years. In consumer lending, Berkshire shifted its origination leadership to the Syracuse team that joined the Company at the time of the Beacon Federal acquisition in the fourth quarter of 2012. This team began expanding its existing prime auto lending program across Berkshire’s footprint and talent recruitment which contributedalso implemented improvements in cross selling and processing home equity loans. In response to growth from business developmentthe downturn in residential mortgage demand, the Company restructured its markets. Berkshire’s loan growth was net of certain non-relationship balances which were not retained during the year, along with certain balances which were sold. Results reflect the Company’s overall strategic focus on balancing growth, earnings,mortgage operations while also upgrading its originations systems and risk objectives. Production of residential mortgages and commercial business loans also reflected improved market conditions. Ongoing low interest rates have pressured gross loan yields and margins, particularly in commercial lending.expanding its team recruitment. The Company continues to target a business mix that satisfies its long term return on equity and interest rate sensitivity
targets, and it uses financial derivatives with national institutional partners as an integral component of this strategy. The Company believes that its risk disciplines and high quality underwriting standards are improving the long run risk profile of its credit portfolio.
TotalIn 2013, total loans increased by $1.03 billion (35%$192 million (5%). During the first half of the year, total loans decreased by $118 million (3%). This was followed by an increase of $310 million (8%) in the second half of the year, with increases in all major categories. Throughout the year, commercial business loans grew at a double digit annualized pace as Berkshire maintained its focus on taking market share from national banks in variable rate relationship-focused commercial business loans. The decrease in loans in the first half was concentrated in residential mortgages ($92 million) and commercial real estate loans ($61 million). The Company sold residential mortgages in the first quarter and replaced them with shorter duration mortgage backed securities based on the Company’s interest rate risk management disciplines. The decrease in commercial real estate loans was due to runoff of acquired impaired and non-relationship balances in the first half of the year in the highly competitive market for lower quality/higher yielding assets. The Company had anticipated that these balances would be gradually reduced over time as other offsetting business was developed in these markets. The Company adhered to its credit and pricing disciplines and accepted the decrease under these conditions. Following an increase in interest rates at midyear, competitive conditions improved and total net loan growth resumed. For the year, the balance of total loans from business activities increased by $544 million (21%) to $3.99$3.169 billion, in 2012. This included $875 million in acquired loans fromrepresenting 76% of the CBT and Beacon acquisitions. Excludingtotal portfolio. The balance of loans acquired in business combinations net loan growth was $157decreased by $352 million (26%) to $1.011 billion, representing 24% of the total portfolio.
Berkshire’s total commercial loans increased by $91 million (5%) in 2012,2013, while total commercial loans from business activities increased by $225 million (15%). Eastern Massachusetts was the primary focus for commercial loan growth, including $125the contribution from the new Burlington (Route 128) team that was recruited in January together with the Westborough team (Route 495) recruited a year earlier. Asset based loan outstandings increased by $39 million (15%) to $297 million and commercial balances also grew in New York and Connecticut, including the contribution from new commercial leadership recruited in Syracuse early in the year. Commercial loan growth also included the benefit of assets acquired through regional loan participations and purchases and growth was net of SBA guaranteed loans sold during the year. At year—end, total accepted commitments to originate new commercial loans totaled $111 million compared to $45 million at the start of the year.
Residential mortgage loan demand has generally favored fixed rate thirty year loans in recent years and the Company’s mortgage banking line of business has primarily sold new originations on a flow basis in the secondary market. Additionally, the Company has periodically bought and sold seasoned loans within its regional footprint. The total balance of residential mortgages reflects the contribution from the acquisition of smaller banks with higher proportionate mortgage balances. The Company sold certain portfolio mortgages in the first half of the year as part of its interest rate risk management disciplines. Following the industry-wide downturn in mortgage demand in the middle of the year, the Company promoted ten year adjustable rate mortgages which were retained in portfolio and $101 million in commercial business loans. Real estate related loans were affected by accelerated runoffcontributed to growth in the second half of the year. This included higher prepayments resulting from record low interest rates,Total residential mortgages increased by $60 million (5%) for the full year due to this growth in the second half.
The consumer loan portfolio consists primarily of home equity loans and indirect auto loans, along with targeted reductionsdirect auto loans and second mortgages. Management of non-relationship commercial accounts. Loans acquiredconsumer lending was transferred to the newly integrated Syracuse operations in 2013 following the Beacon Federal acquisition in the fourth quarter of 2012; Beacon had a strength in consumer lending reflecting its prior history as a result of bank mergers were generally in-market conforming loans except for approximately $83 million in loans associated with Beacon’s two Tennessee branches. CBT’s loan portfolio reflected its emphasis on small business banking. Beacon’s loans were more consumer oriented, together with a more recently developed commercial portfolio concentrated in Central New York. For the year, residential mortgage loans decreased to 33% of total loans from 35%, and commercial mortgages decreased to 36% from 39%. Commercial business loans increased to 15% from 14% and consumer loans increased to 16% from 12%.
Berkshire conducts thorough pre-merger due diligence on loans acquired in business combinations, together with post-merger fair value analysis with the assistance of a third party. The Company recorded the acquired loans at estimated net fair value, including estimated discounts for impaired loans. The Company recorded a net discount of $38.2 million in 2012 on loans acquired in business combinations (4.2% of the acquired book balance). Acquired impaired loans totaled $102.1million (11.2% of total acquired loans). Discount on these loans totaled $43.2 million (42.4% of book value), including $31.4 million of nonaccretable discount representing estimated uncollectable amounts. This net discount included premiums and discounts for loans with various prepayment speeds and prepayment volatility, which has contributed to volatility in quarterly net interest income. Additionally, net interest income is charged or credited based on collections of nonaccretable discount as impaired loans are liquidated. The balance of accretable discount on impaired loans acquired from business combinations totaled $8.2 million at year-end 2012, compared to $1.3 million at year-end 2011. The increase included $11.8 million added for new loans acquired in 2012 less $4.8 million in accretion recorded to income in 2012.
Berkshire continues to take commercial market share from national competitors as a result of the capabilities and responsiveness of the commercial banking teams that it has recruited in recent years. Total commercial loans increased by $447 million (29%) to $2.01 billion in 2012, including $390 million acquired in the bank mergers. In addition to these acquired loans, this increase was primarily due to growth in commercial business loans, which increased by $101 million to $600 million and grew at a 25% rate excluding the $88 million benefit of loans acquired in bank mergers. Growth from business development included the contribution from Berkshire’s new Central Massachusetts commercial banking team, which was recruited in December 2011 and is located in Westborough. Berkshire’s asset based lending team operates from Eastern Massachusetts and serves Berkshire’s entire footprint. Asset based loans outstandingcredit union.
increased in 2012 by $105 million to $258 million. Shortly after year-end, a new Eastern Massachusetts commercial team was recruited to further expand middle market commercial banking in Central/Eastern Massachusetts. Loan growth has included ongoing contributions fromAll of Berkshire’s New York region, including loan participations originated with Beacon prior to its acquisition. Shortly after year-end, new commercial leadership was recruitedconsumer lending programs are targeted for prime grade loans; the Syracuse area to build on the foundation provided with the Beacon merger. Similarly, new commercial leadership was recruited for the Hartford/Springfield market in the second half of 2012 to build on the foundation provided with the CBT merger.Company does not operate subprime lending programs. Berkshire has also enhanced its small businessexpanded Beacon’s existing indirect auto lending program with expanded services provided throughto provide this consumer product across its branch network.
The $304 million (30%) increase in the residential mortgage portfolio to $1.32 billion included $179 million in balances acquired in the bank mergers. The $125 million increase excluding these bank mergers primarily represented business development from the eight new Eastern Massachusetts mortgage lending offices added as a result of the recruitment of the Greenpark mortgage team. Berkshire’s loan production consisted primarily of conforming fixed rate mortgages to borrowers ingeography. Total auto and around its markets. The majority of mortgage production is sold to national institutional secondary market partners and government agencies. Growth in Berkshire’s mortgage portfolio included mortgages which were purchased from Greenpark Mortgage prior to its acquisition, together withother consumer loans increased originations by the expanded mortgage banking operation in the strong refinancing market that developed in the second half of18% during the year due to record low interest rates. Growth of the mortgage portfolio was net of $20 million of seasoned mortgages sold duringthis program expansion. While home equity loans declined by 6% for the year, as part of the Company’s overall asset/liability management. Additional information about mortgage production is includedthese balances increased by 1% in the later discussion of non-interest income infinal quarter as the results of operations section. The balance of residential mortgages includes net deferred costsCompany focused on streamlining its processing and premiums which increased to $11 million from $5 million in 2012 due primarily to premiums paid on purchased Greenpark mortgages. These amounts are amortized into mortgage incomedeveloping cross sale synergies across its geography and have also contributed to increased quarterly volatility in net interest income due to higher volatility in prepayment speeds.
Total consumer loans increased by $281 million (76%) to $651 million in 2012 including $307 million in balances acquired in bank mergers. This included $266 million in balances of acquired other consumer loans consisting primarily of indirect auto loans in the Beacon portfolio. Berkshire’s total auto loan portfolio increased to $165 million at year-end 2012, compared to $21 million at the prior year-end. Beacon had an established auto lending function that Berkshire expects to maintain and may expand in targeted areas. Berkshire’s consumer loan outstandings from business development decreased in 2012 due to the impact of loan refinancings and the Company’s concentration on residential mortgage production. Home equity loans increased by $27 million to $325 million in 2012, including $41 million in balances acquired in bank mergers.product lines.
The yield on average loans was little changed at 4.73%4.69% in the fourth quarter of 2012,2013, compared to 4.74%4.71% in the fourth quarter of the prior year.2012. The benefit of purchase accounting accretion for loans acquired in bank mergers generally offset the yield compression experienced in the industry due to continuing low interest rates. The purchase accounting accretion relates to the higher rates assigned to higher risk and impaired acquired loans when they are fair valued at acquisition. The overall yield on acquired loans was established at 6.0% for CBT and 5.8% for Beacon based on the initial yields assigned as of the merger dates. The net accretion in 20122013 included the new accretion from acquired loans and a decline in the rate of accretion asBeacon loans acquired in 2011 are reduced.the fourth quarter of 2012. The benefit of impaired loan collections to yield accretion including recovery of nonaccretable yield was viewed as unusually high in 2013 due to favorable market conditions for impaired assets as well as the initial workout activities for impaired loans acquired through the Beacon acquisition in the fourth quarter of 2012. There is further information about the impact of accretion in the later discussion of net interest income in the results of operations section.
Berkshire continues to favor an asset sensitivefavors a profile of income related interest rate risk that is neutral or asset sensitive and accepts a profile and seeksof equity at risk which is modestly liability sensitive due to manage the retention of long term fixed rate loans and securities. The majority of fixed rate residential mortgage production is sold servicing releasedmarket factors in the secondary market.ongoing low rate environment. The Bank offers back-to-back interest rate swaps to certain commercial loan customers, which allows the Bank to book a variable rate loan while providing the customer with a contract to fix its interest rate. This
allows the Company to be more competitive with national financing sources without booking long-term, fixed rate assets at current low interest rates, as well as providing a source of fee income. The Bank’spercentage of loans and securities with contractual repricings over threeadjusting within a year was 32% at year-end 2013, compared to 37% at the prior year-end. The percentage of loans adjusting after five years increased slightly to 44%39% from 37% for these periods. The Company estimated that the fair value of assets from 39%net loans equaled book value at year-end 2013, compared to a 1.2% excess over book value at the start of the year, due primarily to growthyear. This reflected changes in the residential mortgage portfolio. Theportfolio during the year, as well as the impact on portfolio durations is believed to be lower due to thefair value of higher rate of prepayments in the current environment. Berkshire utilizes forward startingmedium term interest rate swaps to help maintain an overall asset sensitive interest rate risk profile as measured by the sensitivity of net interest income.rates at year-end 2013.
Asset Quality. Berkshire has a Chief Risk Officer and a Risk Committee of the Board which keep a close focus on maintaining strong asset quality, with mostgreater focus on the loan portfolio due to the low risk characteristics of the investment portfolio. This includes setting loan portfolio objectives, maintaining sound underwriting, close portfolio oversight, and careful management of problem assets and potential problem assets. Additionally, merger due diligence is an integral component of maintaining asset quality. Under accounting standards for business combinations, acquiredAcquired loans are recorded at fair value and are deemed performing regardless of their payment status. Therefore, some overall portfolio measures of asset quality are not comparable between years or among institutions as a result of recent business combinations. The recorded values of impaired loans acquired in business combinations were generally within estimates made by Berkshire during due diligence prior to negotiating the final terms of the merger agreements, and the quality and performance of acquired criticized assets has been within the range of Berkshire’s expectations. A general goal is to achieve significant resolutions of impaired loans acquired in bank mergers in the first year following the acquisition date.
Year-end non-performing assets were little changed at $27 million in 2012 compared to $26 million in 2011. They declined to 0.52% Berkshire’s asset quality has reflected its strong credit disciplines together with the generally favorable economic characteristics of total assets at year-end 2012 due primarily toits footprint among U.S. regions through the asset growth from acquisitions. Loans which became non-performing during the year totaled $21 million in 2012, compared to $29 million in the prior year. The impact of new non-performing assets was mostly offset by resolutions including upgrades, collections,last recession and charge-offs. Increased non-performing commercial business loans were mostly offset by lower non-performing commercial real estate loans. The ten largest non-performing loans totaled $12.8 million and were generally well secured, with $3.3 million in impairment reserves as of year-end. The largest non-performing asset at year-end was approximately $2.4 million. For loans from business activities, the ratio of non-performing loans to total loans was 0.88% at year-end, compared to 1.03% at the start of the year.
Loans classified as performing troubled debt restructurings increased to $4.6 million from $1.3 million during 2012 due to a limited number of commercial credits. There were no loans which were restructured in 2012 that subsequently defaulted during the year. Foreclosed real estate remained negligible at year-end 2012, totaling $1.9 million. Accruing loans over 90 days past due measured 0.48% of total loans at year-end 2012, compared to 0.34% at the start of the year. These loans totaled $19.0 million at year-end 2012, including $15.5 million in loans acquired in business combinations which are recorded as accruing under accounting standards for business combinations. Loans delinquent 30-89 days increased to 0.63% of total loans from 0.55% due to delinquent loans acquired in 2012 bank mergers.recovery.
Net loan charge-offs were 0.26%0.29% of average loans in 2012. Total net charge-offs were $8.8 million in 2012,2013 compared to $7.0 million0.26% in 2011.2012. Loans acquired in business combinations are recorded at fair value, including the impact of estimated credit losses. Therefore, net charge-offs fromAs these loans age, new losses are identified, and total net-charge-offs of acquired loans contributed onlyincreased to $4.5 million in 2013 from $0.2 million in the prior year. Net charge-offs of loans from business activities declined to total net$6.8 million from $8.7 million. Net charge-offs of loans from business activities decreased to 0.24% of related average balances in 2012. Based on an average of period-end balances, net charge-offs2013 from 0.34% in 2012 measured approximately 0.35% of average loans excluding loans acquired in business combinations.the prior year.
The credit risk profileYear-end non-performing assets increased modestly to $30 million in 2013 compared to $27 million at the start of the Company’s loan portfolio is described in the Loans note in the consolidated financial statements.year, measuring 0.53% of total assets compared to 0.52% at these respective dates. The Company’s risk management process focuses primary attention on loans with higher than normal risk, which includes loans rated special mention and classified (substandard and lower). These loans are referred to asincrease was primarily related
criticizedto consumer loans acquired with the Beacon acquisition in the fourth quarter of 2012. Loans which became non-performing during the year totaled $28 million in 2013, compared to $21 million in the prior year, including the full year impact of acquired loans. The impact of new non-performing assets was mostly offset by resolutions including upgrades, collections, and criticized assets arecharge-offs. The ten largest non-performing loans decreased to $11.8 million from $12.8 million during the totalyear and were generally well secured, with $0.8 million in impairment reserves as of criticized loans and foreclosed real estate. Criticized assets increased as a result of the business combinations in 2012. Criticized assets totaled $187 million (3.5% of total assets)year-end. The largest non-performing loan at year-end 2012, compared to $161 million (4.0% of total assets) at the start of the year. The Company views its potential problem loans as thosewas $1.9 million. For loans from business activities, which are rated as classified and continuethe ratio of non-performing loans to accrue interest. Thesetotal loans have a possibility of loss if weaknesses are not corrected. Classified loans acquired in business combinations are recorded at fair value and aredecreased to 0.58% from 0.88% during the year.
Loans classified as performing attroubled debt restructurings increased to $8.3 million from $3.6 million during 2013 due to a limited number of commercial credits. Loans totaling $2.5 million which were restructured in 2013 subsequently defaulted during the timeyear. Foreclosed real estate increased modestly to $2.8 million from $1.9 million during the year. Accruing loans over 90 days past due improved to 0.22% of acquisitiontotal loans from 0.48% during the year and therefore are not generally viewedthe majority of these balances were acquired loans which were initially recorded as potential problem loans. Potential problemaccruing regardless of delinquency status based on accounting rules for business combinations. Loans delinquent 30-89 days decreased to 0.51% of total loans from 0.63% during the year. At year-end 2013, loans deemed impaired totaled $62$39 million, at year-end 2012 compared to $80$42 million at the prior year-end. At year-end 2013, the remaining carrying balance of purchased credit impaired loans was $30 million and the contractual amount owed on these loans was $53 million. The ten largest potential problem loans totaled $48 millioncomparable measures at year-end 2012 with the largest such loan totaling $10 million. All of these ten loans were viewed by the Company as stable or improving. The Company’s evaluation of its credit risk profile also compares the amount of classified assets to the total of the Bank’s Tier 1 Capital plus the loan loss allowance. This ratio was 35% at year-end 2012,$62 million and was unchanged from the prior year-end.$108 million, respectively.
Loan Loss Allowance. The determination of the allowance for loan losses is a critical accounting estimate. The Company’s methodologies for determining the loan loss allowance are discussed in Item 1 of this report and Item 8 includes further information about the accounting policy for the loan loss allowance and the Company’s accounting for the allowance in the consolidated financial statements. During 2014, the Company enhanced its allowance methodology to include historic loss rates from its own portfolio as well as historic loss rates provided by a third party ratings service.
The Company considers the allowance for loan losses appropriate to cover probable losses which can be reasonably estimated and which are inherent in the loan portfolio as of the balance sheet date. Under accounting standards for business combinations, acquired loans are recorded at fair value with no loan loss allowance on the date of acquisition. The fair value of acquired loans includes the impact of estimated loan losses for the life of the portfolio, including factors which are not probable or inherent as of the acquisition date, and including subjective assessments of risk. A loan loss allowance is recorded by the Company for the emergence of new probable and estimable losses relating to acquired loans which were not impaired as of the acquisition date. Because of the accounting for acquired loans, some measures of the loan loss allowance are not comparable to periods prior to the acquisition date or to other financial institutions.
The total amount of the loan loss allowance was $33.2increased by $0.1 million at year-end 2012, compared to $32.4$33.3 million atin 2013. The ratio of the start ofallowance to total loans decreased to 0.80% from 0.83% during the year. The increase was due to growth in general reservesallowance on acquired loans to $1.3 million from $0.5 million. This reflected a general increase in environmental risk for loans acquired in 2011 based on inherent losses which have become probable and estimable in addition to those which were projected at acquisition. For loans from business activities the related year-end allowance was unchanged from year-to-year, with a $0.5 million increase in impaired loan reserves offset by an identical decrease in general pool reserves. Loans from business activities increased in 2012, and as a result the related year-end allowance decreased to 0.93% from 1.21% of these balances. This included the impact of a decline in impaired balances, a change in loan mix, and improved environmental factors. The allowance on acquired loans increased to 0.38% from 1.41% at the beginning of the year. The reduction in coverage0.10% of these balances is consistent with thedue to increased proportion of lower risk residential mortgages, the gradual shift of commercial balances from real estate loans to lower risk loans secured by business operating assets, and the decline in potential problemloss estimates on collectively evaluated loans. The decrease in this ratio is consistent with the Company’s ongoing plan to strengthen the portfolio’s risk metrics and gradually reduce the percentage of the portfolio with inherent losses that are probable and estimable. The year-end allowance provided 3.8X3.0X coverage of 20122013 net charge-offs and 1.3X1.2X coverage of year-end non-accrual loans. The specific reserve for loans from business activities individually evaluated for impairment measured 8%5% of the related loan balances, demonstrating the general strength of collateral support for impaired commercial loans.
Other Assets.
Most categoriesThe credit risk profile of assets increased due to the Company’s expanded operations including business combinations. Loans held for sale increased as a result of Berkshire’s expanded mortgage production. This increase was due toloan portfolio is described in the expansion ofLoan Loss Allowance note in the mortgage banking operationsconsolidated financial statements. The Company’s risk management process focuses primary attention on loans with higher than normal risk, which includes loans rated special mention and the record mortgage production due to heightened refinancingclassified (substandard and lower). These
demand resultingloans are referred to as criticized loans. Criticized loans were reduced in 2013 to $165 million (2.9% of assets) from record low interest rates. Designated mortgage originations$187 million (3.5% of assets) due to targeted resolutions of balances acquired in business acquisitions. The Company views its potential problem loans as those loans from business activities which are rated as classified and continue to accrue interest. These loans have a possibility of loss if weaknesses are not corrected. Classified loans acquired in business combinations are recorded at fair value and are classified as performing at the time of acquisition and therefore are not generally viewed as potential problem loans. Potential problem loans totaled $71 million at year-end 2013 compared to $62 million at the prior year-end. The ten largest potential problem loans totaled $60 million at year-end 2013, with the largest such loan totaling $18 million. This asset is an in-market commercial real estate participation loan on a retail/office property on interest-only payment terms during an interim tenant remarketing period with condition viewed as stable. The Company’s evaluation of its credit risk profile also compares the amount of criticized assets to the total of the Bank’s Tier 1 Capital plus the loan loss allowance. This ratio was 37% at year-end 2013, compared to 43% at the prior year-end.
Other Assets. Loans held for sale decreased due to longstanding secondary market relationshipsthe decline in mortgage originations volume. Capital expenditure activity in 2013 was routine, including de novo branches and are hedged in order to minimize interest rate risk from the time that interest rates are initially locked during the application process. For loansbranch relocations. As a result of restructuring activities certain assets were liquidated, written down, or held for sale Berkshire enters into mandatory delivery or best efforts sale contracts with institutional secondary market purchasers.
Goodwill increasedat year-end. Intangible assets decreased due to thescheduled amortization of intangibles recorded in recent business combinations. Goodwill is the difference between the fair value of consideration paid for these acquisitions and the fair value of net assets and liabilities acquired. The balance of goodwill includes goodwill related to prior acquisitions. Goodwill is analyzed annually for impairment in accordance with accounting standards, and there was no impairment charge recognized based on the most recent analysis in 2012. In the current market environment, there was no significant intangible asset recorded for the fair value of core deposits acquired. Total intangible assets, were $274 million at year-end 2012, comparedincluding goodwill, decreased to $223 million at year-end 2011.
The total net deferred tax asset increased to $58$271 million from $41 million during 2012 primarily due to deferred taxes related to the loan purchase accounting discounts recorded for bank acquisitions. The purchase accounting portion of the asset increased to $28 million from $12$274 million during the year. DeferredThe cash surrender value of life insurance increased due to additional purchases of bank owned life insurance. Net deferred tax assets net of valuation allowances, are expecteddecreased to be realized in$51 million from $58 million during the future throughyear as some assets became current due to the reversal of existing taxable temporary differencesdeferrals and future taxable income. At year end 2012, the balance includedto ongoing earnings. The category of other assets decreased due to lower income tax receivables and lower derivatives assets resulting from changed valuations as a net $6.1 million asset related to approximately $20 million in net operating loss carry forwards from acquired institutions.result of higher interest rates.
DepositsDeposits. . In its overall New England/New York footprint, Berkshire increasedcontinued to develop its deposit market share from business activities based on most recent FDIC data. Berkshire continues to promote lower cost relationship oriented accounts in all of its markets, along with commercial deposits associated with its increased originations of commercial business loans and small business loans. Berkshire has also benefited from ongoing de novo branch expansionbase in its Albany, New York regionfootprint during 2013 while also making strategic adjustments in its funding strategies. Ongoing organic activity included three branches that were opened/relocated and has increased its commercial deposit acquisitionthe development of administrative support in the two new Eastern Massachusetts. Berkshire seeks to flexibly balance its objectives for market share and wallet share growth with its goals for controlling funds costs and its need for funds based on the totality of its asset/liability management goals.
Total deposits increased by $1.00 billion (32%) in 2012 to $4.10 billion. This included $834Massachusetts regional offices. The acquired Beacon operations, including $624 million in acquired deposits, fromwere integrated in the CBTfirst quarter of the year. Other retail initiatives included brand promotions and further development of small business banking, Berkshire’s MyBanker service, and various cross sell programs. Berkshire negotiated the purchase of 20 branches in Central New York which added an additional $440 million in balances when this purchase was completed shortly after year-end.
Berkshire adjusted its strategies in 2013 to reduce certain non-relationship deposit sources, including some sources that were part of the Beacon acquisitions. Excludingoperations as well as certain commercial money market deposits. These reductions took into account the anticipated benefit of low cost deposits acquired deposits, netin the branch acquisition shortly after year-end. Additionally, the Company managed its deposit sources in light of increased marginal impacts of deposit growth was $165 million (5%)on the cost of participating in 2012. This was concentrated in a $120 million increase in demand deposit balances which are targeted by Berkshire’s strategies to promote low cost relationship oriented accounts. Demand deposits increased to 16%the Depositors Insurance Fund (DIF). As part of total deposits from 14% as a result of this strong growth. Time deposits decreased to 29% of total deposits from 31%its restructuring program, the Company consolidated five branches during the year to better balance growth and time account runoff was offsetefficiency in targeted markets.
Total deposits decreased by $252 million (6%) to $3.85 billion in 2013 before $440 million in balances were added with the branch purchase in January 2014. Deposits include deposits held by Berkshire Bank Municipal Bank, which is a New York subsidiary of Berkshire Bank. The Bank is reducing its operations in this special purpose subsidiary which is restricted to municipal depositors. Total deposits in this subsidiary decreased to $42 million at year-end 2013 from $54 million at the start of the year and are expected to further decline in 2014.
During 2013, total demand deposits increased by 1% for the year, including 5% annualized growth in money market accounts which also reflected customer liquidity preferences in the ongoing low rate environment. Berkshire produced growth exceeding 5% from business activities for all major categories of deposits in 2012 except for this decrease in time deposits. The year 2012 was the fourth consecutive year in whichquarter. Berkshire targets low cost demand deposits as part of its relationship based development strategy for the deposit growth rate from business activities exceeded the loan growth rate from business activities, which has contributed to improved liquidity from operations. The ratioacquisition of loans/deposits was 97% at year-end 2012. Berkshire increased its total branch offices to 77 from 60 during the year 2012retail and continued with its ongoing program of gradually introducing its AMEB branch design in new locations. During 2012, Berkshire also introduced its My Banker personalized concierge banking service targeted towards meeting the financial services needs of professionals and others with similar qualifying banking needs.
Deposit growth included the benefit of four Albany area de novo branch offices that were opened in that market during the year. Much of the rest of the growth from business development was in commercial accounts in Central/Eastern Massachusetts as a result of Berkshire’s expanded operations in that market. Year-end commercialaccounts.
demand deposits increased to $413 million in 2012 from $262 million at the start of the year, including the benefit of commercial business development and bank mergers. Berkshire offers deposit insurance on 100% of its deposit balances due to a combination of insurance from the FDIC and the Massachusetts Depositors Insurance Fund. As the Company continues to pursue deposit growth across its expanding franchise, it expects to evaluate deposit protection alternatives.
By emphasizing lower cost non-maturity deposits and lowering time deposit costs, the Company has reduced the cost of its deposits in order to offset the impact of lower asset yields in the current low interest rate environment. The average annualized cost of deposits decreased to 0.53% in the fourth quarter of 2013 from 0.59% in the fourth quarter of 2012, compared to 0.73% in the fourth quarter of 2011. The cost of deposits also benefited from acquired accounts, which had an average cost of 0.50% for Beacon at the time of acquisition. A total of $655 million in time deposits is scheduled to mature in 2013, and the weighted average cost of time deposits is expected to continue to decline based on continuing low interest rates. In its pricing process,prior year. Berkshire seeks to maintain a flexible balance between supporting business volume growth in its regional markets while also supporting its net interest margin in light of ongoing yield compression for earning assets. The Company believes it has further capacity to adjust funding costs in future quarters if appropriate based on market and interest rate conditions. The Company expected the cost of the newly New York deposits to be in the range of 0.15 — 0.20% based on the higher proportion of lower cost transaction balances in the acquired branches.
The Bank is evaluating its future participation in the Depositors Insurance Fund which is supplemental to its FDIC insurance. The Bank plans to continue to pursue net organic growth of its deposits. If there are changes in this program, the Bank expects that current insured accounts will have reasonable notice and transition time if this supplemental insurance is modified. The terms of FDIC insurance are unaffected by any changes in the supplemental insurance program.
Borrowings and Other Liabilities. Berkshire utilizes borrowings to manage short term liquidity, to provide overnight funding for targeted asset classes, as medium term funding for portions of the loan portfolio, and for qualifying regulatory capital to support overall balance sheet soundness. Most outstanding borrowings are from the Federal Home Loan Bank of Boston, but the Bank and the holding company also utilize other established short term funding sources. In 2012, Berkshire expanded itsThe Company balances the flexibility and cost advantage of short term borrowed funds with strategic objectives for deposit funding and capital sources with the institutional placement of subordinated debt described below.liquidity.
Total borrowings increased by $211$616 million to $1.06 billion in 2012, including2013 and were the $117 million fair valueprimary source of borrowings acquiredfunds in bank mergers. As previously discussed, Berkshire routinely restructures the investments2013 for loan and borrowings of acquired banks to conform with its policies. In some cases this restructuring is accomplished shortly before the merger is consummatedinvestment growth and in other cases it is completed promptly after the effective time of the merger. In addition to acquired borrowings, Berkshire increased its use of overnight borrowings to fund growth in mortgage loans held for sale subsequenttargeted deposit reductions. Short term borrowings increased by $709 million to $873 million. All but $10 million of short term borrowings are from the recruitmentFederal Home Loan Bank of its Eastern Massachusetts mortgage banking team. These loans held for saleBoston and are generally liquidated within several weeks and it is common to fund these assets with overnight borrowings, thereby generating a positive spread based on normal credit terms from the long term fixed rate coupons ofFHLBB. The Company elected to extinguish certain FHLBB advances after-year end in conjunction with the mortgages held for sale.
On September 28, 2012, the Company received an investment by institutional investors of $75 million in fifteen year senior subordinated notes issued by the Company. The coupon on these notes is 6 7/8% fixed for the first ten years. Cash proceeds were primarily used to fund the cash consideration required for the acquisition of Beacon Federal Bancorp on October 19. The notes qualify for Tier 2 regulatory capital treatment for bank holding companies. As a savings and loan holding company, Berkshire Hills Bancorp is not presently subject to bank holding company regulatory capital requirements, but it is expected to become subject to these requirements in the future based on anticipated regulatory changes. One of the Company’s objectives with this capital placement was to reduce the long term cost of regulatory capital by obtaining fixed rate regulatory capital with tax deductible interest at this time of record low interest rates.New York branch purchase.
The cost of borrowings decreased steadily in 2012 from 3.35%to 1.69% in the fourth quarter of 2011 to 1.70% in the third quarter of 2012 due to the low interest rate environment and the increased use of overnight borrowings. The cost of borrowings increased to2013 from 2.80% in the fourth quarter of 2012, as the volume of lower cost short-term Federal Home Loan Bank borrowings increased. The average rate on this short term debt was 0.28% at year-end 2013. The overall cost of borrowings includes the impact of related interest rate swaps. In order to obtain fixed rate medium term funds as part of its interest rate risk management, the Company primarily relies on interest rate swaps associated with designated FHLB borrowings; time deposits are also utilized to provide longer duration fixed rate funds. The Company utilized forward starting interest rate swaps to fix the interest rate on a portion of the new borrowings in 2013. The Company elected to extinguish certain FHLB borrowings with a portion of the proceeds from the New York branch acquisition early in 2014.
Other liabilities of $82 million at year-end 2013 included $25 million in liabilities held for sale related to a branch outside of the Company’s footprint which was an operation acquired in a bank acquisition. Also included in other liabilities are derivative liabilities totaling $12 million, which decreased from $30 million at the prior year-end due to the impact of the higher couponmarket interest rates on the subordinated debt discussed above. The cost of borrowings includes the cost of interest rate swaps discussed in the following
section. Berkshire often uses variable rate borrowings from the Federal Home Loan Bank which are matchedloss associated with interest rate swaps with investment grade national banks in order to achieve the lowest cost and most flexible medium term funding. Additionally, Berkshire increased its use of forward starting swaps in 2012 in order to provide future interest rate protection of variable rate borrowings without increasing current period funding costs.derivative financial instruments.
Derivative Financial Instruments and Hedging Activities. At year-end 2012,2013, the Company heldnotional value of the Company’s derivative financial instruments withdecreased by $407 million to $905 million from $1.313 billion at the start of the year due to a $565 million decrease in mortgage banking related derivatives. This decrease was due to the decrease in mortgage banking activity and its impact on both interest rate lock commitments and forward sale commitments that hedge these interest rate locks. There was no significant change in the year-end balance of interest rate
swaps related to commercial loans. The notional amount totaling $1.312 billion, comparedof all other derivative financial instruments increased due to $578a $155 million increase in cash flow hedges on the Company’s FHLBB borrowings. This increase was concentrated in forward starting interest rate swaps fixing the interest rate on a portion of the $616 million increase in FHLBB borrowings recorded during the year as a result of growth in loans and investments and a reduction in deposits.
The net fair value liability associated with derivative instruments decreased to $4 million at year-end 2013 from $10 million at the start of the year. The increase primarily resulted from an increase in derivatives related to mortgage banking, which totaled $618 million in notional amount at year-end 2012, compared to $43 million at the start of the year. Most derivative instruments relate to routine lending activity with customers offset with interest contracts with national institutional counterparties in order to provide customers with the benefit of low rate long term borrowings.
The Company records a non-hedging derivative for interest rate lock commitments related to residential mortgage originations intended for sale. Most mortgage customers elect to lock a fixed interest rate at or around the time of making a mortgage application. The notional amount of these rate lock commitments totaled $283 million at year-end 2012.
The Company enters into forward commitments which are recorded as economic hedges in order to hedge the interest rate risk for rate locked mortgage applications in process and closed mortgage loans held for sale. These commitments are primarily forward sales of to-be-announced mortgage backed securities. Generally, when mortgage loans are closed, the forward commitment is liquidated and replaced with a mandatory delivery forward sale of the mortgageyear due to a secondary market investor. In some cases, a best-efforts forward sale agreement is utilized as$9 million decrease in the forward commitment. At year-end 2012, forward commitments totaled $336 million and were hedging the $283 million in interest rate lock commitments and the $85 million balance of mortgages held for sale. This resulted in a 91% coverage ratio of pipeline interest rate risk and allowed for potential application fallout. The Company endeavors to lock-in its gainloss on sale at the time of the rate lock agreement and to manage pipeline interest rate risk within established guidelines.
As previously discussed, the Company uses interest rate swaps in conjunction with commercial loan originations. The Company enters into a swap contract with the commercial customer and into an offsetting reverse swap contract with a national investment grade financial institution. Each of these contracts is recorded as an economic hedge, and the Company had a $205 million notional amount of customer swaps and an identical amount of reverse swaps at year-end 2012, which was increased from $160 million at the start of the year.
The Company also uses interest rate swaps recorded as cash flow hedges to fix theas a result of higher interest rate on certainrates, which was partially offset by a decline of its variable rate borrowings. These swaps totaled $270 million at year-end 2012, compared to $200 million at the start of the year. The year-end balance included $140$4 million in forward starting swaps.
Thethe net fair value of derivative financialmortgage banking related instruments as a result of the lower volume in the mortgage pipeline at the end of 2013.
The year-end notional amount of cash flow interest rate swaps related to FHLBB borrowings was estimated$410 million. All of these interest rate swaps were subsequently terminated in association with the Company’s election to repay certain FHLBB advances as a result of the New York branch purchase. The terminated swaps included $150 million currently paying at a net lossrate of $102.61% with a weighted average maturity of 2.5 years and $260 million at year-end 2012, compared towhich were forward starting with, on average, a net lossrate of $131.88% and a three year swap period beginning in mid 2015. The Company entered into $300 million atin new forward starting three year cash flow swaps on different FHLBB borrowings which start in the startfirst half of the year. The gross gain on derivative assets recorded in other assets totaled $20 million at year-end 2012, compared to $14 million at the start2016 with an average pay rate of the year. The gross loss on derivative instruments recorded in other liabilities totaled $30 million at year-end 2012, compared to $27 million at the start of the year. This loss is generally secured with investment securities pledged as collateral to counterparties.2.29%.
Stockholders’ Equity. Berkshire pursues a balance of capital to maintain financial soundness while using common equity efficiently with the goal to produce a strong return on equity and book value growth as a basis for shareholder value creation.
A sound capital structure reduces risk and enhances shareholder return and access to capital markets to support the Company’s banking activities and the markets that it serves. In its payment of dividends, management of treasury shares, issuance of equity compensation, and balancing of capital sources, the Company strives to achieve a capital structure that is attractive to the investment community and which satisfies the policy and supervision purposes of the Company’s regulators. When Berkshire negotiates business combinations, it generally expects to use its common shares as a significant component of merger consideration and to balance the mix of cash and stock to arrive at a targeted capital ratio based on the characteristics of the combined banks. All of the Company’s equity is owned by common stockholders.
In 2012, total equity increased by $115 million (21%) to $667 million, including $84 million in common stock issued for bank merger consideration. Berkshire issued 3.665 million shares for this consideration, at an average value of $22.99 based on the Berkshire stock closing price at the time of the acquisitions. Berkshire converted Beacon’s outstanding stock options to equivalent Berkshire stock options and recorded a $6 million credit to be paid in capital for the value of these options. Other sources of equity in 2012 included $3 million received from stock option exercises and $2 million in stock issued for equity compensation. For the year 2012, net income of $33 million funded cash stock dividends to shareholders of $16 million and contributed to a $14 million increase in retained earnings. In the fourth quarter of the year,2013, Berkshire increased its quarterly cash dividendleverage modestly as assets grew by 6%7% and equity grew by 2%, with most comprehensive income being returned to $0.18 per share. This was the second consecutive year with a 6% increase in the quarterly dividend.
shareholders through dividends and stock buybacks. The ratio of tangible equity/equity to tangible assets decreased to 7.5% from 7.8% and the ratio of equity to assets decreased to 12.0% from 8.7% during 2012 due to the additional leverage related to the year’s business combinations.12.6%. Tangible equity is a non-GAAP financial measure commonly used by investors and it excludes goodwill and other intangible assets, which increasedassets. Total shares outstanding decreased by $510.4% to 25.0 million to $274 million due to the business combinations during the year. The ratio ofand stock buybacks offset shares issued for equity to assets decreased to 12.6% from 13.8%, also due to the merger related leverage. Tangiblecompensation including option exercises. As a result, tangible book value per share increased by 4.1% to $15.63 from $15.53 due to the benefit of internal capital generation which offset the dilutive impact of business combinations which were all targeted to produce accretion to future earnings per share. Total$16.27 and total book value per share increased by 2% to $26.53$27.08. Due to an increase to $0.18 from $26.09, also due to$0.17 in the retained earnings benefit, which offsetquarterly dividend beginning in the lowerfourth quarter of 2012, the total dividend increased by 4.4% in 2013 and provided a 4.6% return on starting tangible book value per share value recorded on new shares issued as merger consideration.of $15.63.
At year-end 2012,2013, Berkshire Bank’s regulatory capital ratios exceeded the requirements to be considered “well capitalized”, with the. The total risk-based capital ratio increasing tomeasured 11.6% and was little changed from 11.8% from 11.3% at the start of the year. Berkshire Bank’s federal regulator is the FDIC. The increase reflected the higher proportion of lower risk residential mortgage related assets.
The Company is a savings and loan holding company and is not subject to specific regulatory capital requirements. In the third quarterrequirements as of 2011, the regulationyear-end 2013.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 20122013 AND 20112012
Net income increased by $8.0 million (24%) to $41.1 million in 2013. Earnings per share increased by $0.16 (11%) to $1.65. Berkshire’s results in 20122013 included a full year of operations for Beacon Federal (acquired in October 2012) and 2011 include operations acquiredCBT — The Connecticut Bank and Trust Company (acquired in both years.April 2012). As a result, most categories of revenue, expense, income, and expenseaverage balances increased due to these acquisitions in addition to ongoing operations. Earningsorganic growth from business activities.
During 2013, results were adversely affected by events in 2012 included the partialfirst half of the year. An industry-wide downturn in mortgage banking revenues began near midyear due to a sharp increase in long term interest rates. Additionally, commercial lending revenues were adversely impacted by accelerated outplacements of acquired impaired and non-relationship loans due to institutional demand for these lower quality assets. The near term impact of these events was partially offset by recoveries recorded to interest income through purchased loan accretion for collections of acquired impaired loans. In response to these events, management initiated a restructuring program in the second half of the year, benefitrecording restructuring charges and lowering operating expenses. As a result of operations acquiredthese events, net income decreased by 17% to $18.6 million in 2012the second half of the year from $22.5 million in addition to the full year benefitfirst half of operations acquired in 2011.the year. Earnings per share were affected by shares issued as merger consideration. Eight bank branches acquired in the Legacy acquisition in the third quarter of 2011 were designated as discontinued operations and were divested in thedecreased to $0.75 from $0.90 for these respective periods.
following two quarters. All references to revenue and expenseOperating results in this discussion exclude these discontinued operations. Operating resultsboth years were also affected by merger, conversion, and conversionrestructuring expenses, andtogether with gains recorded on securities and investments in acquired banks.
Net income increased by $15.8 million (91%) to a record $33.2 million in 2012, compared to $17.3 million in 2011. Earnings per share increased by $0.52 (54%) to $1.49 from $0.97. Net merger and nonrecurring items, including securities gains and results of discontinued operations, totaled $11.1 million and $10.4 million after-tax in 2012 and 2011 respectively. These amounts equated to $0.49 per share and $0.57 per share in 2012 and 2011 respectively. Excluding these items, adjusted earnings were $1.98 per share in 2012 and $1.54 in 2011.
The fourth quarter of 2012 was the first quarter in which results included all acquired operations. Net income totaled $9.3 million ($0.38 per share) in that quarter. Net merger and nonrecurring items as described above were $3.9 million ($0.16 per share). Before these net items, results of operations totaled $13.2 million ($0.54 per share).
The fourth quarter return on equity was 5.8%, and measured 8.2% before the net merger and nonrecurring items. The return on equity was 3.6% in 2010 before the Company undertook most of its recent growth initiatives. The Company views its return on equity before net merger and nonrecurring items as indicative of its underlying profitability from operations. The run rate of quarterly operating profitability has more than doubled over the past two years as a result of Berkshire’s growth initiatives including business development, team recruitment, and accretive acquisitions. Over that time, the Company has increased the tangible book value of its shares while also paying a steady and increasing stock dividend.
Berkshire has benefited from positive operating leverage, with revenue growth outpacing growth in operating expenses. Based on its financial and pricing disciplines, it has invested in earning assets and acquisitions according to its targets for double digit returns on its invested capital. Growth has resulted in a larger franchise, with improved market share and wallet share. These initiatives have also further diversified revenue sources and earnings streams, both geographically and among our business lines. Berkshire continues to focus on opportunistic investment and multiple earnings levers to support earnings growth and profitability improvement. It also continues to invest in its franchise, including targeted strengthening of staff, opening new offices, and rebranding selected existing offices.
Berkshire views its net merger related costs as part of the economic investment for its acquisitions. Conversion expenses were primarily related to the core systems conversion in 2012 which is a long term investment in the Company’s operating infrastructure. Berkshire’s project management office oversees an ongoing program of Six Sigma process improvement projects. These investments are intended to be accretive to return on equity and to contribute to long term earnings growth and franchise value. ReferencesThe Company expects to develop revenue synergies, operating efficiencies, and improved product and service capabilities based on the combination of its larger footprint and enhanced infrastructure.
The Company plans to resume earnings before merger, conversion,growth in 2014 based on positive operating leverage resulting from organic volume growth, disciplined expense management, and nonrecurring items (including results of discontinued operations) are not GAAP measures and are not intended to substitute for GAAP income and expense measures. Such items recorded in both years were within the rangeaccretive benefits of the Company’s expectations.New York branch acquisition. Berkshire plans to benefit from market share growth based on the contribution of recruited commercial banking teams as well as expanded sales teams and cross sale activity in most of its business lines.
Total Net Revenue.Berkshire evaluates its top line with the measure of net revenue, which is the sum of net interest income and non-interest income. The Company also evaluates net revenue before security gains/losses and nonrecurring items in order to evaluate the success of its operations. A critical focus of Berkshire’s strategy is to produce positive operating leverage by growing operating revenue at a higher pace than operating expenses. Berkshire also measures revenue per share to assess the accretion to shareholder value potential based on the Company’s growth initiatives.
Total net revenue increased by $55$29.5 million (39%(15%) to a record level of $197$227.0 million in 2013 due to the benefit of business combinations and organic growth. Net revenue per share increased by 3% to $9.09 in 2013 from $8.84 in 2012. Fee income decreased to 22% of net revenue in 2013 from 26% in the prior year due to the decrease in mortgage banking income. Berkshire targets fee income at 30% or more of revenues over the long run. This ratio declined from 28% in 2010 primarily because acquired banks had a higher reliance on net interest income as a revenue source.
Net revenue ended the year at a fourth quarter annualized run rate of approximately $238$222 million, which was a 49% increase over7% decrease from the $160 million annualized run ratefourth quarter of the previous year due to a 10% impact from the decrease in mortgage revenues from the record level
achieved in the fourth quarter of 20112012. Annualized fourth quarter revenue per share decreased by 9% to $8.94 from $9.78
Net Interest Income. Berkshire targets growth in net interest income based on increased business volumes related to market share gains in its markets. The Company also regularly evaluates the use of securities investments to contribute to income and profitability. In 2013, total loans increased by 5%, which was below the Company’s targets. This was due in part to the 26% runoff of higher yielding loans acquired in business combinations which was addressed in the previous discussion of changes in financial condition. This affected net interest income, together with Berkshire’s increased use of lower yielding investment as well as changes in loan mix and yield in the ongoing law interest rate enviorment. Total average earning assets increased by 17% in 2013 compared to 2012, including the full year benefit of business combinations.
Total net interest income increased by $25.4 million (18%) to $168.8 million in 2013 due to the growth in average earning assets. Interest income in 2013 also included a $1.3 million credit for an out of period adjustment. The full year net interest margin increased slightly to 3.63% in 2013 from 3.62% in the prior year. Fourth quarter net interest income decreased by 5% from year to year, measuring $159 million on an annualized basis in the final quarter of 2013. The fourth quarter net interest margin decreased to 3.26% from 3.67%.due to the aforementioned yield compression in 2013.
Net interest income includes purchased loan accretion on loans acquired in business combinations. This includes amortization of accretable yield as well as recoveries of accretable and nonaccretable yield arising from the collection of acquired impaired loans. Due to the Company’s workout activities and the premium market values for lower grade assets in 2013, total purchased loan accretion increased to $18.1 million in 2013 from $6.3 million in 2012. Accretion in 2013 included $17.2 million related to commercial loans and $2.4 million for consumer loans, less a charge of $1.5 million for residential mortgages. The unamortized balance of net accretable yield on impaired loans decreased by $5.7 million to $2.6 million at the end of 2013 and was expected to be substantially fully amortized in 2014. The prospect for additional recoveries of accretable and/or non-accretable yield on future collections of acquired impaired loans is unpredictable but is expected to contribute positively to net interest income due to ongoing favorable conditions for resolving these loans. At year-end 2013, the carrying amount of purchased credit impaired loans totaled $30 million, which was 57% of the contractual balance of these loans. At year-end 2012, the carrying amount was $62 million, which was also 57% of the contract balance of $108 million at that date. These balances decreased during 2013 due to active collection activities on these loans.
The yield on loans decreased to 4.26% in the fourth quarter of 2013 from 4.73% in the fourth quarter of 2012. The loan yield was 4.02% in the fourth quarter of 2013 excluding the benefit of purchased loan accretion, which totaled $2.4 million during that quarter, compared to $3.2 million in the same quarter of 2012. The fourth quarter yield on investment securities decreased to 2.72% from 3.17% from year to year, reflecting portfolio growth in the low rate environment. The cost of funds decreased to 0.73% from 0.84% including the impact of greater utilization of low cost short term borrowings together with ongoing reductions in deposit costs to 0.53% from 0.59%.
The quarterly net interest margin excluding loan accretion measured 3.07% in the final quarter of the year. The Company expects to realize a margin benefit from the acquisition of the low cost New York branch deposits shortly after year-end, along with the termination of interest rate swaps as a result of the deposit acquisition. While net interest income decreased by 3% from the second quarter to the fourth quarter of 2013, the Company’s goal is to produce future growth in net interest income including the benefit of the branch acquisition, an increase in loan balances, further investment purchases, and additional reductions in deposit funding costs.
The Company manages the pricing of its assets and liabilities with the objective of achieving an appropriate net interest margin and return on equity, while also achieving its asset/liability objectives. The Company strives to maintain a modestly asset sensitive interest rate risk profile so that earnings will benefit when interest rates increase from the very low levels that have existed in the most recent years. The current low level of interest rates is generally leading to tighter interest margins in the banking industry. The Company plans to actively manage its balance sheet and pricing and volume objectives to continue to balance current and long term earnings and profitability.
Non-Interest Income. Most of Berkshire’s non-interest income is fee income, which generally represents business conducted with customers in Berkshire’s markets. The Company pursues growth in market share and wallet share across its business lines, including banking, insurance, and wealth management. In commercial banking, Berkshire pursues commercial business loans with relationships that provide non-interest bearing demand deposit balances and that utilize fee services including electronic banking and cash management services.
Non-interest income increased by $4.2 million (8%) to $58.2 million in 2013, including a $0.5 million out-of-period credit. Fee income decreased by 1% and the increase in non-interest income was due to gains on equity securities and increased income from bank owned life insurance. The small decrease in fee income resulted from the 58% reduction in mortgage banking revenue, which was mostly offset by other revenue, including a full year benefit from acquired operations.
The sharp industry-wide contraction in mortgage demand near mid-year was discussed in earlier sections. This followed record volumes in the prior year. The Company had anticipated a more gradual return to normalized market volumes and planned a gradual expansion of future operations to partially offset gradual market changes. The sharp spike in rates depressed revenues more than the Company anticipated. Mortgage banking revenue decreased by $7.2 million in 2013 to $5.2 million due to lower volume and margins. Mortgage operations were restructured in the third quarter, and the Company expanded its recruitment of sales teams in the final quarter and continuing into 2014. In the final quarter of 2013, the gross gain on sale margin was approximately 2.02%, compared to 2.21% in the prior quarter. Mortgage banking revenues also varied from quarter to quarter depending on the volume of mortgages retained for portfolio. In the second half of the year, due to the rise in rates on 30 year fixed rate mortgages, the Company promoted 10/1 adjustable rate mortgages which were retained for the portfolio.
Loan and deposit fee income increased in 2013, including the benefit of the acquired Beacon operations. Loan fee income increased by $3.1 million (60%) to $8.2 million, including $3.9 million in loan servicing revenues, $1.6 million in commercial loan interest rate swap fees, and $1.5 million in revenue from seasoned loan sales. Deposit fees increased by $2.7 million (18%) to $18.3 million. These fees measured 0.47% of average deposits in 2013, compared to 0.45% in the prior year. Included in these fees were overdraft fees which measured 0.20% of average deposits, compared to 0.18% in the prior year. Wealth management fees increased by $1.4 million (19%) to $8.7 million in 2013, including the benefit of improved securities market prices together with organic account growth. Total wealth and investment assets under management increased in 2013 to $1.3 billion at year-end. Insurance revenues decreased by $0.8 million (7%) to $10.0 million due to volume and pricing conditions. In the latter part of the year, the Company implemented new initiatives to expand the distribution of insurance products across the footprint and business lines with the goal of producing future revenue growth.
The Company recorded $4.8 million in securities gains in 2013 due to the sale of community bank common stock to realize gains as a result of strong market price appreciation in 2013. The category of other non-interest income increased by $1.6 million to $2.9 million in 2013. This category included $3.6 million in 2013 for bank
owned life insurance and $0.7 million in book losses on tax credit limited partnerships with an offsetting $0.9 million credit to income tax expense.
Provision for Loan Losses. The provision for loan losses is a charge to earnings in an amount sufficient to maintain the allowance for loan losses at a level deemed adequate by the Company. The level of the allowance is a critical accounting estimate, which is subject to uncertainty. The level of the allowance was included in the discussion of financial condition. The provision for loan losses totaled $11.4 million in 2013, compared to $9.6 million in 2012. The provision for loan losses exceeded net loan charge-offs in both years, and resulted in an increase in the allowance for loan losses that was generally related to higher reserves on loans acquired in prior year business combinations as previously reported in the loan loss allowance discussion.
Non-Interest Expense. Berkshire’s goal is to generate positive operating leverage, growing revenues through market share expansion and maintaining expense management disciplines. Expense results also include merger and systems conversion costs that the Company views as economic investments in franchise expansion and infrastructure development. The Company also incurs current costs for team recruitment, de novo branch expansion, and technology and process development as part of its long term strategy to occupy a leading position as a regional provider in its footprint. In 2013, the Company created the position of Chief Administrative Officer in order to bring more focus to the revenue synergies, expense efficiencies, and sales and service process improvements that are possible as a result of recent expansion and systems conversions. The project management office reports to this position and manages ongoing Six Sigma process improvement projects, as well as acquisition integration — including the Beacon operations integrated in 2013 and the New York branch acquisition which was completed shortly after year-end. Also, in the third quarter of 2013, the Company initiated an expense restructuring program in order to focus on core competencies and adjust operations to the revenue downturn experienced during the year. The Chief Administrative Officer also oversees expenses that the Company views as non-core in assessing its operating activities.
Total non-interest expense increased by $16.6 million to $157.4 million in 2013 including the full year impact of operations acquired in 2012. This 12% increase was lower than the 15% revenue increase. As a result of the restructuring program, the total of compensation/occupancy/technology expense decreased by 7% in the fourth quarter compared to the second quarter, and by 9% compared to the fourth quarter of 2012. Fourth quarter annualized non-interest expense decreased to 2.70% of average assets in 2013 compared to 3.40% in the prior year. Expense included total merger, conversion, and restructuring expense totaling $14.8 million in 2013 and $18.0 million in the prior year. The Company does not view this expense as relating to future ongoing operating expense. Net of this expense, total fourth quarter annualized non-interest expense was 2.52% of average assets in 2013, compared to 2.83% in the prior year. Most major categories of expense increased due to acquired operations. All other expense totaling $17.3 million in 2013 included $3.4 million lending expense, $3.3 million loan workout expense, and $10.6 million in other expense. Full time equivalent staff totaled 939 at year-end 2013 compared to 1,012 at the prior year-end as a result of positions that were consolidated through integration and restructuring activities. An additional 92 full time equivalent staff were added with the purchase of 20 New York branches that was completed in January 2014.
Income Tax Expense. The effective income tax rate was 29% in both 2013 and 2012. Due to growth in pretax income, there was generally lower proportionate benefit related to tax advantaged income, including income from investments and bank owned life insurance. The impact of these changes would have been to increase the effective tax rate, but this was offset by a decline in merger related disallowances compared to 2012, as well as a significant reduction in the valuation allowance on deferred tax assets due to the realization of securities gains in 2013. State income tax expense in 2013 included a $1.0 million charge related to an out-of-period adjustment. The effective tax rate includes numerous adjustments from the statutory rate which are detailed in the Income Taxes note in the consolidated financial statements.
Results of Segment and Parent Operations. Berkshire Hills Bancorp (“the Parent”) has two subsidiary operating segments — banking and insurance. Results in the banking segment generally followed the levels and trends of consolidated results, which have been previously discussed. In the insurance segment, a 7% decrease in revenues was partially offset by a 5% reduction in expenses, and net income decreased by $0.2 million (15%) to $1.2 million.
The Parent’s net interest income included dividends from the banking and insurance segments and non-interest income includes undistributed earnings of these segments. Parent non-interest expense included administrative expense and professional fees related to acquisitions. Most of the Parent’s revenues are non-taxable revenues from subsidiaries, and the Parent therefore receives a tax benefit related to the taxable loss generated by its expenses.
Total Comprehensive Income. While net income increased by 24% in 2013, total comprehensive income was unchanged at $35.1 million in 2013 compared to 2012. The Company recorded a $6.1 million other comprehensive loss in 2013 compared to a $1.9 million gain in 2012. Due to higher interest rates at year-end 2013, available for sale securities changed from an unrealized gain to an unrealized loss, resulting in a $20.0 million net change in the unrealized securities gain/loss position as a result of lower market values for fixed rate investment securities. The Company had a partially offsetting impact related to its fixed rate interest rate swaps recorded as cash flow derivative hedges. The unrealized loss on these hedges decreased by $8.7 million in 2013. Total other comprehensive loss in 2013 also included small changes in other components and was net of a $6.1 million tax benefit.
Quarterly Results. Quarterly results for 2013 and 2012 are presented in a note to the consolidated financial statements. In 2013, quarterly interest income was affected by changes in recoveries collected on acquired impaired loans which resulted in credits to purchased loan accretion included in interest income. Interest income and expense were affected by a decrease in loans and deposits in the first half of the year, followed by a resumption in growth in the second half of the year. Interest income was also affected by compression of asset yields (excluding purchased loan accretion) in the ongoing low interest rate environment. Non-interest income was affected by a decline in mortgage banking revenue which began in the second quarter of 2013. Non-interest income also included the benefit of securities gains on the sale of community bank common stock, particularly in the fourth quarter. Variances in quarterly non-interest expense were primarily due to merger, conversion, and restructuring costs recorded during the year, including the completion of the Beacon integration in the first quarter and the initiation of a restructuring program in the second half of the year. Net income in the first quarter included the impact of merger expenses. Income improved in the second quarter as these expenses declined and the effective tax rate improved. Net income decreased in the third quarter due to the downturn in mortgage revenue and the recordation of restructuring costs, despite the high level of purchased loan accretion recorded in that quarter. Income increased in the fourth quarter due to the benefit of mergersorganic loan growth and organic growth. securities gains.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2012 AND 2011
Berkshire’s results in 2012 and 2011 included operations acquired in both years. As a result, most categories of revenue and expense increased due to these acquisitions in addition to ongoing operations. Earnings per share were affected by shares issued as merger consideration. Eight bank branches acquired in the Legacy acquisition in the third quarter of 2011 were designated as discontinued operations and were divested in the following two quarters. All references to revenue and expense in this discussion exclude these discontinued operations. Operating results were also affected by merger and conversion expenses, and gains recorded on investments in acquired banks.
Net income increased by $15.8 million (91%) to a record $33.2 million in 2012, compared to $17.3 million in 2011. Earnings per share increased by $0.52 (54%) to $1.49 from $0.97. Net merger and conversion items, including
securities gains and results of discontinued operations, totaled $11.1 million and $10.4 million after-tax in 2012 and 2011 respectively. These amounts equated to $0.49 per share and $0.57 per share in 2012 and 2011 respectively.
The fourth quarter of 2012 was the first quarter in which results included all acquired operations. Net income totaled $9.3 million ($0.38 per share) in that quarter. Net merger and conversion items as described above were $3.9 million ($0.16 per share). The fourth quarter return on equity was 5.9%.
Total Net Revenue. Total net revenue increased by $55 million (39%) to a record level of $197 million in 2012. Net revenue per share increased by 12% to $8.84 in 2012 compared to $7.93 in 2011, primarily reflecting the accretive revenue benefit of business combinations. Due to higher mortgage banking revenues, fee income was 26% of net revenue in 2012 compared to 24% in 2011. Berkshire targets fee income at 30% or more of revenues over the long run. This ratio declined from 28% in 2010 primarily because acquired banks had a higher reliance on net interest income as a revenue source.2011
Net Interest Income. Berkshire targets growth in net interest income based on increased business volumes related to market share gains in its markets. The Company also regularly evaluates the use of leveraged securities investments within risk management parameters to improve income and returns on capital. During 2012 and 2011, the Company’s focus was also significantly devoted to integrating assets and liabilities acquired in business combinations to maintain profitable relationships and optimize the benefit of acquired accounts in accordance with the financial targets established for these bank acquisitions. Net interest income increased by $37 million (35%) to $143 million in 2012, compared to 2011, including the benefit of the bank acquisitions net of discontinued operations. This included a full year’s benefit from 2011 acquisitions together with a partial year benefit from 2012 acquisitions.
The net interest margin increased to 3.62% in 2012 from 3.57% in 2011. The margin benefited from the addition of acquired bank balances. Based on fair value analyses performed as of the acquisition date, the net interest margin of acquired Beacon accounts was estimated at approximately 4.9%. This primarily reflected the higher yield assigned to acquired higher risk and impaired loans, including recording all impaired loans as accruing in accordance with accounting principles. Additionally, the yields assigned to acquired time deposits and borrowings reflected current low interest rates and remaining maturities. Berkshire believesestimated that its net interest margin from business activities was declining during 2012. This reflectsreflected the impact of asset repricings in the ongoing low interest rate environment, while deposit liability cost reductions were limited by competitive market conditions and the near zero level of many short term market interest rates.
The significant loan growth in the last two years has resulted in a balance of accretable yield on acquired loans totaling $18.1 million, including $8.2 million related to acquired impaired loans. Growth in residential mortgages has contributed to an increase in deferred loan costs and premiums totaling $10.6 million. The accretable yield is accreted into income while deferred costs are amortized against income. The net amount of purchase accounting loan accretion credited to net interest income was $6.3 million in 2012, compared to $3.2 million in 2011. The net amount of loan premium and cost amortization charged against net interest income was $2.3 million in 2012, compared to $1.1 million in the prior year. The growth in accretable yield and deferred costs have led to greater volatility in the quarterly net interest margin due to the uneven impacts of loan prepayments from quarter to quarter. Additionally, recoveries/charge-offs related to nonaccretable discount are recorded when acquired impaired loans are liquidated, and this activity is also variable and unpredictable.
Changes in asset yields and funds cost in 2012 included both the full year impact of acquisitions in 2011 as well as the partial year impact of acquisitions in 2012. Changes in fourth quarter yields and costs arewere indicative of changes in the run rate of these data from the end of 2011 to the end of 2012. The Company operated in an ongoing low interest rate environment, with further lows in long term rates in the second half of 2012.
The yield on earning assets decreased by 18 basis points to 4.43% in 2012, with the negative impact of asset repricings partially offset by the higher yield on acquired loans. This yield was 4.49% in the fourth quarter of the year, which was
unchanged from the fourth quarter of the prior year due to the benefit of Beacon assets acquired in the fourth quarter of 2012. The cost of funds decreased by 24 basis points in 2012 to 0.84%, reflecting lower deposit and borrowings costs. The cost of deposits decreased from 0.87% in 2011 to 0.65% in 2012, and declined to 0.59% in the fourth quarter of the year. This reflected the reductions in rates paid on all major categories of deposits, reducing the cost of interest bearing deposits by 0.23%.deposits. Lower deposit costs also reflected the strong growth rate in non-interest bearing demand deposits during the year. The Company believes that it has additional potential opportunities to lower deposit costs while continuing to increase its balances. The cost of borrowings trended down through the third quarter of 2012 and then increased to 2.80% in the last quarter of the year. This was due to the $75 million in subordinated debt financing issued for the Beacon acquisition at the end of the third quarter with a 6.875% coupon.
The Company adheres to disciplines in pricing its assets and liabilities in order to maintain an appropriate net interest margin and return on equity, while also achieving its asset/liability objectives. The Company strives to maintain a modestly asset sensitive interest rate risk profile so that long term earnings will benefit when interest rates increase from the very low levels that have existed in the most recent years. The current low level of interest rates is generally leading to tighter interest margins in the banking industry. The Company therefore plans to continue to adjust its pricing and to pursue volume growth in conjunction with its long term net interest margin objectives.
Non-Interest Income. Most of Berkshire’s non-interest income is fee income, which generally represents operating business conducted with customers in Berkshire’s markets. The Company pursues growth in market share and wallet share across its business lines, including banking, insurance, and wealth management. In commercial banking, Berkshire pursues commercial business loans with relationships that provide non-interest bearing demand deposit balances and that utilize fee services including electronic banking and cash management services. Berkshire acquired mortgage banking operations in 2012 and experienced record mortgage origination in the second half of the year due to record low interest rates. Mortgage banking became the second
largest source of non-interest income in 2012 and was the largest source in the second half of the year. The industry also experienced unusually high margins in mortgage banking operations during the year. Berkshire is pursuing further expansion of this business line to offset potential reversion of market volumes and margins towards historic levels.
Non-interest income totaled $54 million in 2012 and increased by $18 million (51%) over the prior year. This increase includedyear including the full year benefitimpact of the Rome and Legacy acquisitions and a partial year benefit of the CBT, Greenpark, and Beacon acquisitions.business combinations The $18 million increase included $13$12 million in growth in mortgage banking income. Excluding mortgage banking income, all other non-interest income increased by $5$6 million (14%(18%) primarily due to the benefit of business combinations, and includedincluding the benefit of gains inon the sale of seasoned loans and payments from new insurance and merchant processing vendors.
Mortgage origination income totaled $13.6$12.4 million in 2012 compared to $0.4 million in 2011. Most mortgage production in both years was fixed rate and Berkshire sells most of its fixed rate production to the secondary markets. Income on mortgages held for sale is recorded when mortgage applications are rate locked based on hedges and forward commitments at that time. Mortgage revenue is reported net of the direct costs of origination. Including the acquired mortgage operations, the Company estimated that the mortgage revenue recorded on loans originated for sale in 2012 was in the range of 1.10% - 1.15% of the mortgage amounts.
All other loan related income totaled $3.9$5.9 million in 2012, and included $1.6 million incontributions from commercial loan servicing fees and $0.9 million in interest rate swap income recorded on commercial lending activity. Deposit related fee income measured 0.45% of average deposit balances in 2012, compared to 0.50% in 2011. This
reduction included the impact of deposits of acquired banks which had a lower proportion of fee producing deposit products and commercial balances. Deposit fee income included overdraft fees which decreased as a percentage of average deposits due to the impact of acquisitions and regulatory changes.
Insurance fee income decreased by 2% in 2012. Due to changing industry conditions, the Company converted a significant portion of its policies to new carriers and surpassed its expectations for account retention. Insurance income has become less seasonal as a result of this change. Insurance income in 2012 included approximately $1.0 million related to successful account transition management, which offset a decrease in contingency income due to adverse claims experience resulting from weather events in 2011. Wealth management income increased by 25% primarily due to a full year benefit of Legacy operations acquired in July 2011. Fourth quarter wealth management fee income increased by 13% in 2012 compared to 2011, due to account growth and improved securities market prices on which much of the income is indexed. Total assets under management, including investment account balances, increased by 14 %14% to $1.1 billion at year-end 2012, reflecting gainssuccess in gaining market share based on service and investment performance.
The Company reported net gains totaling $1.5$1.4 million in 2012 and $2.1$2.0 million in 2011 which were primarily related to gains recorded at the time of the acquisition of merged banks as a result of common stock investments which had been made prior to merger discussions as part of the Company’s ongoing program to invest in common stock of regional community banks. In 2012, the Company reported $1.3 million in all other non-interest income. This included the benefit of income on bank owned life insurance policies. This benefit was partially offset by losses on tax shelter limited partnership interests; these losses are more than offset by the benefit to income tax expense due to income tax credits from these partnerships, which include low income housing and wind and solar power generation. Due to the seasoning of these participations,partnerships, the related losslosses decreased, resulting in the increase in all other non-interest income.
Provision for Loan Losses. The provision for loan losses is a charge to earnings in an amount sufficient to maintain the allowance for loan losses at a level deemed adequate by the Company. The level of the allowance is a critical accounting estimate, which is subject to uncertainty. The level of the allowance was included in the discussion of financial condition. The provision for loan losses totaled $10 million in 2012, compared to $8 million in 2011. The provision for loan losses exceeded net loan charge-offs in both years, and resulted in an increase in the allowance for loan losses that was generally related to higher reserves on acquired loans as previously reported in the loan loss allowance discussion.
Non-Interest Expense. Total non-interest expense increased in 2012 by $24 million (21%) to $141 million. This included a full year’s impact from 2011 acquisitions together with a partial year impact from 2012 acquisitions. Non-interestNon-
interest expense included conversion and merger related expenses totaling $18 million in 2012 and $20 million in 2011. Merger related expense included compensation and severance costs, professional services, and premises related charges. Conversion expense was primarily related to the Company’s core systems conversion in September 2012. Merger and conversion expenses in the last two years were within the range of management’s expectations, and the Company expects to achieve its cost saving targets for the Beacon acquisition in 2013 after the acquired operations are fully integrated.
As previously discussed, Berkshire does not view these merger and conversion expenses as elements of its ongoing operating expenses. Excluding these amounts, non-interest expense increased by $26 million 27% to $123 million. In comparison, total net revenue increased by 39% and Berkshire generated positive operating leverage which contributed to improved profitability. For each acquisition, Berkshire established cost savings targets which were an element of its expected return on investment. The Company believes that it is on track to achieve the cost savings estimates that were established for these mergers. Expense growth in both years included the impact of investments in business expansion, including new branches, and targeted resource additions in certain business lines and infrastructure development. Due to changes in its revenue mix and the impact of merger related, conversion and non-recurring items, the Company relies on non-GAAP measures to assess the efficiency of its operations. The Company believes that its efficiency is improving in accordance with its objectives, as a product of the positive operating leverage and resulting in benefits to its measures of return on equity which were previously discussed.
Most major categories of expense increased due to the additional expenses related to acquired operations. Full time equivalent staff totaled 1,012 employees at year-end 2012 compared to 760 at year-end 2011 (excluding staff related to discontinued operations). FDIC insurance expense continued to decrease to 0.08% of average deposits in relation2012, compared to average deposits.0.12% in the prior year. Expense of other real estate owned also decreased from higher levels in 2011 that resulted from write-downs of properties that were subsequently liquidated. Amortization of intangible assets increased to $5.3 million in 2012 from $4.2 million in the prior year, due primarily to the core deposit intangibles recorded for the bank acquisitions in both years.
Income Tax Expense on Continuing Operations. The effective tax rate on income from continuing operations was 28% in 2012, compared to 10% in 2011. The increase in rate is primarily due to the higher level of pretax income and the lower proportionate benefit of tax advantaged income from investments and bank owned life insurance. These two items provided a 7% reduction in the effective tax rate in 2012, compared to the 35% federal statutory rate. Additionally, the benefit from tax credit limited partnerships and other items offset the expense of the 4% effective rate of state income taxes.
Discontinued Operations. Discontinued operations consisted of eight former Legacy Bank branches held for sale in the second half of 2011. Four branches in Berkshire County were divested in the fourth quarter of 2011 for a net gain. The related effective tax rate was 80% due to the non-deductibility of goodwill for income tax purposes in determining the taxable gain on divestiture. Four branches in New York were divested in January 2012 with a loss resulting from conversion expenses. Discontinued operations provided $0.05 in earnings per share in 2011 and a loss of $0.03 in 2012.
Results of Segment and Parent Operations. Berkshire Hills Bancorp (“the Parent”) has two subsidiary operating segments — banking and insurance. Results in the banking segment generally followed the levels and trends of consolidated results, which have been previously discussed. In the insurance segment, a 3% decrease in revenues was offset by a reduction in expenses so that net income was little changed between 2012 and 2011. The Parent’s net interest income included dividends from the banking and insurance segment and non-interest income includes undistributed earnings of these segments. Parent non-interest expense included professional fees related to the bank acquisitions. Most of the Parent’s revenues are non-taxable revenues from subsidiaries, and the Parent therefore receives a tax benefit related to the taxable loss generated by its expenses.
Total Comprehensive Income. Total comprehensive income includes net income together with other comprehensive income, which was $1.9 million in 2012 and $1.5 million in 2011. Other comprehensive income in both years primarily resulted from unrealized securities gains related to lower market interest rates. Improved results in 2012 were partly offset by a $2.1 million increase in the unrealized loss on derivative hedges due to higher volumes and lower rates in 2012. In 2011, results were net of a $1.1 million net loss on pensions acquired in business combinations.
Quarterly Results. Quarterly results for 2012 and 2011 are presented in a note to the consolidated financial statements. Quarterly results of operations have been significantly affected by acquisitions, with acquired operations recorded beginning on the acquisition date and merger related expenses being recorded most significantly in periods proximate to the acquisition date. Most categories of revenue and expense increased as a result of these acquisitions, and earnings per share were affected by new shares issued as merger consideration. In the second half of 2011, the Company designated eight Legacy branches as discontinued operations; including conversion expenses, these operations operated at a loss pending divestiture, which resulted in a divestiture gain on four Berkshire County branches in the fourth quarter of 2011 and a divestiture loss on four New York branches in the first quarter of 2012. Quarterly results of operations include revisions as noted in the Revision to Financial Statements note in the consolidated financial statements in 2012 and 2011.
Net interest income increased in each quarter of 2012 due to growth in earning assets resulting from acquisitions and business activities. The acquisition of Greenpark Mortgage operations increased fee income beginning in May. Strong mortgage refinancing demand in the second half of the year further boosted fee income while depressing the net interest margin due to the write-off of mortgage premiums and deferred costs on balances refinanced. A $1.4 million net securities gain was recorded in the fourth quarter due primarily to gains on Beacon stock investments recognized on the merger date. The provision for loan losses increased modestly in the second half of 2012 and net loan charge-offs also increased modestly. As noted above, merger related expenses contributed to changes in non-interest expense, along with charges for the Company’s core systems conversion which was completed in September. The effective income tax rate increased during the year as pretax income increased and the proportional benefit of tax preferences decreased. The effective tax rate decreased in the final quarter due to lower pretax income as a result of Beacon merger related charges.
In 2011, in addition to the impact of the acquisitions, net interest income benefited from an improvement in the net interest margin which primarily reflected lower funding costs as deposit rates were reduced in the ongoing low interest rate environment. Changes in the loan loss provision reflected small changes in the loan loss allowance analysis. Third quarter non-interest income included gains recorded on existing investments in Legacy common stock. Quarterly non-interest expense included the impact of the merger related charges noted above. The effective income tax rate for continuing operations decreased to 8% in the second half of the year from 18% in the first half of the year due primarily to the timing of the Legacy acquisition and the related branch divestiture, and costs related to those activities.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2011 AND 2010
Berkshire’s results in 2011 included Rome operations acquired on April 1, 2011 and Legacy operations acquired on July 21, 2011. As a result, most categories of revenue and expense increased due to these acquisitions. Earnings per share were affected by the issuance of 7.0 million additional Berkshire common shares related to these acquisitions. All references to revenue and expense in this discussion exclude discontinued operations of Legacy branches.
Net income increased by $3.7 million (27%) to $17.3 million in 2011, compared to $13.6 million in 2010. Earnings per share decreased slightly to $0.97 from $0.98 due to the additional shares issued for the bank acquisitions. Results in 2011 included $10.4 million in after-tax impact from conversion and merger related items and discontinued operations, compared to $0.4 million for such items in the prior year. Excluding these items, earnings per share benefited from positive operating leverage resulting from revenue growth and disciplined expense management, together with the accretive benefit of the Rome and Legacy acquisitions.
Merger related items were within the range of the Company’s expectations. Merger related expenses consisted primarily of severance and benefit related costs related to the change in control of the acquired entities. Merger expenses also included professional fees and contract termination costs.
Total Net Revenue.Total net revenue increased by $36 million (33% compared to the comparable prior period measure) to a record level of $142 million in 2011. Net revenue per share increased by 3% to $7.93 in 2011. Fee income was 24% of net revenue in 2011, compared to 28% in the prior year, as the acquired banks had a higher reliance on net interest income as a revenue source.
Net Interest Income. Net interest income increased by $30 million (38%) to $107 million in 2011 compared to 2010, including the benefit of the bank acquisitions net of discontinued operations. The net interest margin improved to 3.57% in 2011 compared to 3.28% in 2010. The average yield on earning assets decreased to 4.61% in 2011, compared to 4.73% in the prior year, reflecting the ongoing impact of the low interest rate environment on portfolio yields and on the market interest rates assigned to acquired assets. Net interest income in 2011 included $3.2 million in net credits to interest income for accretion of net discounts on acquired loans. In the ongoing low interest rate environment, the cost of interest bearing liabilities decreased to 1.23% in 2011 compared to 1.72% in the prior year. The cost of deposits decreased to 0.87% in 2011 compared to 1.28% in the prior year.
Non-Interest Income. Non-interest income increased by $6 million (20%) to $36 million in 2011 compared to 2010, including the benefit of the bank acquisitions net of discontinued operations. Deposit related fees increased by $2.8 million (25%) in 2011. Compared to average deposit balances, deposit fees measured 0.50% of average deposits in 2011, compared to 0.53% in the prior year, due primarily to the full year impact of the 2010 adoption of Regulation E affecting overdraft fees. Insurance fee income was flat in 2011, with certain volume gains being offset by ongoing soft insurance premium pricing conditions and lower contingency revenues. The acquired banks had no significant insurance revenues. Wealth management revenues increased by 31% primarily due to the benefit of acquired Legacy operations. Year-end total wealth and investment assets under management increased to nearly $1 billion in 2011 including the acquired Legacy portfolio.
Non-interest income included bank owned life insurance income and losses on tax credit related equity limited partnership interests. Bank owned life insurance income is based on increases in the cash surrender value of these insurance policies. This income was $2.3 million in 2011, compared to $1.4 million in 2010, primarily reflecting the additional acquired policies from the merged banks. Losses on tax credit partnership interests totaled $1.9 million in 2011, compared to $1.4 million in 2010. These losses were more than offset by credits to current period income tax expense which are based on government programs to subsidize the related investments, which include low income housing and solar energy installations. The Company also reported $2.1 million in non-recurring gains in 2011 which primarily related to gains recorded on equity investments in Rome and Legacy which had been made prior to merger discussions as part of the Company’s ongoing program to invest in common stock of regional community banks.
Provision for Loan Losses. The provision for loan losses is a charge to earnings in an amount sufficient to maintain the allowance for loan losses at a level deemed adequate by the Company. The level of the allowance is a critical accounting estimate, which is subject to uncertainty. The provision for loan losses totaled $8 million in 2011, compared to $9 million in 2010. The provision for loan losses exceeded net loan charge-offs in both years, and resulted in an increase in the allowance for loan losses that was generally related to loan growth.
Non-Interest Expense. Total non-interest expense increased by $34 million (42%) to $116 million in 2011 compared to 2010. Most categories of non-interest expense increased as a result of the Rome and Legacy acquisitions in 2011. Non-interest expense in 2011 included $20 million in system conversion and merger related expenses. These expenses included $9 million in compensation and severance related expenses, $5 million in professional services, and $3 million in premises related charges, together with accruals for systems conversion costs. Excluding these items, non-interest expense increased by $15 million (18%). Berkshire estimated that by year-end 2011, it had achieved its targeted recurring non-interest expense savings of 35% related to Rome operations and 42% related to Legacy operations.
At the beginning of the second quarter, the FDIC implemented new banking industry deposit insurance assessment rates and formulas. This change reduced FDIC insurance expense, which measured 0.12% of average deposits in 2011, compared to 0.17% in 2010. Expense of other real estate owned increased in 2011 primarily due to write-downs of foreclosed real estate. Amortization of intangible assets increased due primarily to the core deposit intangibles recorded for the bank acquisitions.
Income from Continuing Operations. Income from continuing operations increased by $3 million (21%) to $16 million in 2011 compared to 2010. The effective tax rate on income from continuing operations was 10% in 2011 compared to 15% in 2010. Results in 2011 and prior years included the impact of an accounting error correction related to the tax credit limited partnerships which was not material to the financial statements. This tax credit, which equated to a 7% effective credit to the 2011 effective tax rate, was previously reported as a component of non-interest income. The decrease in 2011 also reflected the benefit of non-taxable gains on the Rome and Legacy acquisitions.
Income from Discontinued Operations. Income from discontinued operations was $914 thousand in 2011. Discontinued operations related to branches held for divestiture in the second half of 2011. Four of these branches were divested in the fourth quarter and the remaining four were divested in January 2012. The divestiture in 2011 resulted in a $5.0 million pre-tax gain. The tax rate on discontinued operations was 80% due to the non-deductibility of goodwill for income tax purposes in determining the taxable gain on divestiture. Primarily as a result of this higher tax rate on discontinued operations, the effective tax rate on total continuing and discontinued operations increased to 25% in 2011 from 15% in the prior year.
Results of Segment and Parent Operations. Results in the banking segment generally followed the levels and trends of consolidated results, which have been previously discussed. In the insurance segment, revenues decreased by 1% due to ongoing soft pricing conditions and reduced contingency fees in the industry. Expenses decreased by 7%, and as a result, insurance segment net income increased by 27%. The Parent’s net interest income included dividends from the insurance segment. Parent non-interest expense increased due primarily to professional fees related to the bank acquisitions. Most of the parent’s revenues are non-taxable revenues from subsidiaries, and the Parent therefore receives a tax benefit related to the taxable loss generated by its expenses.
Total Comprehensive Income. The Company recorded comprehensive income of $19 million due primarily to $17 million in net income discussed previously. Comprehensive income in 2010 was $10 million, including net income of $14 million which was partially offset by an other comprehensive loss relating to unrealized losses on derivatives instruments due to ongoing low interest rates.
LIQUIDITY AND CASH FLOWS
Liquidity is the ability to meet cash needs at all times with available cash and from established external liquidity sources or by conversion of other assets to cash at a reasonable price and in a timely manner. At year-end 2012,2013, the parent company had $40 million in cash and equivalents, compared to $16 million atwhich was unchanged from the start of the year. This cash was held on deposit in the Bank. The primary ongoing source of funding for the parent company is dividend payments from the Bank and from Berkshire Insurance Group. These subsidiaries paid $17$30 million in dividends to the parent in 2012. Additional potential sources of liquidity are proceeds from borrowings and capital offerings, and from stock option exercises. In 2012, the Company issued $752013, compared to $17 million in subordinated notes to fund merger cash consideration.2012. The Company also arrangedhas a $10 million unsecured line of credit for working capital purposes; this line was fully utilized at year-end.each of the last two year-ends. The main uses of liquidity are the payment of common stockholder dividends, routine operating expenses, debt service on outstanding borrowings and debentures, purchases of treasury stock, and businessbank acquisitions. The Company generally expects to maintain cash on hand equivalent to normal cash uses, including common stock dividends, for at least a one year period. Sources and uses of cash at the parent are reported in the condensed financial statements of the parent company included in the notes to the consolidated financial statements. There are certain restrictions on the payment of dividends by the Bank as discussed in the Stockholders’ Equity note to the consolidated financial statements. As of year-end 2012,2013, the statutory limit on future dividend payments by the Bank totaled $41$39 million. This amount is based on retained earnings of the Bank and is expected to be supplemented by future bank earnings in accordance with the statutory formula.
The Bank’s primary ongoing source of liquidity is customer deposits and the main use of liquidity is the funding of loans and lending commitments. Additional routine sources are borrowings, repayments of loans and investment securities, and the sale and repayments of investment securities. In 2012,2013, the primary uses of funds were loan growth, purchases of investment securities, and an increase in mortgage loans held for sale.targeted reductions of non-relationship deposits. The primary sourcessource of funds were deposit growth and borrowings.was short term borrowings from the FHLBB. The Bank closely monitors its liquidity position on a daily basis. Sources of borrowings include advances from the FHLBB and borrowings at the Federal Reserve Bank of Boston. As of year-end 2012,2013, based on its arrangements and collateral amounts, the Bank had potential borrowing capacity totaling $622$416 million with the Federal Home Loan Bank of Boston. The Bank is also expanding its relationships with correspondent banks and securities firms to maintain availability for overnight borrowings and repurchase agreements. The Bank utilizes the mortgage secondary market as a source of funds for residential mortgages which are sold into that market. Secondary market counterparties include federal mortgage agencies and national financial institutions. The Bank also utilizes national bank counterparties for derivative instruments that it uses in conjunction with its borrowing and mortgage banking activities.
In all three of the most recent years, deposit growth has exceeded loan growth. In 2011 and 2010, excess funds from deposit growth were used to pay down borrowings. In 2012, the Company decided to take advantage of capital market conditions by utilizing fixed rate subordinated debt rather than common equity for merger consideration. The Company also utilized overnight funds to support its expanded mortgage banking operations. As a result, the use of borrowings increased in 2012. One general measure of liquidity is the loan/deposit ratio, which was affected by the activities described above, together with the impact of financial instruments acquired in business combinations. This ratio stood at 97% at year-end 2012, compared to 95% at the start of the year and indicated a favorable but slightly less liquid position as a result of the year’s events. For the industry, a key challenge has been growth in liquidity - as savings activities in the economy have outpaced investment activities. Banks have had to carry more of their deposit funds in liquid cash and securities, rather than in loans. Due to its acquisition activities, the Company has been able to build its balance of loans and loans held for sale in addition to the volume generated from loan operations. The Company believes that it is continuing to improve its access to sources of liquidity and capital. In 2012, this included major expansions in secondary market and loan sales outlets along with financial derivatives sources, expansion of fed funds sources, continued de novo branch expansion, the initiation of a parent company line of credit, the private
placement of institutional subordinated debt which qualifies as regulatory capital, and the higher volume of issued and outstanding common stock. Through its business combinations, Berkshire now has branches in new geographic markets which are a potential source of new deposit funding in the future.
The greatest sources of uncertainty affecting liquidity are deposit withdrawals and usage of loan commitments, which are influenced by interest rates, economic conditions, and competition. Due to the unusual and prolonged low interest rate environment, there is uncertainty about the behavior of deposits if interest rates increase at some future time as anticipated. The Company believes that its market positioning and relationship focus will generally enhance the stability of its deposits, and it also models various scenarios for the purpose of contingency liquidity planning. The Company has had success in building commercial deposits, including large balances from certain sources. The Company monitors its deposit concentrations to manage the impact
Bank offers 100% insurance on all deposit balances as a result of the combination of FDIC insurance and the Massachusetts Depositors Insurance Fund. Due to its growth, the Bank may need to consideris considering alternatives to its use of thisDIF supplementary insurance and its liquidity planning ashas expanded as a result. The Bank relies on competitive rates, customer service, and long-standing relationships with customers to manage deposit and loan liquidity. Based on its historical experience, management believes that it has adequately provided for deposit and loan liquidity needs. Both liquidity and capital resources are managed according to policies approved by the Board of Directors and executive management and the Board reviews liquidity metrics and contingency plans on a regular basis.
CAPITAL RESOURCES
The Bank must satisfy various regulatory capital requirements. Regulatory capital requirements are discussed in the Regulation and Supervision section of Item 1, in the Risk Factors discussion, and in the Stockholders’ Equity note to the consolidated financial statements. Please also see management’s discussion of financial condition for additional information about liquidity and capital at year-end 2012.2013. In November, 2012, the Company renewed a universal shelf registration with the Securities and Exchange Commission for the issuance of up to $150 million in securities, including debt securities, common stock, or preferred stock. The Company did not issue any securities under the previous registration, and does not have any specific plans for issuances under the current registration. The Company is assessing the impact of the new Basel III capital standards previously discussed in the discussion on Regulation and Supervision in this report. At this time, the Company does not anticipate any material impact on its operations from these new capital standards.
Berkshire views its earnings and related internal capital generation as a primary source of capital to support dividends and growth of the franchise. Additionally, the Company generally uses the issuance of common stock as the primary source of consideration for bank acquisitions, and such acquisitions may result in net increases or decreases in its capital ratios. In 2012, the bank acquisitions resulted in a net increase in the Company’s capital ratios due to the use of subordinated debt to achieve a more favorable blended cost of capital. Berkshire’s long term objective is to generate a double digit annual return on equity, and the Company evaluates lending, investment, and acquisition decisions with this objective as a benchmark. In the fourth quarterThe Capital Committee of 2011, Berkshire’s Board of Directors established a new Capital Committee, which is responsible for assisting the Board in planning for future capital needs and for ensuring compliance with regulations pertaining to capital structure and levels. In 2012, Berkshire increased its outstanding shares by 19% from 21.1 million to 25.1 million due to the issuance of merger consideration. The Company believes that this provides further liquidity and visibility to its common stock, and that the market for its stock is an additional capital resource over the long run. Additionally, the Company continues to monitor market conditions for Tier Two regulatory capital such as preferred stock or subordinated debt, which are additional potential future capital resources to the Company and/or the Bank.
AVERAGE BALANCES, INTEREST, AVERAGE YIELDS/COST AND RATE/VOLUME ANALYSIS
Tables with the above information are presented in Item 6 of this report.
CONTRACTUAL OBLIGATIONS
The year-end 20122013 contractual obligations were as follows:
Item 7-7A - Table 1 - Contractual Obligations
|
|
|
| Less than One |
| One to Three |
| Three to Five |
| After Five |
| |||||||||||||||||||||
(In thousands) |
| Total |
| Year |
| Years |
| Years |
| Years |
|
| Total |
| Less than One |
| One to Three |
| Three to Five |
| After Five |
| ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| ||||||||||
FHLBB borrowings (1) |
| $ | 348,471 |
| $ | 246,067 |
| $ | 30,280 |
| $ | 31,645 |
| $ | 40,479 |
|
| $ | 964,428 |
| $ | 892,525 |
| $ | 20,000 |
| $ | 16,583 |
| $ | 35,320 |
|
Subordinated notes |
| 89,617 |
| — |
| — |
| — |
| 89,617 |
|
| 89,679 |
| — |
| — |
| — |
| 89,679 |
| ||||||||||
Operating lease obligations (2) |
| 137,106 |
| 6,505 |
| 13,303 |
| 13,546 |
| 103,752 |
|
| 51,519 |
| 5,980 |
| 9,341 |
| 6,885 |
| 29,313 |
| ||||||||||
Purchase obligations (3) |
| 73,528 |
| 16,396 |
| 21,868 |
| 17,632 |
| 17,632 |
|
| 99,304 |
| 17,607 |
| 30,469 |
| 25,614 |
| 25,614 |
| ||||||||||
Total Contractual Obligations |
| $ | 648,722 |
| $ | 268,968 |
| $ | 65,451 |
| $ | 62,823 |
| $ | 251,480 |
|
| $ | 1,204,930 |
| $ | 916,112 |
| $ | 59,810 |
| $ | 49,082 |
| $ | 179,926 |
|
Merger related obligations are not included.
(1) Consists of borrowings from the Federal Home Loan Bank. The maturities extend through 2027 and the rates vary by borrowing.
(2) Consists of leases, bank branches and ATMs through 2036.2039.
(3) Consists of obligations with multiple vendors to purchase a broad range of services.
Further information about borrowings and lease obligations is in the notes on borrowings and commitments to the financial statements. Other obligations increased, including the impact of business combinations, system upgrades, and overall business expansion.
OFF-BALANCE SHEET ARRANGEMENTS
In the normal course of operations, Berkshire engages in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in the Company’s financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. A further presentation of the Company’s off-balance sheet arrangements is presented in the notes to the consolidated financial statements and in the above discussion relating to payments due under contractual obligations. Information about derivative financial instruments and hedging activities is reported in the related note to the consolidated financial statements, and was included in management’s discussion of changes in financial condition. In addition to the contractual arrangements discussed above, at year-end 2013 the Bank had an agreement to purchase 20 branches and related deposits as described in the subsequent events note to the financial statements and this purchase was completed on January 17, 2014. This transaction included the assumption of operating lease obligations for these operations.
FAIR VALUE MEASUREMENTS
The most significant fair value measurements recorded by the Company are those related to assets and liabilities acquired in business combinations. These measurements are discussed further in the mergers and acquisitions note to the consolidated financial statements.
The Company makes further measurements of fair value of certain assets and liabilities, as described in the related note in the financial statements. Recurring fair values of financial instruments primarily relate to the trading security, securities available for sale, loans held for sale, and derivative instruments. A valuation hierarchy is utilized based on generally accepted accounting principles. Measurements based on Level 3 inputs rely the most on subjective management judgments. Level 3 recurring measurements relate primarily to the $17 million fair value of a local tax advantaged economic development bond issued to a Berkshire County non-profit, which is classified as a trading security. Changes in the fair value of this security are recorded in non-interest income, as are offsetting changes in the accompanying interest rate swap.and derivative instruments. Non-recurring fair value measurements primarily relate to securities held to maturity, restricted equity securities, impaired loans, and goodwillcapitalized mortgage servicing rights, and other
intangibles. real estate owned. When measurement is required, these measures are generally based on Level 3 inputs. Non-recurring fair values
The Company also provides a summary of estimated fair values of financial instruments at each quarter-end. The category of financial assets with the most significant difference historically between carrying value and fair value is the net loan category, which is valued based entirely on Level 3 analysis. The fair value of loans is estimated to be at a $7 million dollar premium to carrying value at year-end 2013, compared to a $49 million (1%(1.2%) premium to carrying value at year-end 2012, compared to a 2% premium at year-end 2011 and a 3% premium at year-end 2010.2012. The premium value of loans has narrowed based on higher prepayment speeds and lower replacement yields despite the benefit of ongoing improvement in the credit profile of the portfolio. Additionally, as the portfolio had grown due tochange in the acquisitionpremium value of loans in business combinationsreflects higher medium term interest rates at year-end 2013 compared to year-end 2012, which are recorded at fairhad a negative impact on the value of fixed rate obligations. At both measurement periods, the fair value premiumdiscount related to loans recorded at cost has declined as a percentage ofsubordinated borrowings generally offset the whole portfolio. The excess fair value of deposits over carrying amount increased modestly due toamounts and included the impact of lower markethigher interest rates despite continuing decreasesat year-end 2013. The reduction in the costpremium value of time deposits. Asloans therefore contributed to a result of the lower loan premium and higher deposit value, there was a declinereduction in the net economic value of equity related to those instruments, based solely on the measures used for the purpose of this analysis. This change reflects the mounting pressure on net interest margins and the increase in the industry,long term interest rates at year-end 2013, but does not take into account the non-interest income generated by these customer relationships or the long term intangible value of the Company’s franchise in its markets.
IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related financial data presented in this Form 10-K have been prepared in conformity with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike many industrial companies, substantially all of the assets and liabilities of the Bank are monetary in nature. As a result, interest rates have a more significant impact on the Bank’s performance than the general level of inflation. Interest rates may be affected by inflation, but the direction and magnitude of the impact may vary. A sudden change in inflation (or expectations about inflation), with a related change in interest rates, would have a significant impact on our operations.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
Please refer to the note on Recent Accounting Pronouncements in Note 1 to the consolidated financial statements for a detailed discussion of new accounting pronouncements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MANAGEMENT OF INTEREST RATE RISK AND MARKET RISK ANALYSIS
Qualitative Aspects of Market Risk. The Company’s most significant form of market risk is interest rate risk. The Company seeks to avoid fluctuations in its net interest income and to maximize net interest income within acceptable levels of risk through periods of changing interest rates. The Company maintains an Asset/Liability Committee that is responsible for reviewing its asset/liability policies and interest rate risk position. This Committee meets monthly and reports trends and interest rate risk position to the Risk Management Committee and Board of Directors on a quarterly basis. The extent of the movement of interest rates is an uncertainty that could have a negative impact on the Company’s earnings. The Company has managed interest rate risk by emphasizing assets with shorter-term repricing durations, periodically selling long term fixed-rate assets, promoting low cost core deposits, and using FHLBB advances to structure its liability repricing durations. The Company also uses interest rate swaps in order to enhance its interest rate risk position and manage its balance sheet.
Quantitative Aspects of Market Risk. The Company uses a simulation model to measure the potential change in net interest income that would result from both an instantaneous or ramped change in market interest rates assuming a parallel shift along the entire yield curve. The chart below shows the analysis of a ramped change. Loans, deposits and borrowings were expected to reprice at the repricing or maturity date. The Company uses prepayment guidelines set forth by market sources as well as Company generated data where applicable. Cash flows from loans and securities are assumed to be reinvested based on current operating conditions and strategies. Other assumptions about balance sheet mix are generally held constant. No material changes have been made to the methodologies used in the model.
78Item 7-7A - Table 2 - Qualitative Aspects of Market Risk
Change in |
| 1- 12 Months |
| 13- 24 Months |
| ||||||
Points (Rate Ramp) |
| $ Change |
| % Change |
| $ Change |
| % Change |
| ||
(In thousands) |
|
|
|
|
|
|
|
|
| ||
At December 31, 2013 |
|
|
|
|
|
|
|
|
| ||
+ 300 |
| $ | (3,395 | ) | (2.13 | ) | $ | (1,872 | ) | (1.19 | )% |
+ 200 |
| (2,398 | ) | (1.51 | ) | (937 | ) | (0.59 | ) | ||
+ 100 |
| 1,165 |
| 0.73 |
| 6,312 |
| 4.00 |
| ||
- 100 |
| (3,664 | ) | (2.30 | ) | (9,262 | ) | (5.87 | ) | ||
|
|
|
|
|
|
|
|
|
| ||
At December 31, 2012 |
|
|
|
|
|
|
|
|
| ||
+ 300 |
| $ | 2,018 |
| 1.35 | % | $ | 5,757 |
| 3.99 | % |
+ 200 |
| 1,126 |
| 0.75 |
| 3,732 |
| 2.59 |
| ||
+ 100 |
| 463 |
| 0.31 |
| 1,779 |
| 1.23 |
| ||
- 100 |
| (3,418 | ) | (2.28 | ) | (10,683 | ) | (7.40 | ) |
At year-end 2013, the table above shows that Berkshire’s net interest income at risk was estimated to be asset sensitive in the event of a 100 basis point rate increase, with modest liability sensitivity in the event of larger rate increases. This position reflected the increased use of short term FHLB borrowings prior to the acquisition of New York deposits which was completed in January 2014. The Company anticipated that its net interest income would be modestly asset sensitive in year two of all modeled two year ramp scenarios including the acquired New York deposits.
In addition to net interest income, some sources of non-interest income are sensitive to changes in interest rates and market conditions, including mortgage banking fees and commercial loan interest rate swap revenue. Mortgage banking fees declined significantly in 2013 due to a steepening of the yield curve which caused an industry-wide reduction in revenue as a result of lower volumes and margins. Changes in interest rates can also affect loan and
Item 7-7A - Table 4 - Qualitative Aspectssecurity prepayment speeds, which can result in changes in the amortization of Market Risk
Change in |
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|
|
|
|
|
|
|
| ||
Interest Rates-Basis |
| 1- 12 Months |
| 13- 24 Months |
| ||||||
Points (Rate Ramp) |
| $ Change |
| % Change |
| $ Change |
| % Change |
| ||
(In thousands) |
|
|
|
|
|
|
|
|
| ||
At December 31, 2012 |
|
|
|
|
|
|
|
|
| ||
+ 300 |
| $ | 2,018 |
| 1.35 | % | $ | 5,757 |
| 3.99 | % |
+ 200 |
| 1,126 |
| 0.75 |
| 3,732 |
| 2.59 |
| ||
+ 100 |
| 463 |
| 0.31 |
| 1,779 |
| 1.23 |
| ||
- 100 |
| (3,418 | ) | (2.28 | ) | (10,683 | ) | (7.40 | ) | ||
|
|
|
|
|
|
|
|
|
| ||
At December 31, 2011 |
|
|
|
|
|
|
|
|
| ||
+ 300 |
| $ | 4,882 |
| 4.22 | % | $ | 13,470 |
| 12.36 | % |
+ 200 |
| 2,977 |
| 2.57 |
| 9,340 |
| 8.57 |
| ||
+ 100 |
| 1,283 |
| 1.11 |
| 4,304 |
| 3.95 |
| ||
- 100 |
| (2,408 | ) | (2.08 | ) | (9,475 | ) | (8.69 | ) |
At year-end 2012, the table above shows that Berkshire has maintained a moderately asset sensitivepremiums and discounts. Additionally, in 2013 interest rate risk profile, although one that is somewhat less so than twelve months earlier. With this profile, net interest income will increase if interest rates rise and net interest income will decline if they fall (assuming a parallel shiftrelated changes in the yield curve and unchanged market spreadsconditions contributed to treasuries for various categoriesan accelerated outflow of assets and liabilities). Short term U.S. treasury rates are currently near zero and the Federal Reserve Bank has indicated an expectation that they will be maintained at these levels through most of the next several years.impaired loans acquired in bank acquisitions. Securities market conditions contributed to growth in wealth management revenues. The Company views it as unlikely that short term rates will decrease significantly from current levels.
The additions of CBT and Beacon, and the expansion of residential mortgage operations, increased interest bearing assets and liabilities, and moderately reduced modeledmonitors interest rate sensitivityand market conditions in managing these sources of net interest income. Based on Berkshire’s review of both CBT’smarket risk to its operating results and Beacon’s balance sheet and balance sheet changes subsequent to the merger, Berkshire modeled that the interest rate risk of both operations was modestly liability sensitive. After integrating these two banks and restructuring the borrowings and securities, Berkshire estimates that there has been a downward shift in its asset sensitivity after completing these mergers, but that the Company overall maintains its asset sensitive posture. This shift includes the impact of the Company’s lending activities, including growth in the fixed rate residential mortgage portfolio. Berkshire maintained its asset sensitive profile and was able to do so while integrating two liability sensitive institutions in part by entering into $100 million of forward starting interest rate swaps in 2012 and issuing a $75 million subordinated debt issue that has a fixed cost for the first 10 years of its term. In 2013, $40 million of the Company’s pool of forward starting interest rate swaps becomes effective.financial condition.
The Company also estimates the sensitivity of the economic value of its equity to interest rate shocks. The Company believes that it is a strategic strength to avoid excess long term earnings at risk when interest rates rise in the future, as anticipated. At year-end 2012,2013, the Company estimated that the economic value of equity would decrease by approximately 4%10% in the event of a 300200 basis point upward interest rate shock, which was well within the Company’s policy limits. The decrease reflectsThis reflected the impact of fixed rate assets on medium and long term modeled net interest income if interest rates increase. This estimate is subject to numerous assumptions and uncertainties and is not intended as a projection of future operating results. The acquisition of New York deposits shortly after year-end was expected to result in a significant reduction in the value of equity at risk in the event of an upward movement in interest rates due to the low cost and anticipated stability of these rural personal and small business deposits.
In the unusual current economic and financial circumstances in the national markets, modeling assumptions depend significantly on subjective judgment which cannot be readily verified by historic data. Additionally, due to the Company’s expansion into new markets, it has more revenues dependent on customer behaviors in products and markets where it has less historic background for its modeling assumptions. The Company’smost significant modeling assumption relates to expectations for the interest sensitivity of non-maturity deposit accounts in a rising rate environment. The model assumes that deposit rate sensitivity will be a percentage of the market interest rate risk focuseschange. The rate sensitivity depends on netthe underlying amount of market rate change and the type of deposit account. The percentage rate movements are as follows: NOW accounts—ranging between 0% and 35%; money market accounts—ranging between 15% and 60%; and savings accounts—ranging between 15% and 40%. The total impact of deposit sensitivity assumptions in the model results in approximately an 80 basis point upward move in deposit costs at the end of two years in the Company’s model of a 200 basis point upward shift in interest income. The Company’s expansion has increased its reliance on fee income sources whichrates.
One of the significant limitations of the simulation is that it assumes parallel shifts in the yield curve. Actual interest rate risks are also affected byoften more complex than this scenario. Due to ongoing distortions in the markets as a result of federal monetary policy, there is elevated uncertainty about future market conditions and about customer demand and behaviors in the event of future interest rate changes. Assumption changes in interest rates. Mortgage banking operations
Table2013 were based on a review of Contents
past performance and future expectations and were expanded significantly in 2012. Mortgage banking revenues and earnings can be significantly affected by interest rate changes which affect mortgage demand, particularly for refinancings,not viewed as wellmaterial. Further, as pricing margins. Other fee income sources that may be sensitive toit grows, the level and trend of interest rates include the Company’s sales of interest rate swaps and commercial cash management services which are compensated with demand deposit balances. The Company’s net income is increasingly sensitive to these changes in non-interest income, in addition to interest income changes. The Company is evaluating enhancementschanges in its supplemental deposit insurance. Changes in deposit protection can result in additional sensitivity to its risk management to develop additional measures, standards,the interest rate structure and optionsdemand for managingthe Company’s deposit products, and this risk.sensitivity could increase when interest rates rise above the current low levels.
The market is expected to continue to experience some general yield compression if short term rates remain near zero for the next three years and if international and other economic events continue to hold down long term U.S. interest rates. The Company expects that interest rates will increase over the medium term from currently suppressed levels and that there is the potential for rate spikes based on economic or financial shocks in the domestic and global markets. Berkshire continues to target ongoing loan growth as it pursues its market share acquisition strategies, and this growth will include a mix of variable and fixed rate loans. The Company’s long term target is to flexibly balance its growth, deposit funding, net interest margin, and interest rate risk management as it pursues its goals of expanding its footprint, increasing its market share, and improving its profitability. The Company believes that, as a result
Berkshire has a number of business strategies to increase net interest income despite the potential for tighter market yields. These include changes in volumes and mix of interest bearing assets and liabilities, some of which are discussed above. The Company also evaluates its pricing strategies on an ongoing basis, and considers its investment, borrowings, and derivatives strategies in managing its income and risk profile. Due to the limitations and uncertainties relating to model assumptions, the modeled computations should not be relied on as projections of income. Further, the computations do not reflect any actions that management may undertake in response to changes in interest rates.
In the unusual current economic and financial circumstances in the national markets, modeling assumptions depend significantly on subjective judgment which cannot be readily verified by historic data. Additionally, due to the Company’s expansion into new markets, it has more revenues dependent on customer behaviors in products and markets where it has less historic background for its modeling assumptions. The most significant modeling assumption relates to expectations for the interest sensitivity of non-maturity deposit accounts in a rising rate environment. The model assumes that deposit rate sensitivity will be a percentage of the market interest rate change. The rate sensitivity depends on the underlying amount of market rate change and the type of deposit account. The percentage rate movements are as follows: NOW accounts—ranging between 0% and 35%; money market accounts—ranging between 30% and 70%; and savings accounts—ranging between 25% and 50%. One of the significant limitations of the simulation is that it assumes parallel shifts in the yield curve. Actual interest rate risks are often more complex than this scenario. Due to the extraordinary fiscal and monetary interventions in the domestic and international markets since 2008, there is elevated uncertainty about future market conditions and about customer demand and behaviors in the event of future interest rate changes. Assumption changes in 2012 were based on a review of past performance and future expectations and were not viewed as material. Of note, in 2012, regulations were changed to allow the payment of interest on business demand deposit balances. This change has not significantly impacted the Company’s operations or interest rate risk environment, but future events could increase risk as a result of this change. Additionally, at the end of 2012, the FDIC terminated its unlimited insurance coverage for transaction account balances. Further, as it grows, the Company is evaluating alternative structures for its supplemental deposit protection offerings. Changes in deposit protection can result in additional sensitivity to the interest rate structure and demand for the Company’s deposit products, and this sensitivity could increase when interest rates rise above the current low levels.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data required by this item are presented elsewhere in this report beginning on page F-1, in the order shown below:
Management’s Report on Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2012 and 2011
Consolidated Statements of Income for the years ended December 31, 2012, 2011 and 2010
Consolidated Statements of Comprehensive Income for the years ended December 31, 2012, 2011, and 2010
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2012, 2011, and 2010
Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011, and 2010
Notes to Consolidated Financial Statements
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
On February 24, 2011, the Company’s Audit Committee dismissed Wolf & Company, P.C. (“Wolf & Company”) as the Company’s principal accountants for the fiscal year ending December 31, 2011, and all quarterly periods therein. The Company’s Audit Committee participated in, and approved the decision to change its independent registered public accounting firm.
The audit report of Wolf & Company on the consolidated financial statements of the Company as of and for the year ended December 31, 2010 did not contain an adverse opinion or disclaimer of opinion, and were not qualified or modified, or expected to be modified or qualified, as to uncertainty, audit scope or accounting principles.
During the fiscal year ended December 31, 2010 and the subsequent interim period through February 24, 2011, there were no: (1) disagreements with Wolf & Company on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to Wolf & Company’s satisfaction, would have caused Wolf & Company to make reference in connection with its opinion to the subject matter, or (2) reportable events under Item 304(a)(1)(v) of Regulation S-K.
Also on February 24, 2011, the Company engaged PricewaterhouseCoopers LLP (“PwC”) as the Company’s principal accountants starting with the fiscal year ending December 31, 2011. The engagement was approved by the Company’s Audit Committee. During the fiscal year ended December 31, 2010, and the subsequent interim period prior to the engagement of PwC, the Company did not consult with PwC, regarding any of the matters or events set forth in Item 304(a)(2)(i) and (ii) of Regulation S-K.None.
ITEM 9A. CONTROLS AND PROCEDURES
The Company’s management, including the Company’s Principal Executive Officer and Principal Financial Officer, has evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a and 15(d) -15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) as of December 31, 2012.2013. Based upon their evaluation, the Principal Executive Officer and Principal Financial Officer
concluded that, as of that date, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”): (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms; and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
The Company evaluated changes in its internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that occurred during the last fiscal quarter. This included the acquisition of Beacon Federal Bancorp, Inc., which did not have control certifications from its prior management for the quarter ending prior to the merger date. The Company’s internal control began to incorporate Beacon on October 19, 2012. Additionally, in the third quarter of 2012, the Company completed the conversion of its core banking system to FIS and its general ledger and certain supporting systems to PeopleSoft. Except for those changes, the Company determined that there were no changes that materially affected, or were reasonably likely to materially affect, the Company’s internal control over financial reporting. Management’s report on internal control over financial reporting and the independent registered public accounting firm’s report on the Company’s internal control over financial reporting are contained in “Item 8 — Financial Statements and Supplementary Data.”
None.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
For information concerning the directors of the Company, the information contained under the sections captioned “Proposals to be Voted on by Stockholders — Proposal 1 - Election of Directors” in Berkshire’s Proxy Statement for the 20132014 Annual Meeting of Stockholders (“Proxy Statement”) is incorporated by reference.
The following table sets forth certain information regarding the executive officers of the Company.
Name |
| Age |
| Position |
|
|
|
|
|
Michael P. Daly |
|
|
| Chairman, President & Chief Executive Officer |
|
|
|
| |
|
|
| Executive Vice President, Commercial Banking | |
|
|
| ||
Sean A. Gray |
|
|
| Executive Vice President, Retail Banking |
Josephine Iannelli | 41 | Executive Vice President, Chief Financial Officer | ||
Linda A. Johnston |
|
|
| Executive Vice President, Human Resources |
Richard M. Marotta | 55 | Executive Vice President, Chief Risk & Administrative Officer |
The executive officers are elected annually and hold office until their successors have been elected and qualified or until they are removed or replaced. Mr. Daly is employed pursuant to a three-year employment agreement which renews automatically if not otherwise terminated pursuant to its terms.
BIOGRAPHICAL INFORMATION
Michael P. Daly has served as President and Chief Executive Officer since October 2002. Before these appointments, Mr. Daly served as Executive Vice President and Senior Loan Officer of the Bank. He has been an employee since 1986. He has served as a Director of the Company and the Bank since 2002. In December 2012, Mr. Daly was promoted to Chairman of the Board.
Kevin P. RileyGeorge F. Bacigalupo has served as Executive Vice President, Chief Financial Officer, and Treasurer since joining the Company in August 2007. He manages the Company’s accounting and finance functions. Priorwas promoted to joining the Company, Mr. Riley was Executive Vice President for Client Information and Relationship Management with KeyCorp. Previously from 1996 to 2002, he served as Executive Vice President and Chief Financial Officer of KeyBank National Association.
Patrick J. Sullivan has served as Executive Vice President of Commercial Banking and Wealth Management since joining the Company in July 2011. Prior to that, he was President and Chief Executive Officer of Legacy Banks and President of Legacy Bancorp. He manages commercial banking (including lending, deposits, and fee services), along with the Company’s Insurance and Wealth Management business units. Previously, Mr. SullivanOctober 2013 having previously served as ExecutiveSenior Vice President, and Managing Director of Corporate Banking with Sovereign/Santander. Prior to that, he was Sovereign’s CEO of New England. His previous background included executive positions in two New England community banks.
Richard M. Marotta joined the Company as Executive Vice President and Chief RiskCredit Officer in January, 2010. Hesince 2011. Mr. Bacigalupo is responsible for overall risk management, commercial credit underwriting, loan workout, loan review, loan documentation, commercial loan servicing, internal audit, compliance, and project management. Mr. Marotta was
previously Executive Vice President and Group Head, Asset Recovery at KeyBank. He has extensive career experience in credit and risk management,business banking, including the asset based lending portfolios.and leasing business lines. Previously, Mr. Bacigalupo was EVP of Specialty Lending at TD Banknorth, where he established the ABL and other middle-market lending groups and oversaw commercial banking relationships with $5 billion in total committed credit. Subsequently, at TD Bank, he was the Senior Lender for New England.
Sean A. Gray was promoted to Executive Vice President, Retail Banking in 2010, having previously served as Senior Vice President, Retail Banking since April 2008. Mr. Gray manages retail banking (including deposits, lending, fee services, branches, and call center) along with mortgage banking, small business banking, marketing, deposit operations information technology, and facilities. Mr. Gray joined the Company in January 2007 as First Vice President, Retail Banking. Prior to joining the Bank, Mr. Gray was Vice President and Consumer Market Manager at Bank of America, in Waltham, Massachusetts.
Josephine Iannelli was promoted to Executive Vice President, Chief Financial Officer in January 2014 having previously served as Senior Vice President, Chief Accounting Officer since March 2013. In her current role, she manages the Company’s accounting and finance functions. Ms. Iannelli has 20 years of financial experience beginning with accounting policy roles at KPMG and KeyCorp. She joined National City Corporation in 2002 leading
the accounting policy group and served in various roles at the bank through their acquisition and integration into PNC Financial. She has also provided independent accounting consulting services for top ten national banks.
Linda A. Johnston was promoted to Executive Vice President, Human Resources in 2010, having previously served as Senior Vice President since November 2002. Ms. Johnston manages the Company’s human resources functions and serves as a key advisor to the Compensation Committee of the Company’s Board of Directors. She is also a Director of the Company’s Foundations. Ms. Johnson has been with the Company for more than 2830 years.
Richard M. Marotta joined the Company as Executive Vice President and Chief Risk Officer in January, 2010 and was promoted to Chief Administrative Officer in July 2013. He is responsible for overall risk management, commercial credit underwriting, loan workout, loan review, loan documentation, commercial loan servicing, compliance, information technology, and project management. Mr. Marotta was previously Executive Vice President and Group Head, Asset Recovery at KeyBank. He has extensive career experience in credit and risk management, including asset based lending portfolios.
Reference is made to the cover page of this report and to the section captioned “Other Information Relating to Directors and Executive Officers - Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement for information regarding compliance with Section 16(a) of the Exchange Act. For information concerning the audit committee and the audit committee financial expert, reference is made to the section captioned “Corporate Governance — Committees of the Board of Directors” and “Audit Committee” in the Proxy Statement.
For information concerning the Company’s code of ethics, the information contained under the section captioned “Corporate Governance — Code of Business Conduct” in the Proxy Statement is incorporated by reference. A copy of the Company’s code of ethics is available to stockholders on the Company’s website at “www.berkshirebank.com.”
ITEM 11. EXECUTIVE COMPENSATION
For information regarding executive compensation, the sections captioned “Director Compensation”, “Compensation Discussion and Analysis,” and “Executive Compensation” in the Proxy Statement are incorporated herein by reference.
For information regarding the Compensation Committee Report, the section captioned “Compensation Committee Report” in the Proxy Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
(a)Security Ownership of Certain Beneficial Owners Information required by this item is incorporated herein by reference to the section captioned “Stock Ownership” in the Proxy Statement. |
|
| |
|
|
| |
|
|
84(b)Security Ownership of Management
Information required by this item is incorporated herein by reference to the section captioned “Stock Ownership” in the Proxy Statement.
(c)Changes in Control
Management of Berkshire knows of no arrangements, including any pledge by any person of securities of Berkshire, the operation of which may at a subsequent date result in a change in control of the registrant. | |
|
|
|
|
| Number of securities |
|
|
| Number of securities |
| |
|
| to be issued upon |
| Weighted-average |
| future issuance under |
| |
|
| exercise of |
| exercise price of |
| equity compensation plans |
| |
|
| outstanding options, |
| outstanding options, |
| (excluding securities |
| |
Plan category |
| warrants and rights |
| warrants and rights |
| reflected in the first column) |
| |
|
|
|
|
|
|
|
| |
Equity compensation plans approved by security holders |
| 570,000 |
| $ | 19.31 |
| 908,000 |
|
|
|
|
|
|
|
|
| |
Equity compensation plans not approved by security holders |
| — |
| — |
| — |
| |
|
|
|
|
|
|
|
| |
Total |
| 570,000 |
| $ | 19.31 |
| 908,000 |
|
(d)Equity Compensation Plan Information
The following table sets forth information, as of December 31, 2013, about Company common stock that may be issued upon exercise of options under stock-based benefit plans maintained by the Company, as well as the number of securities available for issuance under equity compensation plans:
|
| Number of securities |
|
|
| Number of securities |
| |
|
| to be issued upon |
| Weighted-average |
| future issuance under |
| |
|
| exercise of |
| exercise price of |
| equity compensation plans |
| |
|
| outstanding options, |
| outstanding options, |
| (excluding securities |
| |
Plan category |
| warrants and rights |
| warrants and rights |
| reflected in the first column) |
| |
|
|
|
|
|
|
|
| |
Equity compensation plans approved by security holders |
| 420,000 |
| $ | 21.73 |
| 333,000 |
|
|
|
|
|
|
|
|
| |
Equity compensation plans not approved by security holders |
| — |
| — |
| — |
| |
|
|
|
|
|
|
|
| |
Total |
| 420,000 |
| $ | 21.73 |
| 333,000 |
|
In 2013, the Company’s shareholders approved a new equity compensation plan which was to become effective by action of the Board of Directors. That plan was made effective shortly after year-end 2013, and the available shares from that plan are not included in the plan information provided above.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item is incorporated herein by reference to the sections captioned “Other Information Relating to Directors and Executive Officers — Transactions with Related Persons” and “ Procedures Governing Related Persons Transactions” in the Proxy Statement.
Information regarding director independence is incorporated herein by reference to the section captioned “Proposals to be Voted on by Stockholders — Proposal 1 — Election of Directors” in the Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item is incorporated herein by reference to the section captioned “Proposals to be Voted on by Stockholders — Proposal 43 — Ratification of the Independent Registered Public Accounting Firm” in the Proxy Statement.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
|
| (a)[1]Financial Statements
The consolidated financial statements required to be filed in our Annual Report on Form 10-K are included in Part II, Item 8 hereof. [2]Financial Statement Schedules All financial statement schedules are omitted because the required information is either included or is not applicable. [3]Exhibits
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with generally accepted accounting principles.
As of December 31,
The Company’s internal control over financial reporting includes policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
The effectiveness of the Company’s internal control over financial reporting as of December 31,
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Berkshire Hills Bancorp, Inc.
integrated audits. We conducted our
BERKSHIRE HILLS BANCORP, INC.
The accompanying notes are an integral part of these consolidated financial statements.
BERKSHIRE HILLS BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME
The accompanying notes are an integral part of these consolidated financial statements.
BERKSHIRE HILLS BANCORP, INC. CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
The accompanying notes are an integral part of these consolidated financial statements. BERKSHIRE HILLS BANCORP, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
The accompanying notes are an integral part of these consolidated financial statements.
BERKSHIRE HILLS BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued)
The accompanying notes are an integral part of these consolidated financial statements.
BERKSHIRE HILLS BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (CONCLUDED)
The accompanying notes are an integral part of these consolidated financial statements. Note: The Consolidated Statements of Cash Flows for the year ended December 31, 2011 include the cash flows from operating, investing and financing activities associated with discontinued operations.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2013, 2012
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Consolidation
The consolidated financial statements (the “financial statements”) of Berkshire Hills Bancorp, Inc. and its subsidiaries (the “Company” or “Berkshire”) have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The Company is a Delaware corporation and the holding company for Berkshire Bank (the “Bank”), a Massachusetts-chartered savings bank headquartered in Pittsfield, Massachusetts, and Berkshire Insurance Group, Inc. (“Berkshire Insurance Group” or “BIG”). These financial statements include the accounts of the Company, its wholly-owned subsidiaries and the Bank’s consolidated subsidiaries. One of the Bank’s consolidated subsidiaries is Berkshire Bank Municipal Bank, a New York-chartered limited-purpose commercial bank. In consolidation, all significant intercompany accounts and transactions are eliminated. The results of operations of companies or assets acquired are included only from the dates of acquisition. All material wholly-owned and majority-owned subsidiaries are consolidated unless GAAP requires otherwise.
Discontinued Operations
Assets and liabilities related to discontinued operations are carried at the lower of cost or estimated fair value in the aggregate and presented in a separate line item on the consolidated balance sheets. Revenue and expense related to discontinued operations are not reported separately, and net income related to these operations is presented in a separate line item on the consolidated statements of operations.
Reclassifications
Certain items in prior financial statements have been reclassified to conform to the current presentation. The Company has evaluated subsequent events for potential recognition and/or disclosure through the date these consolidated financial statements were issued.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses; the valuation of deferred tax assets; the estimates related to the initial measurement of goodwill and intangible assets and subsequent impairment analyses; the determination of other-than-temporary impairment of securities; and the determination of fair value of financial instruments and subsequent impairment analysis.
Business Combinations
Business combinations are accounted for using the acquisition method of accounting. Under this method, the accounts of an acquired entity are included with the acquirer’s accounts as of the date of acquisition with any excess of purchase price over the fair value of the net assets acquired (including identifiable intangibles) capitalized as goodwill.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
To consummate an acquisition, the Company will typically issue common stock and/or pay cash, depending on the terms of the acquisition agreement. The value of common shares issued is determined based upon the market price of the stock as of the closing of the acquisition.
Cash and Cash equivalents
Cash and cash equivalents include cash, balances due from banks, and short-term investments, all of which mature within ninety days. Due to the nature of cash and cash equivalents and the near term maturity, the Company estimated that the carrying amount of such instruments approximated fair value. The nature of the Bank’s business requires that it maintain amounts due from banks which at times, may exceed federally insured limits. The Bank has not experienced any losses on such amounts and all amounts are maintained with well-capitalized institutions.
Trading Security
The Company elected the fair value option permitted by Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, “Fair Value Measurements and Disclosures”, on a tax advantaged economic development bond originated in 2008. The bond has been designated as a trading account security and is recorded at fair value, with changes in unrealized gains and losses recorded through earnings each period as part of non-interest income.
Securities
Debt securities that management has the intent and ability to hold to maturity are classified as held to maturity and carried at amortized cost. All other securities, including equity securities with readily determinable fair values, are classified as available for sale and carried at fair value, with unrealized gains and losses reported as a component of other net comprehensive income. Management determines the appropriate classification of securities at the time of purchase. Restricted equity securities, such as stock in the Federal Home Loan Bank of Boston (“FHLBB”) are carried at cost. There are no quoted market prices for the Company’s restricted equity securities. The Bank is a member of the FHLBB, which requires that members maintain an investment in FHLBB stock, which may be redeemed based on certain conditions. The Bank reviews for impairment based on the ultimate recoverability of the cost bases in the FHLBB stock.
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
The Company evaluates debt and equity securities within the Company’s available for sale and held to maturity portfolios for other-than-temporary impairment (“OTTI”), at least quarterly. If the fair value of a debt security is below the amortized cost basis of the security, OTTI is required to be recognized if any of the following are met: (1) the Company intends to sell the security; (2) it is “more likely than not” that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) for debt securities, the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. For all impaired debt securities that the Company intends to sell, or more likely than not will be required to sell, the full amount of the depreciation is recognized as OTTI through earnings. Credit-related OTTI for all other impaired debt securities is recognized through earnings. Non-credit related OTTI for such debt securities is recognized in other comprehensive income, net of applicable taxes. In evaluating its marketable equity securities portfolios for OTTI, the Company considers its intent and NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ability to hold an equity security to recovery of its cost basis in addition to various other factors, including the length of time and the extent to which the fair value has been less than cost and the financial condition
and near term prospects of the issuer. Any OTTI on marketable equity securities is recognized immediately through earnings.
Loans Held for Sale
Loans originated prior to April 30, 2012, with the intent to be sold in the secondary market, were valued on an aggregate basis at the lower-of-cost-or-fair value. Loans originated on or after April 30, 2012, with the intent to be sold in the secondary market, are accounted for under the fair value option. Non-refundable fees and direct loan origination costs related to residential mortgage loans held for sale are recognized in noninterest income or noninterest expense as earned or incurred. Fair value is primarily determined based on quoted prices for similar loans in active markets. Gains and losses on sales of residential mortgage loans (sales proceeds minus carrying value) are recorded in noninterest income.
Loans that were previously held for investment that the Company has an active plan to sell are transferred to loans held for sale at fair value. Fair value is primarily determined based on quoted prices for similar loans in active markets or agreed upon sales prices. Gains are recorded in noninterest income to the extent that the fair value exceeds the carrying value of the loans transferred. Any reduction in the loan’s value, prior to being transferred to loans held for sale, is reflected as a charge-off of the recorded investment in the loan resulting in a new cost basis, with a corresponding reduction in the allowance for loan losses. Further changes in the fair value of the loan are recognized in noninterest income or expense, accordingly.
Loans
Loans are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, the unamortized balance of any deferred fees or costs on originated loans and the unamortized balance of any premiums or discounts on loans purchased or acquired through mergers. Interest income is accrued on the unpaid principal balance. Interest income includes net accretion or amortization of deferred fees or costs and of premiums or discounts. Interest income is also net of recoveries or losses recorded on acquired impaired loans. Direct loan originations costs, net of any origination fees, in addition to premiums and discounts on loans, are deferred and recognized as an adjustment of the related loan yield using the interest method. Interest on loans, excluding automobile loans, is generally not accrued on loans which are ninety days or more past due unless the loan is well-secured and in the process of collection. Past due status is based on contractual terms of the loan. Automobile loans generally continue accruing until one hundred and twenty days delinquent, at which time they are charged off. All interest accrued but not collected for loans that are placed on non-accrual or charged-off is reversed against interest income, except for certain loans designated as well-secured. The interest on non-accrual loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. All payments received on non-accrual loans are applied against the principal balance of the loan. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Acquired Loans
Loans that the Company acquired in acquisitions are initially recorded at fair value with no carryover of the related allowance for credit losses. Determining the fair value of the loans involves estimating the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS amount and timing of principal and interest cash flows initially expected to be collected on the loans and discounting those cash flows at an appropriate market rate of interest.
For loans that meet the criteria stipulated in ASC 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality
excess of all cash flows expected at acquisition over the initial fair value of the loan, as interest income on a level-yield basis over the expected remaining life of the loan. The excess of the loan’s contractually required payments over the cash flows expected to be collected is the nonaccretable difference. The nonaccretable difference
For ASC 310-30 loans, the expected cash flows reflect anticipated prepayments, determined on a loan by loan basis according to the anticipated collection plan of these loans. The expected prepayments used to determine the accretable yield
For loans that do not meet the ASC 310-30 criteria, the Company
Acquired loans that met the criteria for nonaccrual of interest prior to the acquisition are considered performing upon acquisition, regardless of whether the customer is contractually delinquent, if the Company can reasonably estimate the timing and amount of the expected cash flows on such loans and if the Company expects to fully collect the new carrying value of the loans. As such, the Company may no longer consider the loan to be nonaccrual or nonperforming and may accrue interest on these loans, including the impact of any accretable yield. The Company has determined that the Company can reasonably estimate future cash flows on the Company’s current portfolio of acquired loans that are past due 90 days or more and on which the Company is accruing interest and the Company expects to fully collect the carrying value of the loans.
Allowance for Loan Losses
The allowance for loan losses is established based upon the level of estimated probable losses in the current loan portfolio. Loan losses are charged against the allowance when management believes the collectability of a loan balance is doubtful. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses includes allowance allocations calculated in accordance with Accounting Standards Codification (“ASC”) Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.”
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The allowance for loan losses is allocated to loan types using both a formula-based approach applied to groups of loans and an analysis of certain individual loans for impairment. The formula-based approach emphasizes loss factors derived from actual historical and industry portfolio loss rates, which are combined with an assessment of certain qualitative factors to determine the allowance amounts allocated to the various loan categories. Allowance amounts are based on an estimate of historical average annual percentage rate of loan loss for each loan segment, a temporal estimate of the incurred loss emergence and confirmation period for each loan category, and certain qualitative risk factors considered in the computation of the allowance for loan losses.
Qualitative risk factors impacting the inherent risk of loss within the portfolio include the following:
·National and local economic and business conditions
·Level and trend of delinquencies
·Level and trend of charge-offs and recoveries
·Trends in volume and terms of loans
·Risk selection, lending policy and underwriting standards
·Experience and depth of management
·Banking industry conditions and other external factors
·Concentration risk
Risk characteristics relevant to each portfolio segment are as follows:
Residential mortgage — The Company generally does not originate loans with a loan-to-value ratio greater than 80 percent and does not grant subprime loans. The Company requires private mortgage insurance (PMI) in cases when the loan-to-value ratio exceeds 80 percent. All loans in this segment are collateralized by residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment.
Commercial mortgage — Loans in this segment are primarily owner-occupied or income-producing properties throughout New England and Northeastern New York. The underlying cash flows generated by the properties are adversely impacted by a downturn in the economy, which in turn, will have an effect on the credit quality in this segment. Management monitors the cash flows of these loans. In addition, construction loans in this segment primarily include real estate development loans for which payment is derived from sale of the property or long term financing at completion. Credit risk is affected by cost overruns, time to sell at an adequate price, and market conditions.
Commercial business loans — Loans in this segment are made to businesses and are generally secured by assets of the business. Repayment is expected from the cash flows of the business. Loans in this segment include asset based loans which generally have no scheduled repayment and which are closely monitored against formula based collateral advance ratios. A weakened economy, and resultant decreased consumer spending, will have an effect on the credit quality in this segment.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Consumer loans — Loans in this segment are primarily home equity lines of credit and second mortgages, together with automobile loans and other consumer loans. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment.
The Company utilizes a blend of historical and industry portfolio loss rates for commercial mortgage and commercial business loans that are assessed by internal risk rating. Historical loss rates for residential mortgages, home equity and other consumer loans are not risk graded but are assessed based on the total of each loan segment. This approach incorporates qualitative adjustments based upon management’s assessment of various market and portfolio specific risk factors into its formula-based estimate. Due to the imprecise nature of
the loan loss estimation process and ever changing conditions, the qualitative risk attributes may not adequately capture amounts of incurred loss in the formula-based loan loss components used to determine allocations in the Company’s analysis of the adequacy of the allowance for loan losses.
The Company evaluates certain loans individually for specific impairment. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Loans are selected for evaluation based upon a change in internal risk rating, occurrence of delinquency, loan classification, or non-accrual status. The evaluation of certain loans individually for specific impairment includes loans that were previously classified as Troubled Debt Restructurings (“TDRs”) or continue to be classified as TDRs. A specific allowance amount is allocated to an individual loan when such loan has been deemed impaired and when the amount of the probable loss is able to be estimated. Estimates of loss may be determined by the present value of anticipated future cash flows or the loan’s observable fair market value, or the fair value of the collateral, if the loan is collateral dependent. However, for collateral dependent loans, the amount of the recorded investment in a loan that exceeds the fair value of the collateral is charged-off against the allowance for loan losses in lieu of an allocation of a specific allowance amount when such an amount has been identified definitively as uncollectible.
Large groups of small-balance homogeneous loans such as the residential mortgage, home equity and other consumer portfolios are collectively evaluated for impairment. As such, the Company does not typically identify individual loans within these groupings as impaired loans or for impairment evaluation and disclosure. The Company evaluates all TDRs for impairment on an individual loan basis regardless of loan type.
Bank-Owned Life Insurance
Bank-owned life insurance policies are reflected on the consolidated balance sheets at cash surrender value. Changes in the net cash surrender value of the policies, as well as insurance proceeds received, are reflected in non-interest income on the consolidated statements of operations and are not subject to income taxes.
Foreclosed and Repossessed Assets
Assets acquired through, or in lieu of, loan foreclosure or repossession are held for sale and are initially recorded at the lower of the investment in the loan or fair value less estimated costs to sell at the date of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS foreclosure or repossession, establishing a new cost basis. Subsequently, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less estimated costs to sell. Revenue and expenses from operations, changes in the valuation allowance, any direct write-downs and gains or losses on sales are included in other real estate owned expense.
Capitalized Mortgage Servicing Rights
Capitalized mortgage servicing rights are included in “other assets” in the consolidated balance sheet. Servicing assets are initially recognized as separate assets at fair value when rights are acquired through purchase or through sale of financial assets with servicing retained. The Company uses the amortization method to subsequently measure servicing assets. Under that method, capitalized mortgage servicing rights are charged to expense in proportion to and over the period of estimated net servicing income. Fair
value of the mortgage servicing rights is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, prepayment speeds and default rates and losses. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the capitalized amount for the tranches. If the Company later determines that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the allowance may be recorded as an increase to income. Capitalized servicing rights are reported in other assets and are amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets.
Premises and Equipment
Land is carried at cost. Buildings, improvements and equipment are carried at cost, less accumulated depreciation and amortization computed on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the initial term of the lease, plus optional terms if certain conditions are met.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of the net assets acquired in a business combination. Goodwill is assigned to reporting units, which are operating segments or one level below an operating segment. Goodwill is assigned to the Company’s reporting units that are expected to benefit from the business combination. Goodwill is assessed annually for impairment, and more frequently if events or changes in circumstances indicate that there may be an impairment. Adverse changes in the economic environment, declining operations, unanticipated competition, loss of key personnel, or other factors could result in a decline in the implied fair value of goodwill. If the implied fair value of goodwill is less than the carrying amount, a loss would be recognized in other noninterest expense to reduce the carrying amount to the implied fair value of goodwill. A goodwill impairment analysis is comprised of two steps. Step 1, used to identify instances of potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, including goodwill, the reporting unit’s goodwill is not considered impaired. If the carrying amount of a reporting unit, including goodwill, exceeds its fair value, the second step of the goodwill impairment analysis is performed to measure the amount of impairment loss, if any. Step 2 of the goodwill impairment analysis compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of goodwill for that reporting unit exceeds the implied fair value of that reporting unit’s goodwill, an impairment loss is recognized in an amount equal to that excess. Subsequent reversals of goodwill impairment are prohibited.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Other Intangibles
Intangible assets are acquired assets that lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset or liability.
The fair values of these assets are generally determined based on appraisals and are subsequently amortized on a straight-line basis or an accelerated basis over their estimated lives. Management assesses the recoverability of these intangible assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable. If the carrying amount exceeds fair value, an impairment charge is recorded to income.
Transfers of Financial Assets
Transfers of an entire financial asset, group of entire financial assets, or a participating interest in an entire financial asset are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets.
Income Taxes
The Company files a consolidated federal income tax return with the Bank and its subsidiaries. Calculation of the Company’s provision for income taxes requires the interpretation of income tax laws and regulations and the use of estimates and judgments in its determination. The Company is subject to examination by governmental authorities that may give rise to income tax issues due to differing interpretations. Changes to the liability for income taxes also occur due to changes in income tax rates, implementation of new business strategies, resolution of issues with taxing authorities, and newly enacted statutory, judicial, and regulatory guidance.
Deferred income taxes are provided to reflect the tax effect of temporary differences between financial statement carrying amounts and the corresponding tax basis of assets and liabilities. Deferred income taxes are calculated by applying enacted statutory tax rates and tax laws to future years in which temporary differences are expected to reverse. The impact on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that the tax rate change is enacted. A deferred tax valuation allowance is established if it is more likely than not that a deferred tax asset will not be realized.
The Company maintains reserves for certain tax positions that arise in the normal course of business. As of December 31,
In evaluating a tax position for recognition, the Company judgmentally evaluates whether it is more likely than not that a tax position will be sustained upon examination, including resolution of related appeals or litigation processes, based on the technical merits of the position. If the tax position meets the more likely than not recognition threshold, the tax position is measured and recognized in the Company’s Consolidated Financial Statements as the largest amount of tax benefit that, in management’s judgment, is greater than 50% likely of being realized upon ultimate settlement.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Insurance Commissions
Commission revenue is recognized as of the effective date of the insurance policy or the date the customer is billed, whichever is later, net of return commissions related to policy cancellations. In addition, the Company may receive additional performance commissions based on achieving certain sales and loss experience measures. Such commissions are recognized when determinable, which is generally when such commissions are received or when the Company receives data from the insurance companies that allows the reasonable estimation of these amounts.
Advertising Costs
Advertising costs are expensed as incurred.
Stock-Based Compensation
The Company measures and recognizes compensation cost relating to share-based payment transactions based on the grant-date fair value of the equity instruments issued. The fair value of restricted stock is recorded as unearned compensation. The deferred expense is amortized to compensation expense based on one of several permitted attribution methods over the longer of the required service period or performance period. For performance-based restricted stock awards, the Company estimates the degree to which performance conditions will be met to determine the number of shares that will vest and the related compensation expense. Compensation expense is adjusted in the period such estimates change.
Income tax benefits related to stock compensation in excess of grant date fair value, less any proceeds on exercise, are recognized as an increase to additional paid-in capital upon vesting or exercising and delivery of the stock. Any income tax benefits that are less than grant date fair value less any proceeds on exercise would be recognized as a reduction of additional paid-in capital to the extent of previously recognized income tax benefits and then as compensation expense for the remaining amount.
Earnings per Common Share
Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. If rights to dividends on unvested options/awards are non-forfeitable, these unvested awards/options are considered outstanding in the computation of basic earnings per share. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustments to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to outstanding stock options and restricted stock awards and are determined using the treasury stock method. Treasury shares are not deemed outstanding for earnings per share calculations.
Wealth Management Assets
Wealth management assets held in a fiduciary or agent capacity are not included in the accompanying consolidated balance sheets because they are not assets of the Company.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Derivative Instruments and Hedging Activities
The Company enters into interest rate swap agreements as part of the Company’s interest rate risk management strategy for certain assets and liabilities and not for speculative purposes. Based on the Company’s intended use for the interest rate swap at inception, the Company designates the derivative as either an economic hedge of an asset or liability or a hedging instrument subject to the hedge accounting provisions of FASB ASC Topic 815, “Derivatives and Hedging.”
Interest rate swaps designated as economic hedges are recorded at fair value within other assets or liabilities. Changes in the fair value of these derivatives are recorded directly through earnings.
For interest rate swaps that management intends to apply the hedge accounting provisions of Topic 815, the Company formally documents at inception all relationships between hedging instruments and hedged items, as well as its risk management objectives and strategies for undertaking the various hedges. Additionally, the Company uses dollar offset or regression analysis at the hedge’s inception and for each reporting period thereafter, to assess whether the derivative used in its hedging transaction is expected to be and has been highly effective in offsetting changes in the fair value or cash flows of the hedged item. The Company discontinues hedge accounting when it is determined that a derivative is not expected to be
or has ceased to be highly effective as a hedge, and then reflects changes in fair value of the derivative in earnings after termination of the hedge relationship.
The Company has characterized its interest rate swaps that qualify under Topic 815 hedge accounting as cash flow hedges. Cash flow hedges are used to minimize the variability in cash flows of assets or liabilities, or forecasted transactions caused by interest rate fluctuations, and are recorded at fair value in other assets or liabilities within the Company’s balance sheets. Changes in the fair value of these cash flow hedges are initially recorded in accumulated other comprehensive loss and subsequently reclassified into earnings when the forecasted transaction affects earnings. Any hedge ineffectiveness assessed as part of the Company’s quarterly analysis is recorded directly to earnings.
The Company enters into interest rate lock commitments with borrowers, and forward commitments to sell loans or to-be-announced mortgage-backed bonds to investors to hedge against the inherent interest rate and pricing risk associated with selling loans. The interest rate lock commitments generally terminate once the loan is funded, the lock period expires or the borrower decides not to contract for the loan. The forward commitments generally terminate once the loan is sold, the commitment period expires or the borrower decides not to contract for the loan. These commitments are considered derivatives which are accounted for by recognizing their estimated fair value on the Consolidated Balance Sheets as either a freestanding asset or liability. See Note 16 to the Consolidated Financial Statements for more information on interest rate lock commitments and forward commitments.
Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Company enters into off-balance sheet financial instruments, consisting primarily of credit related financial instruments. These financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Fair Value Hierarchy
The Company groups assets and liabilities that are measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
Level 1 — Valuation is based on quoted prices in active markets for identical assets or liabilities. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2 — Valuation is based on observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; 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 — Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using unobservable techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
Employee Benefits
The Company maintains an employer sponsored 401(k) plan
terms of the plan. Contributions due under the terms of the defined contribution plans are accrued as earned by employees.
Due to the Rome Bancorp acquisition in 2011, the Company inherited a noncontributory, qualified, defined benefit pension plan for certain employees who met age and service requirements; as well as other post-retirement benefits, principally health care and group life insurance. The Rome pension plan and postretirement benefits that were acquired in connection with the whole-bank acquisition in the second quarter of 2011 were frozen prior to the close of the transaction. The pension benefit in the form of a life annuity is based on the employee’s combined years of service, age, and compensation.
In order to measure the expense associated with the Plans, various assumptions are made including the discount rate, expected return on plan assets, anticipated mortality rates, and expected future healthcare costs. The assumptions are based on historical experience as well as current facts and circumstances. The Company uses a December 31 measurement date for its Plans. As of the measurement date, plan assets are determined based on fair value, generally representing observable market prices. The projected benefit obligation is primarily determined based on the present value of projected benefit distributions at an assumed discount rate.
Net periodic pension benefit costs include interest costs based on an assumed discount rate, the expected return on plan assets based on actuarially derived market-related values, and the amortization of net actuarial losses. Net periodic postretirement benefit costs include service costs, interest costs based on an assumed discount rate, and the amortization of prior service credits and net actuarial gains. Differences between expected and actual results in each year are included in the net actuarial gain or loss amount, which is recognized in other comprehensive income. The net actuarial gain or loss in excess of a 10% corridor is amortized in net periodic benefit cost over the average remaining service period of active NOTES TO CONSOLIDATED FINANCIAL STATEMENTS participants in the Plans. The prior service credit is amortized over the average remaining service period to full eligibility for participating employees expected to receive benefits.
The Company recognizes in its statement of condition an asset for a plan’s overfunded status or a liability for a plan’s underfunded status. The Company also measures the Plans’ assets and obligations that determine its funded status as of the end of the fiscal year and recognizes those changes in other comprehensive income, net of tax.
Out of Period Adjustments In the third quarter of 2013, the Company recorded a correction of an error to recognize $2.2 million in prior period interest income earned on loans acquired in bank acquisitions, of which $1.3 million relates to prior years. Additionally, the Company recorded a correction of an error related to its accounting for a state income tax credit. The correction increased other income by $613 thousand and increased the income tax provision by $1.2 million during the quarter. The adjustment relating to prior years included $505 thousand in other income and $998 thousand in the income tax provision. After evaluating the quantitative and qualitative aspects of these adjustments, the Company concluded that its prior period financial statements were not materially misstated and, therefore, no restatement was required. Recent Accounting Pronouncements
In Reclassifications Out of Accumulated Other Comprehensive Income In February 2013, the FASB issued ASU No. 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income,” to
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
reclassifications. ASU No. 2013-02 does not amend any existing requirements for reporting net income or other comprehensive income in the financial statements. ASU No. 2013-02 requires an entity to
ASU
In January 2014, the FASB issued ASU No. 2014-01, “Accounting for Investments in Qualified Affordable Housing Projects.” ASU No. 2014-01 permits reporting entities to make an accounting policy election to account for investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense. This new guidance also requires new disclosures for all investors in these projects. ASU No. 2014-01 is effective for interim and annual reporting periods beginning after December 15, 2014. Upon adoption, the guidance must be applied retrospectively to all periods presented. However, entities that use the effective yield method to account for investments in these projects before adoption may continue to do so for these pre-existing investments. The Company currently accounts for such investments using the effective yield method and plans to continue to do so for these pre-existing investments after adopting ASU No. 2014-01 on January 1, 2015. The Company expects investments made after January 1, 2015 to meet the criteria required for the proportional amortization method and plans to elect that accounting policy. The adoption of ASU No. 2014-01 is not expected to have a material impact on the Company’s Consolidated Financial Statements. In January 2014, the FASB issued ASU No. 2014-04, “Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.” The objective of this guidance is to clarify when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. ASU No. 2014-04 states that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
a deed in lieu of foreclosure or through a similar legal agreement. Additionally, ASU No.
NOTE 2.
Beacon Federal Bancorp, Inc.
On October 19, 2012, the Company acquired all of the outstanding common shares of Beacon Federal Bancorp, Inc. (BFED). BFED, as a Holding company, had one Banking subsidiary (Beacon Bank) that had seven branches primarily serving eastern New York State, but also including two branches in Tennessee. As a result of the transaction, BFED merged into Berkshire Hills Bancorp, and Beacon Bank merged into Berkshire Bank. This business combination is an extension of the Berkshire franchise and goodwill results from the expected synergies and earnings accretion from this combination, including future cost savings related to BFED’s operations.
On the acquisition date, BFED had 5.871 million outstanding common shares, net of 1.727 million shares held by Berkshire. BFED shareholders received 2.701 million Berkshire common shares based on an exchange ratio of 0.5590 shares of Berkshire common stock for each BFED share. BFED shareholders also received a total of $60.2 million in cash representing a payment $20.50 per BFED share. The 2.701 million shares of Berkshire common stock issued in this exchange were valued at $23.06 per share based on the closing price of Berkshire posted on October 18, 2012 resulting in a consideration value of $62.3 million. The BFED shares held by Berkshire were valued at $5.2 million, and the value in excess of the carrying value was recorded as a $1.1 million non-recurring gain in the statement of income. BFED had a stock option plan, and as part of the acquisition agreement, Berkshire agreed to continue the vesting schedules of option holders of BFED stock with corresponding BHLB stock with a share conversion ratio of 92%. The fair value of the vested portion of the options was $5.7 million, and was included as part of consideration paid for BFED.
The results of BFED’s operations will be included in the Company’s Consolidated Statement of Income from the date of acquisition.
The assets and liabilities in the BFED acquisition were recorded at their fair value based on management’s best estimate using information available at the date of acquisition. Consideration paid, and fair values of BFED’s assets acquired and liabilities assumed are summarized in the following tables:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Explanation of Certain Fair Value Adjustments
(a)The adjustment represents the write down of the book value of investments to their estimated fair value based on fair values on the date of acquisition. (b)The adjustment represents the write down of the book value of loans to their estimated fair value based on current interest rates and expected cash flows, which includes an estimate of expected loan loss inherent in the portfolio. Loans that met the criteria and are being accounted for in accordance with
ASC 310-30 had a carrying amount of $78.3 million. Non-impaired loans not accounted for under 310-30 had a carrying value of $619.5 million. (c)The amount represents the adjustment of the book value of buildings, and furniture and equipment, to their estimated fair value based on appraisals and other methods. The adjustment includes a $2.4 million fair value write-up of a building under a capital lease arrangement. The adjustments will be depreciated over the estimated economic lives of the assets. (d)The adjustment represents the value of the core deposit base assumed in the acquisition. The core deposit asset was recorded as an identifiable intangible asset and will be amortized over the average life of the deposit base. (e)Represents identified intangibles related to assumed leases and acquired wealth management and insurance customer lists, which will be amortized over the remaining useful lives. (f)Represents net deferred tax assets resulting from the fair value adjustments related to the acquired assets and liabilities, identifiable intangibles, and other purchase accounting adjustments. (g) The amount primarily consists of a $0.5 million fair value adjustment to write-down other real estate owned, and a $0.4 million write-down of mortgage servicing assets acquired, which were based on appraisals, and valuation reports, respectively. These adjustments are not accretable into earnings in the statement of income. (h)The adjustment is necessary because the weighted average interest rate of deposits exceeded the cost of similar funding at the time of acquisition. (i)Adjusts borrowings to their estimated fair value based on interest rates of similar borrowings available on the date of acquisition. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (j)Adjusts the book value of other liabilities to their estimated fair value at the acquisition date. The adjustment primarily consists of a $4.1 million increase to an acquired capital lease obligation, and a $2.3 write-off of deferred revenue.
Except for collateral dependent loans with deteriorated credit quality, the fair values for loans acquired from BFED were estimated using cash flow projections based on the remaining maturity and repricing terms. Cash flows were adjusted by estimating future credit losses and the rate of prepayments. Projected monthly cash flows were then discounted to present value using a risk-adjusted market rate for similar loans. For collateral dependent loans with deteriorated credit quality, to estimate the fair value, the Company analyzed the value of the underlying collateral of the loans, assuming the fair values of the loans were derived from the eventual sale of the collateral. Those values were discounted using market derived rates of return, with consideration given to the period of time and costs associated with the foreclosure and disposition of the collateral. There was no carryover of BFED’s allowance for credit losses associated with the loans that were acquired as the loans were initially recorded at fair value.
Information about the acquired loan portfolio subject to purchased credit impaired accounting guidance (ASC 310-30) as of October 19, 2012 is, as follows:
The core deposit intangible asset recognized as part of the BFED merger is being amortized over its estimated useful life of approximately ten years utilizing an accelerated method. Other intangibles consist of leasehold intangible liabilities and customer list intangible assets, which are amortized over the estimated useful life using a straight-line method, and an accelerated method, respectively.
The goodwill, which is not amortized for book purposes, was assigned to the banking segment and is not deductible for tax purposes.
The fair value of savings and transaction deposit accounts acquired from BFED was assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. The fair value of time deposits was estimated by discounting the contractual future cash flows using market rates offered for time deposits of similar remaining maturities. The fair value of borrowed funds was estimated by discounting the future cash flows using market rates for similar borrowings.
Direct merger, acquisition and integration costs of the BFED acquisition were expensed as incurred, and totaled $5.6 million in 2013 and $5.0 million during 2012.
The Connecticut Bank and Trust Company
On April 20, 2012, the Company acquired all of the outstanding common shares of The Connecticut Bank and Trust Company (“CBT”). CBT operated eight banking offices serving the Greater Hartford area and was merged with and into Berkshire Bank. This business combination is an extension of the Berkshire franchise and the goodwill recognized results from the expected synergies and earnings NOTES TO CONSOLIDATED FINANCIAL STATEMENTS accretion from this combination, including future cost savings related to CBT’s operations. The combination was negotiated between the companies and was approved unanimously by their boards of directors.
CBT shareholders received 965 thousand shares of the Company common stock and $9.0 million in cash. On the acquisition date, CBT had 3.6 million outstanding common shares. Through a cash/share election procedure, the Company paid $8.25 per share for 30% of the outstanding common shares and for 70% of the outstanding shares, the Company exchanged its stock in a ratio of 0.381 shares of the Company’s common stock for each share of CBT stock. The 965 thousand shares of Company common stock issued in this exchange were valued at $22.80 per share based on the closing price of Berkshire posted on April 19, 2012 resulting in consideration paid of $22 million. Berkshire paid $0.2 million in cash consideration to settle all outstanding CBT options. The Company issued no new Berkshire options in connection with the merger.
As part of the acquisition, the Company repurchased and retired from the United States Department of Treasury (“Treasury”) each share of Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series A, of CBT issued and outstanding for $5.4 million and the outstanding warrant issued to the Treasury to purchase CBT common stock for $0.8 million.
The results of CBT’s operations will be included in our Consolidated Statement of Income from the date of acquisition.
The assets and liabilities in the CBT acquisition were recorded at their fair value based on management’s best estimate using information available at the date of acquisition. Consideration paid, and fair values of CBT’s assets acquired and liabilities assumed are summarized in the following tables:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Explanation of Certain Fair Value Adjustments
(a)The adjustment represents the write down of the book value of investments to their estimated fair value based on fair values on the date of acquisition. (b)The adjustment represents the write down of the book value of loans to their estimated fair value based on current interest rates and expected cash flows, which includes an estimate of expected loan loss inherent in the portfolio. Loans that met the criteria and are being accounted for in accordance with ASC 310-30 had a carrying amount of $23.7 million. Non-impaired loans not accounted for under 310-30 had a carrying value of $192.1 million. (c)The adjustment represents the value of the core deposit base assumed in the acquisition. The core deposit asset was recorded as an identifiable intangible asset and will be amortized over the average life of the deposit base. (d)Represents an intangible liability related to assumed leases, which was recorded as an identifiable intangible and will be amortized over the remaining life of the leases. (e)This amount primarily consists of adjustments in the net deferred tax assets resulting from the fair value adjustments related to the acquired assets and liabilities, identifiable intangibles, and other deferred tax items including recognition of a $4.8 million deferred tax asset related to operating losses, which CBT had a full valuation allowance against. (f)The adjustment is necessary because the weighted average interest rate of deposits exceeded the cost of similar funding at the time of acquisition. (g)Adjusts borrowings to their estimated fair value calculated based on interest rates of similar borrowings available on the date of acquisition. (h)Adjusts the book value of other liabilities to their estimated fair value at the acquisition date.
The method to determine the fair value of the loans acquired from CBT was consistent with the method used in the BFED acquisition. Accordingly, there was no carryover of CBT’s allowance for credit losses associated with the loans that were acquired as the loans were initially recorded at fair value.
Information about the acquired loan portfolio subject to purchased credit impaired accounting guidance (ASC 310-30) as of April 20, 2012 is, as follows (in thousands): NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The core deposit intangible asset recognized as part of the CBT merger is being amortized over its estimated useful life of approximately eight years utilizing an accelerated method. Other intangibles consist of leasehold intangible liabilities, which are amortized over the life of each respective lease using a straight-line method.
The goodwill, which is not amortized for book purposes, was assigned to the banking segment and is not deductible for tax purposes.
The fair value of savings and transaction deposit accounts acquired from CBT was assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. The fair value of time deposits was estimated by discounting the contractual future cash flows using market rates offered for time deposits of similar remaining maturities. The fair value of borrowed funds was estimated by discounting the future cash flows using market rates for similar borrowings.
Direct merger, acquisition and integration costs of the CBT acquisition were expensed as incurred, and totaled $0.5 million in 2013, $4.7 million in 2012 and $0.6 million in 2011.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Greenpark Mortgage Corporation
On April 30, 2012, Berkshire Bank acquired the operations, and purchased certain assets and assumed certain limited liabilities of Greenpark Mortgage Corporation (“Greenpark”), as contemplated by the Asset Purchase Agreement dated February 2, 2012, by and between Berkshire Bank and Greenpark. The purchase of Greenpark’s operations increases the Company’s consumer lending capabilities, and expands the Company’s geographical footprint into eastern Massachusetts along with broadening its sources of fee-based income.
The purchase price for Greenpark’s operations was $4.0
The results of Greenpark’s operations are included in the Consolidated Statements of Income from the date of acquisition.
The assets and liabilities in the Greenpark transaction were recorded at their fair value based on management’s best estimate using information available at the date of purchase. The Greenpark transaction is an asset purchase for legal purposes, which limits the Company’s exposure to the assumption of liabilities as defined in the purchase agreement, and to any potential unknown liabilities that result from operations that occur subsequent to the purchase date. The transaction is also considered an asset purchase for tax purposes, which results in a step-up in tax basis of assets acquired and liabilities assumed along with tax deductible goodwill. For book purposes, the Company will account for the transaction as a business combination in accordance with applicable accounting guidance, as it represents an acquisition of a business with a distinct set of inputs and processes to produce outputs.
The goodwill, representing the excess of consideration paid over the net fair value of assets and liabilities acquired, is not amortized for book purposes, and is assigned to our banking segment.
Consideration paid, and fair values of Greenpark’s assets acquired and liabilities assumed are summarized in the following tables:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Explanation of Certain Fair Values
(a)Includes a portion of the cash consideration paid for premiums as described above, which adjusts the loans to fair value. (b)Represents the fair value of the acquired derivative associated with commitments to originate loans at a specified locked-rate (“interest rate lock commitments”). (c)Represents the fair value of certain acquired office equipment. (d)Consists of forward contracts acquired at fair value, which serves to hedge the movements in fair value of the interest rate lock commitments.
Financial Information
The following table discloses unaudited pro forma supplemental information from the combined results of operations of 2012 and 2011 assuming the acquisitions of BFED, CBT, and Greenpark had been completed as of January 1, 2011:
The unaudited pro forma supplemental information combines the historical results of Berkshire, BFED, CBT, and management’s estimate of the results of Greenpark’s operations under the Company’s management. The unaudited pro forma information includes adjustments for scheduled amortization and accretion of fair value adjustments recorded at the time of the merger. These adjustments would have been different if they had been recorded on January 1, 2011, and they do not include the impact of prepayments. The unaudited pro forma information is also adjusted for the impacts of the actual merger financing on revenue and expense. The pro forma income does not indicate what would have occurred had the acquisitions taken place on January 1, 2011 and does not indicate expected future results. No adjustments were made to eliminate BFED and CBT’s credit losses that may not have been necessary had the acquired loans been recorded at fair value as of the beginning of 2011. Adjustments were also not made to reflect any changes to the asset and liability positions in the balance sheets of the acquired companies during 2011 or 2012 that may have resulted in changes to net interest income had the acquisitions occurred as of beginning of 2011. Additionally, operating cost savings and other business synergies expected as a result of the acquisition are not reflected in the pro forma amounts. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS recurring expenses and income related to the acquisitions including professional fees, system conversion and integration costs, and the gains recorded in connection with the acquisitions are excluded in the 2012 and 2011 periods in which the amounts were recognized. In 2012 non-recurring expenses excluded from the unaudited pro forma supplemental information were $6.7 million, $5.2 million, and $555 thousand for BFED, CBT, and Greenpark, respectively. Also excluded during 2012, was a $1.1 million non-recurring gain on BFED stock that was held by the Company at the time of acquisition. In 2011 non-recurring expenses excluded from the unaudited pro forma supplemental information were $910 thousand for CBT and none for BFED and Greenpark. Furthermore, the unaudited pro forma supplemental information is adjusted for income tax expense related to the pre-tax adjustments.
The Company has determined that it is impractical to report the amounts of revenue and earnings of the acquired entities since the acquisition dates. Due to the integration of their operations with those of the Company, the Company does not record revenue and earnings separately for these operations. The revenue and earnings of these operations are included in the consolidated statement of income.
Cash and cash equivalents include cash on hand, amounts due from banks, and short-term investments with original maturities of three months or less. Short-term investments included $1.8 million and $5.8 million pledged as collateral support for derivative financial contracts at year-end
The Company holds a tax advantaged economic development bond that is being accounted for at fair value. The security had an amortized cost of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of securities available for sale (“AFS”) and securities held to maturity (“HTM”):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At year-end
The amortized cost and estimated fair value of AFS and HTM securities by contractual maturity at year-end
At year-end
Proceeds from the sale of AFS securities in 2013, 2012, and 2011
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Securities with unrealized losses, segregated by the duration of their continuous unrealized loss positions, are summarized as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Debt Securities
The Company expects to recover its amortized cost basis on all debt securities in its AFS and HTM portfolios. Furthermore, the Company does not intend to sell nor does it anticipate that it will be required to sell any of its securities in an unrealized loss position as of December 31,
recovery is supported by the Company’s strong capital and liquidity positions as well as its historical low portfolio sales. The following summarizes, by investment security type, the basis for the conclusion that the debt securities in an unrealized loss position within the Company’s portfolio were not other-than-temporarily impaired at year-end
AFS municipal bonds and obligations
At year-end
AFS residential mortgage-backed securities
At year-end
AFS corporate bonds
At year-end
AFS trust preferred securities
At year-end NOTES TO CONSOLIDATED FINANCIAL STATEMENTS securities in unrealized loss positions. The Company’s evaluation of the present value of expected cash flows on these securities supports its conclusions about the recoverability of the securities’ amortized cost basis. Except for the security discussed below, the aggregate unrealized loss on the other securities in unrealized loss positions represented
At year-end
afforded by
HTM tax advantaged economic development bonds
At year-end
AFS other bonds and obligations
At year-end
Marketable Equity Securities
In evaluating its marketable equity securities portfolio for OTTI, the Company considers its more likely than not ability to hold an equity security to recovery of its cost basis in addition to various other factors, including the length of time and the extent to which the fair value has been less than cost and the financial condition and near term prospects of the issuer. Any OTTI is recognized immediately through earnings.
At year-end
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company’s loan portfolio A substantial portion of the loan portfolio is secured by real estate in western Massachusetts, southern Vermont, northeastern New York, and in the Bank’s New England lending areas. The ability of many of the Bank’s
Total loans include loans from business activities and loans acquired from business combinations. Loans from business combinations are those loans acquired from the acquisitions of Beacon, CBT, Legacy Bancorp, Inc., and Rome Bancorp, Inc.
Year-end loans consisted of the following:
Total unamortized net costs and premiums included in the year-end total loans for historical loans were the following:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company occasionally transfers a portion of its originated commercial loans to participating lending partners. The amounts transferred have been accounted for as sales and are therefore not included in the Company’s accompanying consolidated balance sheets. The Company and its lending partners share ratably in any gains or losses that may result from a borrower’s lack of compliance with contractual terms of the loan. The Company continues to service the loans, collects cash payments from the borrowers, remits payments (net of servicing fees), and disburses required escrow funds to relevant parties. At year-end
In 2013, the Company purchased loans aggregating $178.6 million and sold loans aggregating $932.5 million. In 2012, the Company purchased loans aggregating $166.5 million and sold loans aggregating $780 million.
Most of the Company’s lending activity occurs within its primary markets in Western Massachusetts, Southern Vermont and Northeastern New York. Most of the loan portfolio is secured by real estate, including residential mortgages, commercial mortgages, and home equity loans. Year-end loans to operators of non-residential buildings totaled $556.7 million, or 13.3%, and $493.5 million, or 12.4%
At year-end
At year-end
The carrying amount of the acquired loans at December 31,
The following table summarizes activity in the accretable yield for the acquired loan portfolio that falls under the purview of ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of past due loans at December 31,
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is summary information pertaining to non-accrual loans at year-end
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of impaired loans at year-end
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
No additional funds are committed to be advanced in connection with impaired loans.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Troubled Debt Restructuring Loans
The Company’s loan portfolio also includes certain loans that have been modified in a Troubled Debt Restructuring (TDR), where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months. TDRs are evaluated individually for impairment and may result in a specific allowance amount allocated to an individual loan.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table discloses the recorded investment and number of modifications for TDRs within the last year where a concession has been made, that then defaulted in the current reporting period. For the twelve months ended December 31, 2012, there were no loans that were restructured within the last twelve months that have subsequently defaulted.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(2)Other Reductions classification consists of transfer to other real estate owned and charge-offs to loans. The evaluation of certain loans individually for specific impairment includes loans that were previously classified as TDRs or continue to be
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 7.LOAN LOSS ALLOWANCE Activity in the allowance for loan losses for 2013, 2012, and 2011 was as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Credit Quality Information
The
The Company risk rates its residential mortgages, including 1-4 family and residential construction loans, based on a three rating system: Pass, Special Mention and Substandard. Loans that are current within 59 days are rated Pass. Residential mortgages that are 60-89 days delinquent are rated Special Mention. Loans delinquent for 90 days or greater are rated Substandard and generally placed on non-accrual status. Home equity loans are risk rated based on the same rating system as the Company’s residential mortgages.
Ratings for other consumer loans, including auto loans, are
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Acquired Loans Credit Quality Analysis
Upon acquiring a loan portfolio, our Internal Loan Review function undertakes the same process of assigning risk ratings as historical loans, which may differ from the risk rating policy of the predecessor company. Loans which are rated Substandard or lower according to the rating process outlined below are deemed to be credit impaired loans accounted for under ASC 310-30, regardless of whether they are classified as performing or non-performing.
The Bank utilizes an eleven grade internal loan rating system for each of its acquired commercial real estate, construction and commercial loans as outlined in the Credit Quality Information section of this Note. The Company risk rates its residential mortgages, including 1-4 family and residential construction loans, based on a three rating system: Pass, Special Mention and Substandard. Residential mortgages that are current within 59 days are rated Pass. Residential mortgages that are 60 — 89 days delinquent are rated Special Mention. Residential mortgages delinquent for 90 days or greater are rated Substandard. Home equity loans are risk rated based on the same rating system as the Company’s residential mortgages. Other consumer loans are rated based on a two rating system. Other consumer loans that are current within 119 days are rated Performing while loans delinquent for 120 days or more are rated Non-performing. Non-performing other consumer loans are deemed to be credit impaired loans accounted for under ASC 310-30.
The Company subjects loans that do not meet the ASC 310-30 criteria to ASC 450-20 by collectively evaluating these loans for an allowance for loan loss. The Company applies a methodology similar to the methodology prescribed for originated loans, which includes the application of environmental factors to each category of loans. The methodology to collectively evaluate the acquired loans outside the scope of ASC 310-30 includes the application of a number of environmental factors that reflect management’s best estimate of the level of incremental credit losses that might be recognized given current conditions. This is reviewed as part of the allowance for loan loss adequacy analysis. As the loan portfolio matures and environmental factors change, the loan portfolio will be reassessed each quarter to determine an appropriate reserve allowance.
A decrease in the expected cash flows in subsequent periods requires the establishment of an allowance for loan losses at that time for ASC 310-30 loans. At December 31,
The Company presented several tables within this footnote of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the Company’s loans by risk rating at year-end
Residential Credit Risk Profile by Internally Assigned Grade
Commercial Credit Risk Profile by Creditworthiness Category
Commercial Business Credit Risk Profile by Creditworthiness Category
Consumer Credit Risk Profile Based on Payment Activity
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Residential Mortgages Credit Risk Profile by Internally Assigned Grade
Commercial Mortgages Credit Risk Profile by Creditworthiness Category
Commercial Business Loans Credit Risk Profile by Creditworthiness Category
Consumer Loans Credit Risk Profile Based on Payment Activity
The following
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8. PREMISES AND EQUIPMENT
Year-end premises and equipment are summarized as follows:
Depreciation and amortization expense for the years 2013, 2012,
NOTE 9. GOODWILL AND OTHER INTANGIBLES
Goodwill and other intangible assets are presented in the tables below. The increase in goodwill in 2013 and 2012 is as follows:
(1) Goodwill related to the acquisition of Beacon was adjusted due to the subsequent recognition of certain identifiable liabilities that had not been recognized as part of the original accounting. Year-end goodwill relates to the following reporting units:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company tests goodwill impairment annually in the fourth quarter or more frequently if events or changes in circumstances indicate that impairment is possible. No impairment was recorded on goodwill for
The components of other intangible assets are as follows:
Other intangible assets are amortized on a straight-line or accelerated basis over their estimated lives, which range from eight to eleven years. Amortization expense related to intangible assets totaled $5.3 million in
The estimated aggregate future amortization expense for intangible assets remaining at year-end For the years 2013, 2012, and 2011, no impairment charges were identified for the Company’s intangible assets.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10. OTHER ASSETS
Year-end other assets are summarized as follows:
The Bank has sold loans in the secondary market and has retained the servicing responsibility and receives fees for the services provided. Mortgage loans sold and serviced for others amounted to $641.2 million, $603.7 million,
Mortgage servicing rights activity was as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11. DEPOSITS
A summary of year-end time deposits is as follows:
NOTE 12. BORROWED FUNDS
Borrowed funds at December 31,
Short-term debt includes Federal Home Loan Bank of Boston (“FHLBB”) advances with an original maturity of less than one year and a short-term line-of-credit drawdown through US Bank.
The Bank is approved to borrow on a short-term basis from the Federal Reserve Bank of Boston as a non-member bank. The Bank has pledged certain loans and securities to the Federal Reserve Bank to support this arrangement. No borrowings with the Federal Reserve Bank of Boston took place for the period ended December 31, NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Long-term FHLBB advances consist of advances with an original maturity of more than one year. The advances outstanding at December 31, 2013 include callable advances totaling $5.0 million, and amortizing advances totaling $5.5 million. The advances outstanding at December 31, 2012 include callable advances totaling $5.0 million, and amortizing advances totaling $5.6
A summary of maturities of FHLBB advances at year-end
The Company holds 100% of the common stock of Berkshire Hills Capital Trust I (“Trust I”) which is included in other assets with a cost of $0.5 million. The sole asset of Trust I is $15.5 million of the Company’s junior subordinated debentures due in 2035. These debentures bear interest at a variable rate equal to LIBOR plus 1.85% and had a rate of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 13.OTHER LIABILITIES
Year-end other liabilities are summarized as follows:
NOTE 14. EMPLOYEE BENEFIT PLANS
The Company accounts for its pension and postretirement plans by recognizing in the financial statements an asset for a plan’s overfunded status or a liability for a plan’s underfunded status. The Company reports changes in the funded status of its pension and postretirement plan as a component of other comprehensive income, net of applicable taxes, in the year in which changes occur.
Pension Plans
The Company maintains a legacy employer sponsored defined benefit pension plan (the “Plan”) for which participation and benefit accruals were frozen in 2011. Accordingly, no employees are permitted to commence participation in the Plan and future salary increases and years of credited service are not considered when computing an employee’s benefits under the Plan. As of December 31,
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information regarding the pension plan at December 31,
Net pension cost is comprised of the following for the year ended December 31,
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Changes in plan assets and benefit obligations recognized in accumulated other comprehensive income during 2013 and 2012 are as follows:
The Company expects to make cash contributions of
The
The principal actuarial assumptions used at December 31,
The discount rate that is used in the measurement of the pension obligation is determined by comparing the expected future retirement payment cash flows of the pension plan to the Citigroup Above Median Pension Liability Index as of the measurement date. The expected long-term rate of return on Plan assets reflects long-term earnings expectations on existing Plan assets and those contributions expected to be received during the current plan year. In estimating that rate, appropriate consideration was given to historical returns earned by Plan assets in the fund and the rates of return expected to be available for reinvestment. The rates of return were adjusted to reflect current capital market assumptions and changes in investment allocations.
The Company’s overall investment strategy with respect to the Plan’s assets is primarily for preservation of capital and to provide regular dividend and interest payments. The Plan’s targeted asset allocation is 65% equity securities and 35% fixed-income securities. Equity securities primarily include investments in large cap core, value, and growth stocks. The fixed income portion of the Plan assets is invested in one index fund which is an investment grade, intermediate term index. Equity securities are expected to earn a return in the range of 5% to 9% and fixed income securities are expected to earn a return in the range of 2% to 6%. The long-term inflation rate was estimated to be 3%. When these overall return expectations are applied to the Plan’s target allocation, we expect a future rate of return of 7% to 11%.
The fair values for investment securities are determined by quoted prices in active markets, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair values of the Plan’s assets by asset category and level within the fair value hierarchy are as follows at December 31,
The fair values of the Plan’s assets by asset category and level within the fair value hierarchy are as follows at December 31,
The Plan did not hold any assets classified as Level 3 during
Estimated benefit payments under our pension plans over the next ten years at December 31,
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Postretirement Benefits
The Company has an unfunded post-retirement medical plan which was assumed in connection with the Rome Bancorp acquisition in 2011. The postretirement plan has been modified so that participation is closed to those employees who did not meet the retirement eligibility requirements by March 31, 2011. The Company contributes partially to medical benefits and life insurance coverage for retirees. Such retirees and their surviving spouses are responsible for the
remainder of the medical benefits, including increases in premiums levels, between the total premium and the Company’s contribution. Information regarding the postretirement plan at December 31,
The postretirement benefit obligation recognized in accumulated other comprehensive income and the accrued liability for the years ended December 31,
The Company expects to contribute
The amount expected to be amortized from other comprehensive income into net periodic postretirement cost over the next fiscal year is NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Discount rates of
above, increases in premium levels are the financial responsibility of the plan beneficiary. Thus an increase or decrease in 1% of the health care cost trend rates utilized would have had an immaterial effect on the service and interest cost as well as the accumulated post-retirement benefit obligation for the postretirement plan as of December 31,
Estimated benefit payments under the postretirement benefit plan over the next ten years at December 31,
401(k) Plan
The Company provides a 401(k) Plan in which most employees participate. The Company contributes a non-elective 3% of gross annual wages for each participant, regardless of the participant’s deferral, in addition to a 100% match up to 4% of gross annual wages. The Company’s contributions vest immediately. Expense related to the plan was $2.9 million in 2013, $2.5 million in 2012, and $1.9 million in
Employee Stock Ownership Plan (“ESOP”)
As part of the acquisition of Beacon during 2012, along with two acquisitions during 2011, the Company acquired ESOP plans that were frozen and terminated prior to the completion of those transactions. On the acquisition dates, all amounts in the plans were vested and the loans under the plans were repaid from the sale proceeds of unallocated shares.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 15. INCOME TAXES
Provision for Income Taxes
The components of the Company’s provision for income taxes for the years ended December 31, 2013, 2012,
Effective Tax Rate
The following is a reconciliation of the statutory federal income tax rate to the Company’s effective tax rate for the years ended December 31, 2013, 2012,
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred Tax Liabilities and Assets
As of December 31,
The components of the
The NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The
originally recorded in connection with the Company’s acquisition of Legacy Bancorp, Inc. during 2011. The release is due to having more realized and expected capital gains against which to offset the capital loss carry-forward during
The valuation allowances as of December 31,
Tax Attributes
At December 31,
Unrecognized Tax Benefits
On a periodic basis, the Company evaluates its income tax positions based on tax laws and regulations and financial reporting considerations, and records adjustments as appropriate. This evaluation takes into consideration the status of taxing authorities’ current examinations of the Company’s tax returns, recent positions taken by the taxing authorities on similar transactions, if any, and the overall tax environment in relation to
The following table presents changes in unrecognized tax benefits for the years ended December 31, 2013, 2012,
The Company does not expect any significant changes to its unrecognized tax benefits during the next twelve months.
As of December 31, NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company’s income tax returns, including the tax histories acquired through business combinations, remain subject to examination by the Federal Internal Revenue Service
NOTE 16. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
At year-end
As part of the Company’s risk management strategy, the Company enters into interest rate swap agreements to mitigate the interest rate risk inherent in certain of the Company’s assets and liabilities. Interest rate swap agreements involve the risk of dealing with both Bank customers and institutional derivative counterparties and their ability to meet contractual terms. The agreements are entered into with counterparties that meet established credit standards and contain master netting and collateral provisions protecting the at-risk party. The derivatives program is overseen by the Risk Management Committee of the Company’s Board of Directors. Based on adherence to the Company’s credit standards and the presence of the netting and collateral provisions, the Company believes that the credit risk inherent in these contracts was not significant at December 31,
The Company pledged collateral to derivative counterparties in the form of cash totaling
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information about interest rate swap agreements and non-hedging derivative assets and liabilities at December 31, 2013 follows:
Information about interest rate swap agreements and non-hedging derivative asset and liabilities at
Cash Flow Hedges
The effective portion of unrealized changes in the fair value of derivatives accounted for as cash flow hedges is reported in other comprehensive income and subsequently reclassified to earnings in the same period or periods during which the hedged forecasted transaction affects earnings. Each quarter, the Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged item or NOTES TO CONSOLIDATED FINANCIAL STATEMENTS transaction. The ineffective portion of changes in the fair value of the derivatives is recognized directly in earnings.
The Company has also entered into
The Company has entered into an interest rate swap with a notional value of $15 million to convert the floating rate of interest on its junior subordinated debentures to a fixed rate of interest. The purpose of the hedge was to protect the Company from the risk of variability arising from the floating rate interest on the debentures. Amounts included in the Consolidated Statements of Income and in the other comprehensive
income section of the Consolidated Statements of Comprehensive Income (related to interest rate derivatives designated as hedges of cash flows), were as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Hedge ineffectiveness on interest rate swaps designated as cash flow hedges was immaterial to the Company’s financial statements during the years ended 2012. Amounts reported in accumulated other comprehensive loss related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate liabilities.
Economic hedges
The Company has an interest rate swap with a
The Company also offers certain derivative products directly to qualified commercial borrowers. The Company economically hedges derivative transactions executed with commercial borrowers by entering into mirror-image, offsetting derivatives with third-party financial institutions. The transaction allows the Company’s customer to convert a variable-rate loan to a fixed rate loan. Because the Company acts as an
intermediary for its customer, changes in the fair value of the underlying derivative contracts mostly offset each other in earnings. Credit valuation adjustments arising from the difference in credit worthiness of the commercial loan and financial institution counterparties totaled
The Company utilizes forward sale commitments to hedge interest rate risk and the associated effects on the fair value of interest rate lock commitments and loans held for sale. The forward sale commitments are accounted for as derivatives with changes in fair value recorded in current period earnings.
The company uses the following types of forward sale commitments contracts:
·Best efforts loan sales,
·Mandatory delivery loan sales, and
·To be announced (TBA) mortgage-backed securities sales.
A best efforts contract refers to a loan sales agreement where the Company commits to deliver an individual mortgage loan of a specified principal amount and quality to an investor if the loan to the underlying borrower closes. The Company may enter into a best efforts contract once the price is known, which is shortly after the potential borrower’s interest rate is locked.
A mandatory delivery contract is a loan sales agreement where the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. Generally, the Company may enter into mandatory delivery contracts shortly after the loan closes with a customer. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company may sell to-be-announced mortgage-backed securities to hedge the changes in fair value of interest rate lock commitments and held for sale loans, which do not have corresponding best efforts or mandatory delivery contracts. These security sales transactions are closed once mandatory contracts are written. On the closing date the price of the security is locked-in, and the sale is paired-off with a purchase of the same security. Settlement of the security purchase/sale transaction is done with cash on a net-basis.
Non-hedging derivatives
The Company enters into interest rate lock commitments (“IRLCs”) for residential mortgage loans, which commit the Company to lend funds to a potential borrower at a specific interest rate and within a specified period of time. IRLCs that relate to the origination of mortgage loans that will be held for sale are considered derivative financial instruments under applicable accounting guidance. Outstanding IRLCs expose the Company to the risk that the price of the mortgage loans underlying the commitments may decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan. The IRLCs are free-standing derivatives which are carried at fair value with changes recorded in noninterest income in the Company’s consolidated statements of income. Changes in the fair value of IRLCs subsequent to inception are based on changes in the fair value of the underlying loan. Such changes result from the fulfillment of the commitment and changes in the probability that the loan will fund within the terms of the commitment, affected primarily by changes in interest rates and the passage of time.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Amounts included in the Consolidated Statements of Income related to economic hedges and non-hedging derivatives were as follows:
Assets and Liabilities Subject to Enforceable Master Netting Arrangements Interest Rate Swap Agreements (“Swap Agreements”) The Company enters into swap agreements to facilitate the risk management strategies for commercial banking customers. The Company mitigates this risk by entering into equal and offsetting swap agreements with highly rated third party financial institutions. The swap agreements are free-standing derivatives and are recorded at fair value in the Company’s consolidated statements of condition. The Company is party to master netting arrangements with its financial institution counterparties; however, the Company does not offset assets and liabilities under these arrangements for financial statement presentation purposes. The master netting arrangements provide for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract. Collateral generally in the form of marketable securities is received or posted by the counterparty with net liability positions, respectively, in accordance with contract thresholds. The Company had net asset positions with its commercial banking counterparties totaling $7 million and $14.7 million as of December 31, 2013 and December 31, 2012, respectively. The Company had net liability positions with its financial institution counterparties totaling $10.2 million and $29.8 million as of December 31, 2013 and December 31, 2012, respectively. At December 31, 2013, the Company also had a net liability position of $0.7 million with its commercial banking counterparties as compared to zero liability at December 31, 2012. The collateral posted by the Company that covered liability positions was $10.2 million and $29.8 million as of December 31, 2013 and December 31, 2012, respectively. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table presents the assets and liabilities subject to an enforceable master netting arrangement as of December 31, 2013 and December 31, 2012: Offsetting of Financial Assets and Derivative Assets
Offsetting of Financial Liabilities and Derivative Liaibilities
Offsetting of Financial Assets and Derivative Assets
Offsetting of Financial Liabilities and Derivative Liaibilities
NOTE 17. OTHER COMMITMENTS, CONTINGENCIES, AND OFF-BALANCE SHEET ACTIVITIES
Credit Related Financial Instruments. The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the accompanying consolidated balance sheets.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument is represented by the contractual amount of these commitments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments.
A summary of financial instruments outstanding whose contract amounts represent credit risk is as follows at year-end:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These letters of credit are primarily issued to support borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company considers standby letters of credit to be guarantees and the amount of the recorded liability related to such guarantees was not material at year-end
Operating Lease Commitments. Future minimum rental payments required under operating leases at year-end
Lease Obligations. Future obligations required under the capital lease at year-end
Future obligations required under the financing lease at year-end
Employment and Change in Control Agreements. The Company and the Bank have entered into a three-year employment agreement with one senior executive. The Company and the Bank also have change in control agreements with several officers which provide a severance payment in the event employment is terminated in conjunction with a defined change in control.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Legal Claims.Various legal claims arise from time to time in the normal course of business. In the opinion of management, claims outstanding at year-end
NOTE 18. STOCKHOLDERS’ EQUITY AND EARNINGS PER COMMON SHARE
Minimum Regulatory Capital Requirements
The Bank is subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if imposed, could have a direct material impact on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting and other factors. The Company, as a savings and loan holding company, has no specific quantitative capital requirements.
Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital to average assets (as defined). As of year-end
As of year-end
The Bank’s actual and required capital amounts were as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A reconciliation of the Company’s year-end total stockholders’ equity to the Bank’s regulatory capital is as follows:
Common stock
The Bank is subject to dividend restrictions imposed by various regulators, including a limitation on the total of all dividends that the Bank may pay to the Company in any calendar year. The total of all dividends shall not exceed the Bank’s net income for the current year (as defined by statute), plus the Bank’s net income retained for the two previous years, without regulatory approval. Dividends from the Bank are an important source of funds to the Company to make dividend payments on its common and preferred stock, to make payments on its borrowings, and for its other cash needs. The ability of the Company and the Bank to pay dividends is dependent on regulatory policies and regulatory capital requirements. The ability to pay such dividends in the future may be adversely affected by new legislation or regulations, or by changes in regulatory policies relating to capital, safety and soundness, and other regulatory concerns.
The payment of dividends by the Company is subject to Delaware law, which generally limits dividends to an amount equal to an excess of the net assets of a company (the amount by which total assets exceed total liabilities) over statutory capital, or if there is no excess, to the Company’s net profits for the current and/or immediately preceding fiscal year.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Accumulated
Year-end components of accumulated other comprehensive loss are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table presents the components of other comprehensive loss for the years ended December 31, 2013, 2012, and 2011:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the changes in each component of accumulated other comprehensive income, for the years ended December 31, 2013, 2012, and 2011:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following table presents the amounts reclassified out of each component of accumulated other comprehensive income for the years ended December 31, 2013, 2012, and 2011:
Earnings Per Common Share
Basic earnings per common share (“EPS”) excludes dilution and is computed by dividing net income applicable to common stock by the weighted average number of common shares outstanding for the year. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock (such as stock options) were exercised or converted into additional common shares that would then share in the earnings of the entity. Diluted EPS is computed by dividing net income applicable to common stock by the weighted average number of common shares outstanding for the year, plus an incremental number of common-equivalent shares computed using the treasury stock method.
Earnings per common share has been computed based on the following (average diluted shares outstanding is calculated using the treasury stock method):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
For the year ended 2013, 338 thousand options were anti-dilutive and therefore excluded from the earnings per share calculations. For the year ended 2012, 600 thousand options were anti-dilutive and therefore excluded from the earnings per share calculations. For the year ended 2011, 394 thousand options were anti-dilutive and therefore excluded from the earnings per share calculations.
NOTE 19. STOCK-BASED COMPENSATION PLANS
The 2011 Equity Compensation Plan (the “Plan”) permits the granting of a combination of Restricted
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of activity in the Company’s stock compensation plans is shown below:
Stock Awards
The total compensation cost for stock awards recognized as expense was $2.1 million, $2.0 million,
The weighted average fair value of stock awards granted was $24.49, $23.76, and $20.88 in 2013, 2012, and
The total fair value of stock awards vested during 2013, 2012, and 2011
Option Awards
Option awards are granted with an exercise price equal to the market price of the Company’s stock at the date of grant, and vest over periods up to five years. The options grant the holder the right to acquire a share of the Company’s common stock for each option held, and have a contractual life of ten years. As of year-end
The Company generally issues shares from treasury stock as options are exercised. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The expected dividend yield and expected term are based on management estimates. The expected volatility is based on historical volatility. The risk-free interest rates for the expected term are based on the U.S. Treasury yield curve in effect at the time of the grant. The Company acquired options in the Beacon transaction
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The total intrinsic value of options exercised was $2.9 million, $2.7 million,
NOTE 20. FAIR VALUE MEASUREMENTS
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets and financial liabilities that are carried at fair value.
Recurring Fair Value Measurements of Financial Instruments
The following table summarizes assets and liabilities measured at fair value on a recurring basis as of year-end
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1)Total fair value excludes the $1.3 million of unrealized losses on forward commitments presented under other assets on the consolidated balance sheet. (2)Total fair value includes the $1.3 million of unrealized losses on forward commitments presented under other assets on the consolidated balance sheet.
Trading Security at Fair Value. The Company holds one security designated as a trading security. It is a tax advantaged economic development bond issued to the Company by a local nonprofit which provides wellness and health programs. The determination of the fair value for this security is determined based on a discounted cash flow methodology. Certain inputs to the fair value calculation are unobservable and there is little to no market activity in the security; therefore, the security meets the definition of a Level 3 security. The discount rate used in the valuation of the security is sensitive to movements in the 3-month LIBOR rate.
Securities Available for Sale. AFS securities classified as Level 1 consist of publicly-traded equity securities for which the fair values can be obtained through quoted market prices in active exchange NOTES TO CONSOLIDATED FINANCIAL STATEMENTS markets. AFS securities classified as Level 2 include most of the Company’s debt securities. The pricing on Level 2 was primarily sourced from third party pricing services, overseen by management, and is based on models that consider standard input factors such as 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 condition, among other things. The Company holds one pooled trust preferred security. The
Loans held for sale.The Company elected the fair value option for all loans held for sale (HFS) originated on or after May 1, 2012. Loans HFS are classified as Level 2 as the fair value is based on input factors such as quoted prices for similar loans in active markets.
The changes in fair value of loans held for sale for years ended December 31, 2013 and 2012 were gains of $2.6 million and losses of $2.8 million, respectively. The changes in fair value are included in mortgage banking income in the Consolidated Statements of Income.
Derivative Assets and Liabilities.
Interest Rate Swap.The valuation of the Company’s interest rate swaps is obtained from a third-party pricing service and is determined using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis is based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves.
The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings.
Although the Company has determined that the majority of the inputs used to value its interest rate derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of year-end
valuation of its derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Interest Rate Lock Commitments. The Company enters into IRLCs for residential mortgage loans, which commit the Company to lend funds to a potential borrower at a specific interest rate and within a specified period of time. The estimated fair value of commitments to originate residential mortgage loans for sale is based on quoted prices for similar loans in active markets. However, this value is adjusted by a factor which considers the likelihood that the loan in a lock position will ultimately close, and by the non-refundable costs of originating the loan. The closing ratio is derived from the Bank’s internal data and is adjusted using significant management judgment. The costs to originate are primarily based on the Company’s internal commission rates that are not observable. As such, IRLCs are classified as Level 3 measurements.
Forward Sale Commitments. The Company utilizes forward sale commitments as economic hedges against potential changes in the values of the IRLCs and loans held for sale. To be announced (TBA) mortgage-backed securities forward commitment sales are classified as Level 1, and consist of publicly-traded debt securities for which identical fair values can be obtained through quoted market prices in active exchange markets. The fair values of the Company’s best efforts and mandatory delivery loan sale commitments are determined similarly to the IRLCs using quoted prices in the market place that are observable, however; costs to originate and closing ratios included in the calculation are internally generated and are based on management’s judgment and prior experience, which are considered factors that are not observable. As such, best efforts and mandatory forward sale commitments are classified as Level 3 measurements.
The table below presents the changes in Level 3 assets that were measured at fair value on a recurring basis at year-end
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Quantitative information about the significant unobservable inputs within Level 3 recurring assets as of December 31, 2013 and 2012 are as follows:
Non-Recurring Fair Value Measurements
The Company is required, on a non-recurring basis, to adjust the carrying value or provide valuation allowances for certain assets using fair value measurements in accordance with GAAP. The following is a summary of applicable non-recurring fair value measurements. There are no liabilities measured on a non-recurring basis.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Quantitative information about the significant unobservable inputs within Level 3 non-recurring assets as of December 31, 2013 and 2012 are as follows:
(a)Where dollar amounts are disclosed, the amounts represent the lowest and highest fair value of the respective assets in the population except for adjustments for market/property conditions, which represents the range of adjustments to individuals properties.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(a)Where dollar amounts are disclosed, the amounts represent the lowest and highest fair value of the respective assets in the population except for adjustments for market/property conditions, which represents the range of adjustments to individuals properties. There were no Level 1 or Level 2 nonrecurring fair value measurements for year-end
Impaired Loans. Loans are generally not recorded at fair value on a recurring basis. Periodically, the Company records non-recurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Non-recurring adjustments can also include certain impairment amounts for collateral-dependent loans calculated when establishing the allowance for credit losses. Such amounts are generally based on the fair value of the underlying collateral supporting the loan and, as a result, the carrying value of the loan less the calculated valuation amount does not necessarily represent the fair value of the loan. Real estate collateral is typically valued using appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace. However, the choice of observable data is subject to significant judgment, and there are often adjustments based on judgment in order to make observable data comparable and to consider the impact of time, the condition of properties, interest rates, and other market factors on current values. Additionally, commercial real estate appraisals frequently involve discounting of projected cash flows, which relies inherently on unobservable data. Therefore, real estate collateral related nonrecurring fair value measurement adjustments have generally been classified as Level 3. Estimates of fair value for other collateral that supports commercial loans are generally based on assumptions not observable in the marketplace and therefore such valuations have been classified as Level 3.
Capitalized mortgage loan servicing rights. A loan servicing right asset represents the amount by which the present value of the estimated future net cash flows to be received from servicing loans are expected to more than adequately compensate the Company for performing the servicing. The fair value of servicing rights is estimated using a present value cash flow model. The most important assumptions used in the valuation model are the anticipated rate of the loan prepayments and discount rates. Adjustments are only recorded when the discounted cash flows derived from the valuation model are less than the carrying value of the asset. Although some assumptions in determining fair value are based on standards used by market participants, some are based on unobservable inputs and therefore are classified in Level 3 of the valuation hierarchy.
Other real estate owned (“OREO”). OREO results from the foreclosure process on residential or commercial loans issued by the Bank. Upon assuming the real estate, the Company records the property at the fair value of the asset less the estimated sales costs. Thereafter, OREO properties are recorded at the lower of cost or fair value. OREO fair values are primarily determined based on Level 3 data including sales comparables and appraisals.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Summary of Estimated Fair Values of Financial Instruments
The estimated fair values, and related carrying amounts, of the Company’s financial instruments follow. Certain financial instruments and all non-financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented herein may not necessarily represent the underlying fair value of the Company.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1)Total fair value excludes the $1.3 million of unrealized losses on forward commitments presented under other assets on the consolidated balance sheet. (2)Total fair value includes the $1.3 million of unrealized losses on forward commitments presented under other assets on the consolidated balance sheet.
Other than as discussed above, the following methods and assumptions were used by management to estimate the fair value of significant classes of financial instruments for which it is practicable to estimate that value.
Cash and cash equivalents. Carrying value is assumed to represent fair value for cash and cash equivalents that have original maturities of ninety days or less.
Restricted equity securities. Carrying value approximates fair value based on the redemption provisions of the issuers.
Cash surrender value of life insurance policies.Carrying value approximates fair value.
Loans, net. The carrying value of the loans in the loan portfolio is based on the cash flows of the loans discounted over their respective loan origination rates. The origination rates are adjusted for substandard and special mention loans to factor the impact of declines in the loan’s credit standing. The fair value of the loans is estimated by discounting future cash flows using the current interest rates at which similar loans with similar terms would be made to borrowers of similar credit quality.
Accrued interest receivable.Carrying value approximates fair value. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deposits. The fair value of demand, non-interest bearing checking, savings and money market deposits is determined as the amount payable on demand at the reporting date. The fair value of time deposits is estimated by discounting the estimated future cash flows using market rates offered for deposits of similar remaining maturities.
Borrowed funds. The fair value of borrowed funds is estimated by discounting the future cash flows using market rates for similar borrowings. Such funds include all categories of debt and debentures in the table above.
Off-balance-sheet financial instruments. Off-balance-sheet financial instruments include standby letters of credit and other financial guarantees and commitments considered immaterial to the Company’s financial statements.
NOTE 21.OPERATING SEGMENTS
The Company has two reportable operating segments, Banking and Insurance, which are delineated by the consolidated subsidiaries of Berkshire Hills Bancorp, Inc. Banking includes the activities of the Bank and its subsidiaries, which provide retail and commercial banking, along with wealth management and investment services. Insurance includes the activities of BIG, which provides retail and commercial insurance services. The only other consolidated financial activity of the Company is the Parent, which consists of the transactions of Berkshire Hills Bancorp, Inc. Management fees for corporate services provided by the Bank to Berkshire Insurance Group and the Parent are eliminated.
The accounting policies of each reportable segment are the same as those of the Company. The Insurance segment and the Parent reimburse the Bank for administrative services provided to them. Income tax expense for the individual segments is calculated based on the activity of the segments, and the Parent records the tax expense or benefit necessary to reconcile to the consolidated total. The Parent does not allocate capital costs. Average assets include securities available-for-sale based on amortized cost.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A summary of the Company’s operating segments is as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 22. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Condensed financial information pertaining only to the Parent, Berkshire Hills Bancorp, is as
CONDENSED BALANCE SHEETS
CONDENSED STATEMENTS OF INCOME
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONDENSED STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 23. QUARTERLY DATA (UNAUDITED)
Quarterly results of operations were as follows:
A correction was identified in 2013 for prior period interest income earned on loans acquired in bank acquisitions and the accounting for a state income tax credit, which was deemed to be immaterial in relation to quarterly results. There has been no correction to quarterly results previously disclosed for 2013. The correction for fiscal year 2013 is included in third quarter 2013 financial results.
A correction was identified in 2012 for the accounting treatment of lease agreements with contractual cost escalators, which was deemed to be immaterial in relation to quarterly results. There has been no correction to quarterly results previously disclosed for
NOTE 24. NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
Presented below is net interest income after provision for loan losses for the three years ended 2013, 2012,
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 25. SUBSEQUENT EVENTS
On As a result of the Bank of America, National Association branch acquisition, on March 4, 2014 the Bank terminated all of its interest rate swaps associated with FHLB advances with 3-month LIBOR based floating interest rates with an aggregate notional amount of $30 million, all of its interest rate swaps associated with 90 day rolling FHLB advances issued using the FHLB’s 3-month fixed interest rate with an aggregate notional amount of $145 million, and all of its forward-starting interest rate swaps associated with 90 day rolling FHLB advances issued using the FHLB’s 3-month fixed interest rate with an aggregate notional amount of $235 million, with various institutions. In the first quarter of 2014 the Bank elected to extinguish $215 million of FHLB advances related to the terminated swaps. As a result the Bank has reclassified $8.6 million of losses from the effective portion of the unrealized changes in the fair value of the terminated derivatives from other comprehensive loss to earnings as the forecasted transactions related to the FHLB advances will
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