1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2004
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________________ to _________________
Commission File Number 1-15781
BERKSHIRE HILLS BANCORP, INC.
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 04-3510455
- --------------------------------------------------------------------------------
(State or other jurisdiction of incorporation (I.R.S. Employer
or organization) Identification No.)
24 North Street, Pittsfield, Massachusetts 01201
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(413) 443-5601
- --------------------------------------------------------------------------------
(Registrant telephone number, including area code)
Not Applicable
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
The Registrant had 5,873,563 shares of common stock, par value $0.01
per share, outstanding as of November 3, 2004.
2
BERKSHIRE HILLS BANCORP, INC.
FORM 10-Q
INDEX
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (unaudited)
Consolidated Balance Sheets as of
September 30, 2004 and December 31, 2003 1
Consolidated Statements of Income for the Three and Nine
Months Ended September 30, 2004 and 2003 2
Consolidated Statements of Changes in Stockholders' Equity
for the Nine Months Ended September 30, 2004 and 2003 3
Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 2004 and 2003 4
Notes to Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 9
Item 3. Qualitative and Quantitative Disclosures About Market Risk 16
Item 4. Controls and Procedures 18
PART II: OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 19
Item 3. Defaults Upon Senior Securities 19
Item 4. Submission of Matters to a Vote of Security Holders 19
Item 5. Other Information 19
Item 6. Exhibits 19
Signatures 21
3
PART 1. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS.
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
Unaudited
September 30, December 31,
2004 2003
----------------- ----------------
(In thousands)
Assets:
Cash and due from banks $ 15,908 $ 15,583
Short-term investments 6,689 1,859
----------------- ----------------
Total cash and cash equivalents 22,597 17,442
Securities available-for-sale, at fair value 387,950 307,425
Securities held-to-maturity, at amortized cost 26,255 36,903
Federal Home Loan Bank stock, at cost 16,898 12,923
Savings Bank Life Insurance stock, at cost 2,043 2,043
Loans held for sale 571 -
Loans 817,805 792,227
Allowance for loan losses (9,392) (8,969)
----------------- ----------------
Net loans 808,413 783,258
Premises and equipment, net 13,389 12,626
Accrued interest receivable 5,400 5,080
Goodwill and other intangibles 5,763 10,233
Net deferred tax assets 1,505 1,725
Bank owned life insurance 8,004 7,721
Due from broker 378 7,089
Other assets 11,343 14,080
----------------- ----------------
Total assets $ 1,310,509 $ 1,218,548
================= ================
Liabilities:
Deposits $ 853,115 $ 830,244
Federal Home Loan Bank advances 324,831 251,465
Loans sold with recourse - 473
Due to broker - 5,646
Accrued expenses and other liabilities 4,075 5,293
----------------- ----------------
Total Liabilities 1,182,021 1,093,121
----------------- ----------------
Minority Interests - 2,252
Stockholders' equity:
Preferred stock ($.01 par value: 1,000,000 shares
authorized; no shares issued and outstanding) - -
Common stock ( $.01 par value: 26,000,000 shares
authorized; 7,673,761 shares issued at September 30, 2004 and December 31,
2003; 5,873,563 shares outstanding at September 30, 2004;
and 5,903,082 shares outstanding at December 31, 2003) 77 77
Additional paid-in capital 77,154 75,764
Unearned compensation (7,832) (8,507)
Retained earnings 92,469 86,276
Accumulated other comprehensive income 4,345 5,559
Treasury stock at cost (1,800,198 shares at September 30, 2004
and 1,770,679 shares at December 31, 2003) (37,725) (35,994)
----------------- ----------------
Total stockholders' equity 128,488 123,175
----------------- ----------------
Total liabilities and stockholders' equity $ 1,310,509 $ 1,218,548
================= ================
See accompanying notes to unaudited consolidated financial statements.
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BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Unaudited
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- -------------------------------
2004 2003 2004 2003
-------------- -------------- -------------- --------------
(In thousands, except per share data)
Interest and dividend income:
Bond interest $ 4,130 $ 1,676 $ 12,116 $ 4,799
Stock dividends 279 269 887 747
Short-term investment interest 6 5 24 103
Loan interest 11,131 11,908 32,247 36,249
-------------- -------------- -------------- --------------
Total interest and dividend income 15,546 13,858 45,274 41,898
-------------- -------------- -------------- --------------
Interest expense:
Interest on deposits 3,097 3,343 9,209 10,714
Interest on FHLB advances and other borrowings 2,207 1,206 5,906 3,362
-------------- -------------- -------------- --------------
Total interest expense 5,304 4,549 15,115 14,076
-------------- -------------- -------------- --------------
Net interest income 10,242 9,309 30,159 27,822
Provision for loan losses 365 575 1,140 1,685
-------------- -------------- -------------- --------------
Net interest income, after provision for loan losses 9,877 8,734 29,019 26,137
Noninterest income:
Customer service fees 580 568 1,738 1,743
Trust department fees 611 573 1,835 1,563
Loan fees 63 142 245 337
Gain on sale of securities, net 310 356 1,013 1,513
Gain on sale of loans, net - 102 84 240
Other income 162 171 651 352
-------------- -------------- -------------- --------------
Total noninterest income 1,726 1,912 5,566 5,748
-------------- -------------- -------------- --------------
Operating expenses:
Salaries and benefits 4,195 3,877 12,687 12,577
Occupancy and equipment 997 895 3,030 2,858
Marketing and advertising 207 137 634 379
Data processing 305 375 1,030 920
Professional services 442 260 1,226 742
Office supplies 126 146 387 473
Foreclosed real estate and other loans, net 150 333 404 740
Other general and administrative expenses 759 850 2,279 2,648
-------------- -------------- -------------- --------------
Total operating expenses 7,181 6,873 21,677 21,337
-------------- -------------- -------------- --------------
Income from continuing operations before taxes 4,422 3,773 12,908 10,548
Provision for income taxes 1,415 1,358 4,144 4,037
-------------- -------------- -------------- --------------
Income from continuing operations 3,007 2,415 8,764 6,511
-------------- -------------- -------------- --------------
Loss from discontinued operations (including loss on sale of $75,000) - (1) (653) (208)
Income tax benefit - - (222) (71)
-------------- -------------- -------------- --------------
Net loss from discontinued operations - (1) (431) (137)
-------------- -------------- -------------- --------------
Net income $ 3,007 $ 2,414 $ 8,333 $ 6,374
============== ============== ============== ==============
Earnings per share:
Basic $ 0.57 $ 0.46 $ 1.58 $ 1.20
Diluted $ 0.53 $ 0.43 $ 1.45 $ 1.12
Weighted average shares outstanding:
Basic 5,270 5,196 5,284 5,301
Diluted 5,721 5,655 5,735 5,711
See accompanying notes to unaudited consolidated financial statements.
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5
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003
Unaudited
Accumulated
Additional Other
Common Paid-in Unearned Retained Comprehensive Treasury
Stock Capital Compensation Earnings Income Stock Total
---------- ---------- -------------- ---------- --------------- ---------- -----------
(In thousands)
Balance at December 31, 2003 $ 77 $ 75,764 $ (8,507) $ 86,276 $ 5,559 $ (35,994) $ 123,175
----------
Comprehensive income :
Net Income - - - 8,333 - - 8,333
Change in net unrealized gain on
securities available-for-sale, net
of reclassification adjustment and
tax effects - - - - (1,214) - (1,214)
----------
Total comprehensive income 7,119
----------
Reversals from discontinued operations - 142 - (142) - - -
Cash dividends declared ($0.36 per share) - - - (1,965) - - (1,965)
Treasury stock purchased - - - - - (2,545) (2,545)
Treasury stock released - 358 - - - 238 596
Reissuance of Treasury stock under
Stock Option Plan (32,415 shares) - - - (33) - 576 543
Change in unearned compensation - MRP - 219 319 - - - 538
Change in unearned compensation - ESOP - 671 356 - - - 1,027
---------- ---------- ------------ ----------- ------------ ----------- ----------
Balance at September 30, 2004 $ 77 $ 77,154 $ (7,832) $ 92,469 $ 4,345 $ (37,725) $ 128,488
========== ========== ============ =========== ============ ========== ==========
Balance at December 31, 2002 $ 77 $ 74,632 $ (9,535) $ 80,010 $ 5,542 $ (30,158) $ 120,568
----------
Comprehensive income :
Net Income - - - 6,374 - - 6,374
Change in net unrealized gain on
securities available-for-sale, net
of reclassification adjustment and
tax effects - - - - (115) - (115)
----------
Total comprehensive income 6,259
----------
Cash dividends declared ($0.36 per share) - - - (1,981) - - (1,981)
Treasury stock purchased - - - - - (6,885) (6,885)
Treasury stock released - - - (41) - 721 680
Change in unearned compensation - MRP - 570 287 - - - 857
Change in unearned compensation - ESOP - 403 356 - - - 759
---------- ---------- ------------ ----------- ------------ ----------- ----------
Balance at September 30, 2003 $ 77 $ 75,605 $ (8,892) $ 84,362 $ 5,427 $ (36,322) $ 120,257
========== ========== ============ =========== ============ =========== ==========
See accompanying notes to unaudited consolidated financial statements.
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6
BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Unaudited
Nine Months Ended
September 30,
---------------------------------------
2004 2003
----------------- -----------------
(In thousands)
Cash flows from operating activities:
Continuing operations:
Net income $ 8,764 $ 6,583
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for loan losses 1,140 1,685
Net amortization of securities 954 1,500
Depreciation and amortization expense 1,252 1,226
Management Awards Plan Expense 920 857
Employee Stock Ownership Plan Expense 1,027 759
Increase in cash surrender value of Bank Owned Life Insurance (283) (126)
Gain on sales and dispositions of securities, net (1,013) (1,513)
Gain on sale of loans, net (84) (240)
Loss on sale/write-down of foreclosed real estate, net 2 44
Deferred tax provision 294 239
Changes in operating assets and liabilities:
Accrued interest receivable and other assets 2,417 (126)
Accrued expenses and other liabilities (778) (214)
----------------- -----------------
Net cash provided by continuing operations 14,612 10,674
Discontinued operations:
Net loss (431) (209)
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization expense 188 377
Amortization of goodwill and other intangibles 94 151
Minority interests - (138)
Proceeds from the sale of discontinued operations 2,049 -
Loss on sale of discontinued operations 75 -
----------------- -----------------
Net cash provided by discontinued operations 1,975 181
Total net cash provided by operating activities 16,587 10,855
----------------- -----------------
Cash flows from investing activities:
Continuing operations:
Activity in available-for-sale securities:
Sales 4,159 10,430
Maturities 25,501 106,800
Principal payments 45,153 23,823
Purchases (155,768) (192,064)
Activity in held-to-maturity securities:
Maturities 13,616 12,016
Principal payments 10,655 35,368
Purchases (13,797) (44,981)
Purchase of Federal Home Loan Bank stock (3,975) (3,976)
Purchase of Bank Owned Life Insurance - (7,500)
(continued)
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BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(concluded)
Unaudited
Nine Months Ended
September 30,
---------------------------------------
2004 2003
----------------- -----------------
(In thousands)
Loan originations, net of pricipal payments and purchases $ (79,103) $ (124,527)
Proceeds from sale of loans from portfolio 52,296 45,613
Additions to banking premises and equipment (2,748) (1,110)
Proceeds from sale of foreclosed real estate 23 -
Proceeds from sale of real estate - 1,456
Purchase of common stock in connection with stock awards plan 214 -
----------------- -----------------
Net cash used by continuing operating investing activities (103,774) (138,652)
Discontinued operations:
Additions to banking premises and equipment (76) (42)
Proceeds from sale of equipment 621 -
----------------- -----------------
Net cash provided (used) by discontinued investing activities 545 (42)
Total net cash used by investing operations (103,229) (138,694)
----------------- -----------------
Cash flows from financing activities:
Net increase in deposits 22,871 45,422
Net decrease in securities sold under agreements to repurchase - (700)
Proceeds from Federal Home Loan Bank advances with maturities
in excess of three months 254,000 92,000
Repayment of Federal Home Loan Bank advances with maturities
in excess of three months (170,634) (71,684)
Proceeds of borrowings with maturities of three months or
less, net of repayments (10,000) 38,000
Net decrease in loans sold with recourse (473) (603)
Treasury stock purchased (2,545) (6,886)
Exercise of officer stock options and non-employee director benefit programs 543 681
Dividends (1,965) (1,981)
----------------- -----------------
Net cash provided by financing activities 91,797 94,249
----------------- -----------------
Net change in cash and cash equivalents 5,155 (33,590)
Cash and cash equivalents at beginning of period 17,442 60,655
----------------- -----------------
Cash and cash equivalents at end of period $ 22,597 $ 27,065
================= =================
Supplemental cash flow information:
Interest paid on deposits 9,203 10,732
Interest paid on borrowed funds 5,742 3,318
Income taxes paid 1,627 1,111
Due to broker - 20,019
Due from broker 378 -
Transfer from loans to foreclosed real estate 25 -
See accompanying notes to unaudited consolidated financial statements.
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BERKSHIRE HILLS BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004 and 2003
(Unaudited)
Note 1. Basis of Presentation
- -------------------------------
The consolidated interim financial statements of Berkshire Hills
Bancorp, Inc. ("Berkshire Hills" or the "Company") and its wholly owned
subsidiaries, Berkshire Bank (the "Bank"), Berkshire Hills Funding Corp. and
Berkshire Hills Technology, Inc. herein presented are intended to be read in
conjunction with the consolidated financial statements presented in the
Company's most recent Securities and Exchange Commission Form 10-K and
accompanying notes to the Consolidated Financial Statements filed by the Company
for the year ended December 31, 2003. The consolidated financial information at
September 30, 2004 and for the three- and nine-month periods ended September 30,
2004 and 2003 are derived from unaudited consolidated financial statements but,
in the opinion of management, reflect all adjustments necessary to present
fairly the results for these interim periods in accordance with accounting
principles generally accepted in the United States of America. These adjustments
consist only of normal recurring adjustments. The interim results are not
necessarily indicative of the results of operations that may be expected for the
entire year.
On June 18, 2004, the Company announced the sale of the business
assets of EastPoint Technologies, LLC ("EastPoint"), a software and data
processing provider for financial institutions, to a subsidiary of Open
Solutions Inc. (NASDAQ: OPEN). The Company owned 60.3 percent of EastPoint and
recognized approximately $2.8 million on the sale. The transaction resulted in a
net loss of $75,000 to the Company ($49,500 net of taxes). This loss, included
in a current year net operating loss of $653,000 ($431,000 net of taxes) from
EastPoint through June 18, 2004, was recorded as a loss from discontinued
operations. The Company also has the potential to receive up to an additional
$625,000 in two years. Prior periods presented have been adjusted to reflect the
sale of EastPoint and the discontinued operations.
Note 2. Commitments
- ---------------------
At September 30, 2004, the Company had outstanding commitments to
originate new residential and commercial loans totaling $44.1 million, which are
not reflected on the consolidated balance sheet. In addition, unadvanced funds
on home equity lines totaled $53.8 million and unadvanced commercial lines,
including unadvanced construction loan funds, totaled $66.4 million. The Company
anticipates it will have sufficient funds to meet these commitments.
6
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Note 3. Earnings Per Share
- ----------------------------
Basic earnings per share represent net income divided by the weighted
average number of common shares outstanding during the period. Diluted earnings
per share reflect additional common shares that would have been outstanding if
potential dilutive shares, such as stock options, had been issued. Unallocated
shares of common stock held by the Bank's employee stock ownership plan are not
included in the weighted average number of common shares outstanding for either
basic or diluted earnings per share calculations. Earnings per share data is
presented for the three and nine months ended September 30, 2004 and 2003.
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- ----------------------------
2004 2003 2004 2003
-------------- ------------- ------------- -------------
(In thousands, except per share amounts)
Net income from continuing operations $ 3,007 $ 2,415 $ 8,764 $ 6,511
Net loss from discontinued operations - (1) (431) (137)
-------------- ------------- ------------- -------------
Net income $ 3,007 $ 2,414 $ 8,333 $ 6,374
============== ============= ============= =============
Weighted average common shares 5,270 5,196 5,284 5,301
Dilutive effect of potential common shares
related to stock compensation plans 451 459 451 410
-------------- ------------- ------------- -------------
Weighted average common shares
including potential dilution 5,721 5,655 5,735 5,711
============== ============= ============= =============
Continuing operations:
Basic earnings per share $ 0.57 $ 0.46 $ 1.66 $ 1.23
Diluted earnings per share $ 0.53 $ 0.43 $ 1.53 $ 1.14
Discontinued operations:
Basic loss per share $ - $ - $ (0.09) $ (0.03)
Diluted loss per share $ - $ - $ (0.08) $ (0.02)
Net income:
Basic earnings per share $ 0.57 $ 0.46 $ 1.58 $ 1.20
Diluted earnings per share $ 0.53 $ 0.43 $ 1.45 $ 1.12
Note 4. Tangible Book Value
- -----------------------------
The tangible book value per share of Berkshire Hills' common stock at
September 30, 2004 was $20.89, based on tangible stockholders' equity of $122.7
million and outstanding shares of 5,873,563. The tangible book value per share
at December 31, 2003 was $19.13 based on tangible stockholders' equity of $112.9
million and total outstanding shares of 5,903,082.
Note 5. Dividend
- ------------------
On July 22, 2004, the Company's Board of Directors declared a cash
dividend of $0.12 per share, which was paid on August 20, 2004, to stockholders
of record on August 5, 2004.
Note 6. Goodwill and Other Intangibles
- ----------------------------------------
Goodwill and other intangibles include goodwill associated with the
acquisition by Berkshire Hills Technology of a majority interest in EastPoint,
as well as the Company's purchase of two branches from another financial
institution in 1991 and three branches in 1998, which are evaluated for
impairment on an annual basis. Intangible assets refer to customer relationships
acquired in association with the EastPoint purchase, which were included in the
sale of business assets of EastPoint on June 18, 2004. The carrying amount of
goodwill and other intangibles as of September 30, 2004 was $5.8 million and
$10.2 million on December 31, 2003. As of December 31, 2003, the gross carrying
amount and accumulated amortization of these customer relationships were
$101,000 and $507,000, respectively. The amortization expense and other
intangible assets amounted to $94,000 for the nine-month period ended September
30, 2004 and $153,000 for the nine-month period ending September 30, 2003.
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Note 7. Stock Compensation Plans
- ----------------------------------
Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based Compensation," encourages all entities to adopt a
fair value based method of accounting for employee stock compensation plans,
whereby compensation cost is measured at the grant date based on the value of
the award and is recognized over the service period, which is usually the
vesting period. However, it also allows an entity to continue to measure
compensation cost for those plans using the intrinsic value based method of
accounting prescribed by Accounting Principals Board Opinion No. 25, "Accounting
for Stock Issued to Employees," whereby compensation cost is the excess, if any,
of the quoted market price of the stock at the grant date (or other measurement
date) over the amount an employee must pay to acquire the stock. Stock options
issued under the Company's stock plans have no intrinsic value at the grant
date, and under Opinion No. 25, no compensation cost is recognized for them.
At September 30, 2004 and December 31, 2003, the Company had stock
option plans and has elected to continue with the accounting methodology in
Opinion No. 25, and as a result, has provided pro forma disclosures of net
income and earnings per share, as if the fair value based method of accounting
has been applied. The following table illustrates the effect on net income and
earnings per share if the Company had applied the fair value recognition
provisions of SFAS No. 123 to stock-based employee compensation.
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------- ----------------------------------
2004 2003 2004 2003
---------------- ---------------- --------------- ----------------
(In thousands, except per share amounts)
Net income as reported $ 3,007 $ 2,414 $ 8,333 $ 6,374
Deduct: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax effects 133 104 399 312
---------------- ---------------- --------------- ----------------
Proforma net income $ 2,874 $ 2,310 $ 7,934 $ 6,062
================ ================ =============== ================
Earnings per share
Basic - as reported $ 0.57 $ 0.46 $ 1.58 $ 1.20
================ ================ =============== ================
Basic - proforma $ 0.55 $ 0.44 $ 1.50 $ 1.14
================ ================ =============== ================
Diluted - as reported $ 0.53 $ 0.43 $ 1.45 $ 1.12
================ ================ =============== ================
Diluted - proforma $ 0.50 $ 0.41 $ 1.38 $ 1.06
================ ================ =============== ================
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
The following analysis discusses changes in the financial condition
and results of operations at and for the three and nine months ended September
30, 2004 and 2003, and should be read in conjunction with Berkshire Hills
Bancorp, Inc.'s Consolidated Financial Statements and the notes thereto,
appearing in Part I, Item 1 of this document.
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements that are based on
assumptions and may describe future plans, strategies and expectations of
Berkshire Hills and Berkshire Bank. These forward-looking statements are
generally identified by use of the words "believe," "expect," "intend,"
"anticipate," "estimate," "project" or similar expressions. Berkshire Hills' and
Berkshire Bank's ability to predict results or the actual effect of future plans
or strategies is inherently uncertain. Factors which could have a material
adverse effect on the operations of Berkshire Hills and its subsidiaries
include, but are not limited to, changes in interest rates, national and
regional economic conditions, legislative and regulatory changes, monetary and
fiscal policies of the U.S. government, including policies of the U.S. Treasury
and the Federal Reserve Board, the quality and composition of the loan or
investment portfolios, demand for loan products, deposit flows, competition,
demand for financial services in Berkshire Hills' and Berkshire Bank's market
area, changes in real estate market values in Berkshire Hills' and Berkshire
Bank's market area, and changes in relevant accounting principles and
guidelines. These risks and uncertainties should be considered in evaluating
forward-looking statements and undue reliance should not be placed on such
statements. Except as required by applicable law or regulation, Berkshire Hills
does not undertake, and specifically disclaims any obligation, to release
publicly the result of any revisions which may be made to any forward-looking
statements to reflect events or circumstances after the date of the statements
or to reflect the occurrence of anticipated or unanticipated events.
GENERAL
Berkshire Hills is a Delaware corporation and the holding company for
Berkshire Bank, a state-chartered savings bank headquartered in Pittsfield,
Massachusetts. Established in 1846, Berkshire Bank is one of Massachusetts'
oldest and largest independent banks. With eleven full-service branch offices
serving communities throughout Berkshire County, Massachusetts as well as a
full-service branch office in Oriskany Falls, New York and a representative
office in Albany, New York, Berkshire Bank is the largest banking institution
based in western Massachusetts. The Bank is a community-based financial
institution that originates a variety of loan products including real estate
loans, commercial loans and consumer loans primarily in Berkshire County and its
surrounding areas. The Bank offers a wide variety of deposit products and other
investment products and financial services, including asset management and trust
services and municipal finance.
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2004 AND DECEMBER 31, 2003
Total assets at September 30, 2004 were $1.31 billion, an increase of
$92.0 million, or 7.6%, from December 31, 2003. The increase in assets was
primarily due to an increase of $73.9 million, or 20.6%, in securities and $25.6
million, or 3.2%, in loans. This increase was largely funded by a $73.4 million
increase in Federal Home Loan Bank advances, and an increase of $22.9 million in
deposits.
LOANS
Loans increased $25.6 million from December 31, 2003. Residential real
estate loans decreased $36.7 million during the first nine months of 2004
primarily due to the securitization of $38.7 million of one- to four-family
longer-term fixed rate mortgages, as the Bank continued to reduce its exposure
to loans and investments with longer maturities. Commercial real estate loans
increased $48.1 million, as the Bank has been successful in soliciting new
relationships and due to an improving commercial real estate market in Berkshire
County. However, commercial loans decreased $7.1 million as our market
experienced weak demand for commercial and industrial financing during the first
nine months of 2004. The automobile loan portfolio increased $16.1 million
during the first nine months of 2004, as increased marketing efforts aimed at
generating high quality loans with FICO scores above 700 continued to gain
momentum. Home equity loans increased $5.7 million, or 12.4%, due equally to
draw-downs on existing equity lines of credit and new loan originations.
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At September 30, 2004 At December 31, 2003
----------------------------- -----------------------------
Percent Percent
Balance of total Balance of total
------------- ------------- -------------- -------------
(Dollars in thousands)
Real estate loans:
Residential one- to four-family $ 214,100 26.18% $ 254,939 32.18%
Residential land development
and construction 14,754 1.80% 10,583 1.33%
Commercial real estate 217,373 26.58% 166,796 21.05%
Commercial land development
and construction 20,560 2.51% 24,136 3.05%
Multi-family 16,616 2.03% 15,514 1.96%
----------- ------------ -----------
Total real estate loans 483,403 59.11% 471,968 59.57%
Commercial loans 159,156 19.46% 166,296 20.99%
Consumer loans:
Automobile 119,787 14.65% 103,674 13.09%
Home equity loans 51,465 6.29% 45,783 5.78%
Other 3,994 0.49% 4,506 0.57%
----------- ------------ -----------
Total consumer loans 175,246 21.43% 153,963 19.44%
Total loans 817,805 100.00% 792,227 100.00%
========== ===========
Less: Allowance for loan losses (9,392) 1.15% (8,969) 1.13%
----------- ------------
Loans, net $ 808,413 $ 783,258
=========== ============
ALLOWANCE FOR LOAN LOSSES
All banks that manage loan portfolios will experience losses to
varying degrees. The allowance for loan losses is the amount available to absorb
these losses and represents management's evaluation of the risks inherent in the
portfolio based on the collectibility of the loans, changing collateral values,
past loan loss history, specific borrower situations and general economic
conditions. Management continually assesses the adequacy of the allowance for
loan losses and makes monthly provisions to maintain the allowance at a level
considered adequate to cover losses in the loan portfolio. Because future events
affecting the loan portfolio cannot be predicted with complete accuracy, there
can be no assurances that management's estimates are correct and that the
existing allowance for loan losses is adequate. However, management believes
that, based on the information available on September 30, 2004, the Company's
allowance for loan losses is sufficient to cover losses inherent in the
Company's loan portfolio as of such date.
The allowance consists of allocated, general and unallocated
components. The allocated component relates to loans that are classified as
either doubtful, substandard or special mention. For such loans that are also
classified as impaired, an allowance is established when the discounted cash
flows (or collateral value or observable market price) of the impaired loan is
lower than the carrying value of that loan. The general component covers
non-classified loans and is based on historical loss experience adjusted for
qualitative factors such as the credit history and credit quality of the
borrower, the type and geographic concentration of loans in the portfolio, and
the local economic environment. An unallocated component is maintained to cover
uncertainties that could affect management's estimate of probable losses. The
unallocated component of the allowance reflects the margin of imprecision
inherent in the underlying assumptions used in the methodologies for estimating
losses in the portfolio.
At September 30, 2004, the allowance for loan losses totaled $9.4
million, or 1.15%, of total loans outstanding and 346.06% of nonperforming
loans, as compared to $9.0 million, or 1.13%, of total loans outstanding and
280.37% of nonperforming loans at December 31, 2003. Charged-off loans totaled
$1.5 million during the first nine months of this year as compared to $3.3
million for the same nine-month period last year. The improvement was almost
exclusively from indirect automobile loans, as the Bank's credit risk profile
for these loans has improved greatly since the Bank sold $9.9 million, of nearly
all of its sub-prime automobile loans, in December 2003.
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The following table sets forth information regarding the allowance for
loan losses for the nine-month periods ended September 30, 2004 and 2003.
Nine Months Ended
-----------------------------------------------
September 30, 2004 September 30, 2003
---------------------- ---------------------
(Dollars in thousands)
Allowance for loan losses, beginning of period $ 8,969 $ 10,308
Charge-offs:
Residential one- to four-family - -
Residential land development and construction - -
Commercial real estate 34 -
Commercial land development and construction - -
Multi-family - -
Commercial 12 43
Consumer (1) 1,419 3,247
-------------------- -------------------
Total charge-offs 1,465 3,290
-------------------- -------------------
Recoveries:
Residential one- to four-family - -
Residential land development and construction - -
Commercial real estate - -
Commercial land development and construction - -
Multi-family - -
Commercial 158 437
Consumer (1) 590 957
-------------------- -------------------
Total recoveries 748 1,394
-------------------- -------------------
Net charge-offs 717 1,896
Provision for loan losses 1,140 1,685
-------------------- -------------------
Allowance for loan losses, end of period $ 9,392 $ 10,097
==================== ===================
Net loans charged-off to total loans 0.09% 0.24%
Allowance for loan losses to total loans 1.15% 1.26%
Allowance for loan losses to nonperforming loans 346.06% 276.55%
Recoveries to charge-offs 51.06% 42.37%
- -------------------------------------------------------
(1) Consists primarily of automobile loans.
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NONPERFORMING ASSETS
The following table sets forth information regarding nonperforming
assets as of September 30, 2004 and December 31, 2003.
At September 30, 2004 At December 31, 2003
-------------------------- --------------------------
(Dollars in thousands)
Nonaccruing loans:
Residential one- to four-family $ 332 $ 348
Residential land development and construction - -
Commercial real estate 614 496
Commercial land development and construction - -
Multi-family - -
Commercial 1,463 1,887
Automobile 297 451
Home equity - -
Other consumer 8 17
------------------------ ------------------------
Total 2,714 3,199
------------------------ ------------------------
Other real estate owned - -
------------------------ ------------------------
Total nonperforming assets $ 2,714 $ 3,199
======================== ========================
Total nonperforming loans to total loans 0.33% 0.40%
Total nonperforming assets to total assets 0.21% 0.26%
Generally, the Company ceases accruing interest on all loans, except
automobile loans, when principal or interest payments are 90 days or more past
due, unless management determines the principal and interest to be fully secured
and in the process of collection. Once management determines that interest is
uncollectible and ceases accruing interest on a loan, all previously accrued
interest is reversed against current interest income. With regard to automobile
loans, all delinquent automobile loans remain on accrual status until they are
120 days past due, at which time they are charged off, except for loans to
customers in bankruptcy proceedings, which are transferred to nonaccrual status.
At September 30, 2004, the Company had $40,000 in automobile loans that were 90
days past due and still accruing as compared to $306,000 at December 31, 2003.
Nonaccruing loans totaled $2.7 million at September 30, 2004, a
decrease of $485,000 from December 31, 2003. Commercial real estate nonaccruing
loans increased $118,000 from December 31, 2003, primarily due to the addition
of two adequately reserved loans which are current with their payments.
Offsetting the increase was a decrease of $424,000 in commercial loans and a
decrease of $154,000 in automobile loans due to improved credit quality, as well
as, collections and loan amortizations received.
INVESTMENT SECURITIES
Securities, including Federal Home Loan Bank stock and Savings Bank
Life Insurance stock, totaled $433.1 million at September 30, 2004, an increase
of $73.9 million, or 20.6%, from December 31, 2003. The increase was primarily
due to the securitization of $38.7 million of the Bank's one- to four-family
fixed rate mortgages and the purchase of pass-through mortgage-backed securities
with average maturities of 3.5 years, which have limited risk of average life
extension. These securities were purchased to leverage the Bank's capital and
reduce interest rate risk exposure to longer-term investments while taking
advantage of a steep yield curve. The Bank sold securities totaling $378,000 in
the third quarter for a net gain of $310,000. The net unrealized gain in the
securities portfolio, net of taxes, decreased $1.2 million to $4.3 million at
September 30, 2004, primarily due to a decline in the market value of the debt
portfolio, which was recognized in accumulated other comprehensive income on the
consolidated statement of changes in stockholders' equity.
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BANK OWNED LIFE INSURANCE ("BOLI")
The single premium BOLI contract executed in May 2003 totaled $8.0
million at September 30, 2004, an increase of $283,000 from December 31, 2003.
The income earned on BOLI is recorded as an increase in the asset and
noninterest income.
DEPOSITS
Customers' deposits are the primary funding vehicle for the Company's
asset base. The following table sets forth the Company's deposit stratification
as of September 30, 2004 and December 31, 2003.
At September 30, 2004 At December 31, 2003
----------------------------- ------------------------------
Percent Percent
Balance of deposits Balance of deposits
------------- ------------- ------------- -------------
(Dollars in thousands)
Demand deposits $ 104,204 12.21% $ 102,788 12.38%
NOW accounts 96,945 11.36% 94,606 11.39%
Savings accounts 166,720 19.54% 171,603 20.67%
Money Market accounts 160,423 18.82% 139,897 16.85%
------------- ------------- ------------- -------------
Total Core Accounts 528,292 61.93% 508,894 61.29%
Certificates of Deposit 324,823 38.07% 321,350 38.71%
------------- -------------
Total deposits $ 853,115 $ 830,244
============= =============
Core deposits increased $19.4 million, or 3.8%, from December 31, 2003
and certificates of deposit increased $3.5 million, or 1.1%, from December 31,
2003, as the Bank continued to actively pursue relationships through its TRUSTED
SOLUTIONS SM brand campaign initiated in early 2004.
BORROWINGS
Borrowings from the Federal Home Loan Bank of Boston totaled $324.8
million at September 30, 2004, a $73.4 million, or 29.2%, increase from $251.5
million at December 31, 2003, as the Bank took advantage of the lower cost of
borrowings relative to the cost of deposits to fund earning asset growth. This
increase represented new borrowings with terms ranging from one month to four
years. The Company had additional borrowing capacity of $49.7 million at the
Federal Home Loan Bank of Boston at September 30, 2004.
STOCKHOLDERS' EQUITY
At September 30, 2004, the Company had $128.5 million in stockholders'
equity compared to $123.2 million at December 31, 2003, an increase of $5.3
million. The increase was primarily due to net income of $8.3 million and
increases to additional paid-in capital of $1.4 million. Partially offsetting
these increases in stockholders' equity were decreases of $1.2 million in net
unrealized gain on securities, net of taxes, due to a decline in the market
value of the debt portfolio, which was recognized in accumulated other
comprehensive income, the payment of cash dividends of $0.36 per common share
amounting to $2.0 million and net increases in treasury stock transactions of
$1.7 million.
COMPARISON OF OPERATING RESULTS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER
30, 2004 AND 2003
NET INTEREST INCOME. Net interest income is the largest component of
the Company's revenue stream and is the difference between the interest and
dividends earned on the loan and investment portfolios and the interest paid on
the Company's funding sources, primarily customer deposits and advances from the
Federal Home Loan Bank of Boston. Net interest income increased $933,000, or
10.0%, for the three months ended September 30, 2004, and increased $2.3
million, or 8.4%, for the nine months ended September 30, 2004, primarily due to
an increase in average earning assets and a lower cost of funds offset by a
decrease in the yield on average interest-earning assets. The yield on average
earning assets declined to 4.99% for the three months ended September 30, 2004
compared to 5.22% for the three months ended September 30, 2003 and declined to
4.96% for the nine-month period ended September 30, 2004, from 5.49% for the
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nine-month period ended September 30, 2003, due primarily to the lower interest
rate environment and the Company's strategy to shorten the duration of its
earning assets. The Company's net interest margin was 3.29% for the three-month
period and 3.30% for the nine-month period ended September 30, 2004, compared to
3.51% for the three months ended September 30, 2003 and 3.64% for the nine
months ended September 30, 2003. The decreases in net interest margin were
attributable to the low interest rate environment, as maturing loans and
securities were reinvested at lower yields with shorter durations. The Company
expects the net interest margin to remain stable over the next twelve months
under a flat to gradual decline of 100 basis points in general market interest
rates and respond positively to a gradual rise of 200 basis points.
Total interest and dividend income increased $1.7 million, or 12.2%,
for the three months ended September 30, 2004 and $3.4 million, or 8.1%, for the
nine months ended September 30, 2004, compared to the same periods last year.
The increases occurred primarily due to an increase of $184.2 million in average
earning assets for the three months ended September 30, 2004 and an increase of
$198.8 million in average earning assets for the nine-month period ended
September 30, 2004. Interest earned on the Company's investment portfolio
increased $2.5 million for the three months ended September 30, 2004, and $7.4
million for the nine months ended September 30, 2004, as higher average balances
were able to offset lower average rates earned. Loan interest declined $777,000,
or 6.5%, for the three months ended September 30, 2004 and declined $4.0
million, or 11.0%, for the nine months ended September 30, 2004 as compared to
the same periods last year. The decline was due to the sale of higher rate
sub-prime automobile loans in December 2003, the securitization of $55.0 million
of one- to four- family fixed-rate mortgages and the impact of lower market
interest rates.
An increase in average funding liabilities of $173.0 million for the
three months ended September 30, 2004, and $328.3 million for the nine months
ended September 30, 2004, resulted in increases in interest expense of $755,000
for the three-month period and $1.0 million for the nine months ended September
30, 2004, compared to the same periods last year. Interest expense on deposits
fell by $246,000 for the three-month period and $1.5 million for the nine-month
period ended September 30, 2004 compared to the same periods last year, as
higher average balances were offset by lower interest rates and increases in
lower cost core deposits. Interest paid on Federal Home Loan Bank of Boston
advances and other borrowings increased $1.0 million for the three months ended
September 30, 2004 and $2.5 million for the nine months ended September 30, 2004
compared to the same period last year, consistent with the average increase of
$154.0 million in borrowings for the three and nine month periods ended
September 30, 2003.
PROVISION FOR LOAN LOSSES. The Company's provision for loan losses was
$365,000 for the three months ended September 30, 2004 and $1.1 million for the
nine months ended September 30, 2004, as compared to $575,000 and $1.7 million
for the same periods last year. The decrease in the provision for the three and
nine months ended September 30, 2004 was largely attributed to a $13.0 million
decrease in sub-prime automobile loans from September 30, 2003. The Company also
considered net loan charge-offs, which decreased $1.2 million to $717,000 for
the first nine months of this year compared to the same period last year.
Foremost in this decrease were consumer loan net charge-offs which decreased
$1.5 million, consisting mainly of sub-prime automobile loans. Additional
factors management considered were the level of delinquent loans, which declined
from 0.98% of total loans at September 30, 2003, to 0.73% at September 30, 2004,
and nonaccrual loans which declined $937,000, or 25.7%, from September 30, 2003.
NONINTEREST INCOME. For the three and nine months ended September 30,
2004, noninterest income decreased $186,000 and $182,000, respectively, as
compared to the same periods last year. Included in these decreases were
decreases of $79,000 and $92,000 in loan fees during the three and nine months
ended September 30, 2004. Gain on sale of securities decreased $46,000 and
$500,000 for the three and nine months ended September 30, 2004, as compared to
the same periods last year. Gain on the sale of loans decreased $102,000 and
$156,000 for the three and nine months ended September 30, 2004 as compared to
the same periods last year, as the Company did not sell as many loans during
2004 as in 2003 and due to heavy refinancing activity in 2003, as the Company
did not originate as many loans for sale in 2004. These decreases were partially
offset by increases of $38,000 and $272,000 in trust department fees for the
three and nine months ended September 30, 2004, compared to the same period last
year. The increase in trust department fees was due to an increase of $43.5
million, or 15.4%, in assets under management from September 30, 2003. An
increase of $299,000 in other income during the nine months ended September 30,
2004 resulted primarily from increases in the cash surrender value on life
insurance policies due to a $7.5 million BOLI contract executed in May 2003.
OPERATING EXPENSES. Operating (noninterest) expenses increased
$308,000, or 4.5%, and $340,000, or 1.6%, respectively, for the three- and
nine-month periods ended September 30, 2004, compared to the same periods last
year. Salaries and benefits increased $318,000, or 8.2%, and $110,000, or 0.9%,
for the three- and nine-month periods ended September 30, 2004, respectively,
compared to the same periods last year. The increase in salaries and benefits
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for the three-month period was attributed to increases in retirement benefit
expense, the timing of payments to directors and an increase in incentive
compensation. The implementation of the TRUSTED SOLUTIONS SM advertising
campaign increased marketing expenses $70,000 and $255,000 for the three and
nine months ended September 30, 2004, respectively. Professional services fees
increased $182,000 and $484,000 for the three and nine months ended September
30, 2004, respectively, primarily due to the implementation of Six Sigma, a
productivity improvement program, and due to the additional costs of complying
with the additional corporate government requirements contained in the
Sarbanes-Oxley Act. Occupancy expenses increased $172,000 during the nine-month
period. These increases were partially offset by a reduction in foreclosed real
estate and other loan expenses, which were primarily driven by repossessed
automobile expenses, which declined $183,000 and $336,000 for the three and nine
months ended September 30, 2004, respectively, due to the reduction in lower
quality automobile loans. Also, decreases in FDIC insurance premiums of $91,000
and $369,000 for the three and nine months ended September 30, 2004, resulted
from efforts made by management to improve the Bank's risk and earnings profile.
INCOME TAXES. The Company's effective tax rate was 32.0% for the three
and nine months ended September 30, 2004. Excluding the income tax and
associated charges relating to the Bank's REIT disallowance in March 2003 and
subsequent settlement in June 2003, the Company's effective tax rate would have
been 36.0% for the three and nine months ended September 30, 2003. The lower
effective tax rate in 2004 was due in part to an increase in securities
purchased in the Bank's subsidiary securities corporations, which are taxed at a
lower rate. The Company expects its effective tax rate will be approximately
32.0% for the remainder of 2004.
REGULATORY CAPITAL
The Company's capital to assets ratios for September 30, 2004 and
December 31, 2003 were 9.81% and 10.11%, respectively. The various regulatory
capital ratios for the Bank at September 30, 2004 and December 31, 2003 were as
follows:
FDIC Minimums
At September 30, 2004 At December 31, 2003 to be Well Capitalized
------------------------ ----------------------- ------------------------
Total capital to risk weighted assets: 12.67% 12.57% 10.00%
Tier 1 capital to risk weighted assets: 11.29 11.07 6.00
Tier 1 capital to average assets: 7.98 7.87 5.00
As of September 30, 2004, Berkshire Bank met the conditions to be
classified as "well capitalized" under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, an institution must
maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage
ratios. As part of management's revised strategy to address the overall credit
risk to the Bank, management has determined to maintain capital levels in an
amount in excess of the regulatory requirements.
LIQUIDITY
Liquidity is the ability to meet current and future financial
obligations of a short-term nature. The Bank further defines its liquidity
requirements as the ability to respond to the needs of depositors and borrowers,
as well as maintaining the flexibility to take advantage of investment
opportunities. The Bank's primary sources of funds consist of deposit inflows,
loan repayments, maturities, loan sales, paydowns of mortgage-backed securities,
sales/calls of investments and borrowings from the Federal Home Loan Bank of
Boston. While maturities and scheduled amortization of loans and securities are
predictable sources of funds, deposit outflows and mortgage prepayments are
greatly influenced by general interest rates, economic conditions and
competition.
Berkshire Bank's primary investing activities are: (1) originating
residential one- to four-family mortgage loans, commercial business and real
estate loans, multi-family loans, home equity loans and lines of credit and
consumer loans; and (2) investing in mortgage- and asset-backed securities, U.S.
government and agency obligations, and debt obligations. These activities are
funded primarily by principal and interest payments on loans, maturities and
sales of securities, deposits and Federal Home Loan Bank of Boston advances.
While maturities and scheduled amortization of loans and securities are
predictable sources of funds, deposit flows and mortgage prepayments are greatly
influenced by interest rates, economic conditions and competition. Berkshire
Bank closely monitors its liquidity position on a daily basis. If the Bank
requires funds beyond its ability to generate them internally, additional
sources of funds are available
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through advances or a line of credit with the Federal Home Loan Bank and through
repurchase agreements with the Depositors Insurance Fund, the Bank's excess
deposit insurer, and Lehman Brothers.
Outstanding commitments for all loans and unadvanced construction
loans and lines of credit totaled $164.3 million at September 30, 2004.
Management of Berkshire Bank anticipates that it will have sufficient funds
available to meet its current loan commitments. Certificates of deposit
scheduled to mature in one year or less from September 30, 2004 were
approximately $187.5 million. Berkshire Bank relies primarily on competitive
rates, customer service and long-standing relationships with customers to retain
deposits. Occasionally, the Bank will also offer special competitive promotions
to its customers to increase retention and promote deposit growth. Based upon
the Bank's historical experience with deposit retention, management believes
that, although it is not possible to predict future terms and conditions upon
renewal, a significant portion of such deposits will remain with the Bank.
Funding for the Company is provided by dividend payments from the
Bank. These dividend payments have primarily been used to pay holding company
obligations, including the payment of dividends and the funding of stock
repurchase programs. The Bank's ability to pay dividends and other capital
distributions to the Company is generally limited by the Massachusetts banking
regulations and the regulations of the Federal Deposit Insurance Corporation.
Additionally, the Massachusetts Banking Commissioner and Federal Deposit
Insurance Corporation may prohibit the payment of dividends which are otherwise
permissible by regulation for safety and soundness reasons.
OFF-BALANCE SHEET ARRANGEMENTS
In the normal course of operations, the Company engages in a variety
of financial transactions that, in accordance with generally accepted accounting
principles, are not recorded in the Company's financial instruments. 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 Company's Form 10-K for the year ended December 31, 2003.
For the nine months ended September 30, 2004, the Company did not
engage in any off-balance sheet transactions reasonably likely to have a
material effect on the Company's financial condition, results of operation or
cash flows.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK.
QUALITATIVE ASPECTS OF MARKET RISK. The Bank's most significant form
of market risk is interest rate risk. The principal objectives of the Bank's
interest rate risk management are to evaluate the interest rate risk inherent in
certain balance sheet accounts, determine the level of risk appropriate given
its business strategy, operating environment, capital and liquidity requirements
and performance objectives, and manage the risk consistent with its established
policies. The Bank maintains an Asset/Liability Committee consisting of nine
members of senior management and the Senior Financial Analyst, who are
responsible for reviewing the Bank's asset/liability policies and interest rate
risk position. The Asset/Liability Committee meets quarterly and reports to the
Loan and Investment Committee of the Bank and the Board of Directors. The extent
of the movement of interest rates is an uncertainty that could have a negative
impact on the earnings of the Bank.
The Bank manages interest rate risk by:
o emphasizing the origination of adjustable rate loans and, from
time to time, selling a portion of its longer-term fixed rate loans as
market interest rate conditions dictate;
o securitizing a portion of the Bank's long-term, fixed rate mortgages;
o originating shorter-term commercial and consumer loans;
o investing in high quality liquid investment securities that provide
adequate liquidity and flexibility to take advantage of opportunities
that may arise from fluctuations in market interest rates, the overall
maturity and duration of which is monitored in relation to the
repricing of its loan and funding portfolios;
o promoting lower cost liability accounts such as core deposits; and
o using Federal Home Loan Bank advances to better structure maturities of
its interest rate sensitive liabilities.
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For the Bank, market risk also includes price risk, primarily security
price risk. The securities portfolio had unrealized gains before taxes of $6.8
million at September 30, 2004. Changes in this figure are reflected, net of
taxes, in accumulated other comprehensive income as a separate component of
Berkshire Hills' stockholders' equity. Since December 31, 2003, this component
has decreased by $1.7 million. It is not possible to predict with complete
accuracy the direction and magnitude of market value changes in the securities
portfolio. Unfavorable market conditions or other factors could cause price
declines in the securities portfolio.
QUANTITATIVE ASPECTS OF MARKET RISK. Berkshire Bank uses a simulation
model to measure the potential change in net interest income, incorporating
various assumptions regarding the shape of the yield curve, the pricing
characteristics of loans, deposits and borrowings, prepayments on loans and
securities and changes in the balance sheet mix. The model assumes the yield
curve is derived from the interpolated Treasury yield curve and that an
instantaneous increase or decrease of market interest rates would cause a
simultaneous parallel shift along the entire yield curve. Loans, deposits and
borrowings are expected to reprice at the new market rate on the contractual
review or maturity date. The Bank closely monitors its loan prepayment trends
and uses prepayment guidelines set forth by Freddie Mac, Fannie Mae and other
market sources, as well as Bank generated figures where applicable. All
prepayments and maturities are assumed to roll over into the types of loans with
the maturity or repricing characteristics that management believes will be
generated going forward. Berkshire Bank further assumes that its securities'
cash flows, especially its mortgage-backed securities cash flows, are such that
they will generally follow industry standards and that prepayments will be
reinvested in the same category at the prevailing market rate. Finally, the
model assumes that the balance sheet size and mix will remain relatively
unchanged throughout the next calendar year.
The table below sets forth, as of September 30, 2004 and December 31,
2003, estimated net interest income and the estimated changes in the Company's
net interest income for the next twelve-month period, which may result in
instantaneous increases or decreases in market interest rates of 100 and 200
basis points.
Increase/
(decrease)
in market
interest rates At September 30, 2004 At December 31, 2003
-------------------------------------------- --------------------------------------------
in basis points Dollar Percent Dollar Percent
(rate shock) Amount Change change Amount Change change
----------------- ------------- ------------- ------------- ------------- -------------- -------------
(Dollars in thousands)
200 $ 41,780 $ 932 2.28 % $ 37,144 $ (1,757) (4.52)%
100 41,127 279 0.68 38,162 (739) (1.90)
Static 40,848 - - 38,901 - -
(100) 40,848 - - 39,478 577 1.48
(200) 38,946 (1,902) (4.66) 37,116 (1,785) (4.59)
In the event of a sudden and sustained decrease in prevailing market
interest rates of 100 basis points, the September 30, 2004 table indicates no
significant dollar change in net interest, while the December 31, 2003 table
indicates an increase of $577,000. The primary reason for no change in net
interest income under a declining interest rate environment of 100 basis points
are the actions that the Bank has taken to mitigate the impact of relatively
smaller changes in market interest rates while becoming better positioned for
more significant increases in market interest rates. These steps include the
origination of short-term adjustable rate commercial and residential mortgage
loans, the origination of home equity lines of credit and the sale of
longer-term, fixed rate mortgages. In the event of a sudden and sustained 200
basis point decline in market interest rates, the September 30, 2004 table
indicates a decrease of $1.9 million, slightly greater than the decrease of $1.8
million indicated by the December 31, 2003 table, reflecting the fact that the
Bank's core deposits would reach rate floors while assets would continue to
price lower.
In the event of a sudden and sustained increase in prevailing market
interest rates of 100 and 200 basis points, the September 30, 2004 table
indicates that net interest income would increase by $279,000 and $932,000,
respectively. The December 31, 2003 table indicates that a sudden and sustained
increase of 100 and 200 basis points would decrease net interest income by
$739,000 and $1.8 million, respectively. The primary reason for this change in
the Bank's interest rate risk sensitivity is management's desire to better
position the Bank's balance sheet for the eventual rise in market interest
rates. This goal was achieved through the continued strategy of selling
longer-term, fixed rate residential mortgages, emphasizing the origination of
adjustable rate commercial and residential loans and by extending the average
maturity of FHLB borrowings.
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Computation of prospective effects of hypothetical interest rate
changes are based on a number of assumptions, including the level of market
interest rates, the degree to which certain assets and liabilities with similar
maturities or periods to repricing react to changes in market interest rates,
the expected prepayment rates on loans and investments, the degree to which
early withdrawals occur on certificates of deposit, and other deposit flows. As
a result, these computations should not be relied upon as indicative of actual
results. Further, the computations do not reflect any actions that management
may undertake in response to changes in interest rates.
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ITEM 4. CONTROLS AND PROCEDURES.
The Company's management, including the Company's principal executive
officer and principal financial officer, have evaluated the effectiveness of the
Company's "disclosure controls and procedures," as such term is defined in Rule
13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). Based upon their evaluation, the principal executive officer
and principal financial officer concluded that, as of the end of the period
covered by this report, 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.
There has been no change in the Company's internal control over
financial reporting identified in connection with the evaluation required by
Rule 13a-15 that occurred during the Company's last fiscal quarter that has
materially affected or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
The Company is not involved in any legal proceedings other than
routine legal proceedings occurring in the normal course of business. Such
routine proceedings, in the aggregate, are believed by management to be
immaterial to the Company's financial condition or results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The Company did not repurchase any shares in the third quarter of 2004.
On June 3, 2003, the Company authorized the purchase of up to 298,886
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. As of September 30, 2004, 110,841 shares remain available
for purchase under the plan. No plans expired during the three months
ended September 30, 2004. The Company has no plans that it has elected
to terminate prior to expiration or under which it does not intend to
make further purchases.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS
3.1 Certificate of Incorporation of Berkshire Hills Bancorp, Inc. (1)
3.2 Bylaws of Berkshire Hills Bancorp, Inc. (2)
4.0 Stock Certificate of Berkshire Hills Bancorp, Inc. (1)
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive
Officer
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial
Officer
32.1 Section 1350 Certification of Chief Executive Officer
32.2 Section 1350 Certification of Chief Financial Officer
- -----------------------------
(1) Incorporated herein by reference into this document from the Exhibits filed
with the Securities and Exchange Commission on the Registration Statement
on Form S-1 on March 11, 2000, and any amendments thereto,
Registration No. 333-32146.
(2) Incorporated herein by reference into this document from the Exhibits to
the Form 10-K as filed with the Securities and Exchange Commission on
March 11, 2004.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
BERKSHIRE HILLS BANCORP, INC.
Dated: November 5, 2004 By: /s/ Michael P. Daly
-----------------------------------
Michael P. Daly
President, Chief Executive Officer
and Director
(principal executive officer)
Dated: November 5, 2004 By: /s/ Wayne F. Patenaude
-------------------------------------
Wayne F. Patenaude
Senior Vice President,
Chief Financial Officer and Treasurer
(principal financial and accounting
officer)
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