UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended DECEMBER 31, 2007
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
---------------- -----------------
Commission File Number 0-13649
BERKSHIRE BANCORP INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-2563513
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification number)
160 BROADWAY, NEW YORK, NEW YORK 10038
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 791-5362
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Traded
-------------------------------------- -------------------------------------
COMMON STOCK, PAR VALUE $.10 PER SHARE THE NASDAQ STOCK MARKET LLC
(THE NASDAQ GLOBAL MARKET)
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark if the Registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes [ ] No [X]
Indicate by check mark if the Registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and smaller
reporting company" in Rule 12b-2 of the Exchange Act.) (Check one):
Large accelerated filer [ ] Accelerated filer [ ]
Non-accelerated filer [ ] Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Act. Yes [ ] No [X]
Aggregate market value of voting and non-voting common stock held by
non-affiliates of the Registrant as of June 30, 2007: $56,945,930.
Number of shares of Common Stock outstanding as of March 24, 2008: 7,054,183.
DOCUMENTS INCORPORATED BY REFERENCE: None
FORWARD-LOOKING STATEMENTS. STATEMENTS IN THIS ANNUAL REPORT ON FORM 10-K THAT
ARE NOT BASED ON HISTORICAL FACT MAY BE "FORWARD-LOOKING STATEMENTS" WITHIN THE
MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. WORDS SUCH AS
"BELIEVE", "MAY", "WILL", "EXPECT", "ESTIMATE", "ANTICIPATE", "CONTINUE" OR
SIMILAR TERMS IDENTIFY FORWARD-LOOKING STATEMENTS. A WIDE VARIETY OF FACTORS
COULD CAUSE THE ACTUAL RESULTS AND EXPERIENCES OF BERKSHIRE BANCORP INC. (THE
"COMPANY") TO DIFFER MATERIALLY FROM THE RESULTS EXPRESSED OR IMPLIED BY THE
COMPANY'S FORWARD-LOOKING STATEMENTS. SOME OF THE RISKS AND UNCERTAINTIES THAT
MAY AFFECT OPERATIONS, PERFORMANCE, RESULTS OF THE COMPANY'S BUSINESS, THE
INTEREST RATE SENSITIVITY OF ITS ASSETS AND LIABILITIES, AND THE ADEQUACY OF ITS
LOAN LOSS ALLOWANCE, INCLUDE, BUT ARE NOT LIMITED TO: (I) DETERIORATION IN
LOCAL, REGIONAL, NATIONAL OR GLOBAL ECONOMIC CONDITIONS WHICH COULD RESULT,
AMONG OTHER THINGS, IN AN INCREASE IN LOAN DELINQUENCIES, A DECREASE IN PROPERTY
VALUES, OR A CHANGE IN THE HOUSING TURNOVER RATE; (II) CHANGES IN MARKET
INTEREST RATES OR CHANGES IN THE SPEED AT WHICH MARKET INTEREST RATES CHANGE;
(III) CHANGES IN LAWS AND REGULATIONS AFFECTING THE FINANCIAL SERVICES INDUSTRY;
(IV) CHANGES IN COMPETITION; (V) CHANGES IN CONSUMER PREFERENCES; (VI) CHANGES
IN BANKING TECHNOLOGY; (VII) ABILITY TO MAINTAIN KEY MEMBERS OF MANAGEMENT;
(VIII) POSSIBLE DISRUPTIONS IN THE COMPANY'S OPERATIONS AT ITS BANKING
FACILITIES; (IX) COST OF COMPLIANCE WITH NEW CORPORATE GOVERNANCE REQUIREMENTS;
AND OTHER FACTORS REFERRED TO IN THE SECTIONS OF THIS ANNUAL REPORT ENTITLED
"BUSINESS" AND "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS."
CERTAIN INFORMATION CUSTOMARILY DISCLOSED BY FINANCIAL INSTITUTIONS,
SUCH AS ESTIMATES OF INTEREST RATE SENSITIVITY AND THE ADEQUACY OF THE LOAN LOSS
ALLOWANCE, ARE INHERENTLY FORWARD-LOOKING STATEMENTS BECAUSE, BY THEIR NATURE,
THEY REPRESENT ATTEMPTS TO ESTIMATE WHAT WILL OCCUR IN THE FUTURE.
THE COMPANY CAUTIONS READERS NOT TO PLACE UNDUE RELIANCE UPON ANY
FORWARD-LOOKING STATEMENT CONTAINED IN THIS ANNUAL REPORT. FORWARD-LOOKING
STATEMENTS SPEAK ONLY AS OF THE DATE THEY WERE MADE AND THE COMPANY ASSUMES NO
OBLIGATION TO UPDATE OR REVISE ANY SUCH STATEMENTS UPON ANY CHANGE IN APPLICABLE
CIRCUMSTANCES.
PART I
ITEM 1. BUSINESS
GENERAL. Berkshire Bancorp Inc., a Delaware corporation, is a bank
holding company registered under the Bank Holding Company Act of 1956.
References herein to "Berkshire", the "Company" or "we" and similar pronouns
shall be deemed to refer to Berkshire Bancorp Inc. and its consolidated
subsidiaries unless the context otherwise requires. Berkshire's principal
activity is the ownership and management of its indirect wholly-owned
subsidiary, The Berkshire Bank (the "Bank"), a New York State chartered
commercial bank. The Bank is owned through Berkshire's wholly-owned subsidiary,
Greater American Finance Group, Inc. ("GAFG").
We file annual, quarterly and current reports, proxy statements and
other information with the Securities and Exchange Commission (the "SEC"). You
may read and copy our reports or other filings made with the SEC at the SEC's
Public Reference Room, located at 450 Fifth Street, N.W., Washington, DC 20549.
You can also access information that we file electronically on the SEC's website
at WWW.SEC.GOV.
We do not presently have a website. However, as soon as practicable
after filing with or furnishing to the SEC, we will provide at no cost, paper or
electronic copies of our Annual Reports on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K and amendments to those reports. Requests
should be directed to:
Berkshire Bancorp Inc.
Investor Relations
160 Broadway, First Floor
New York, NY 10038
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TRUST PREFERRED SECURITIES. As of May 18 2004, the Company established
Berkshire Capital Trust I, a Delaware statutory trust, ("BCTI"). The Company
owns all the common capital securities of BCTI. BCTI issued $15.0 million of
preferred capital securities to investors in a private transaction and invested
the proceeds, combined with the proceeds from the sale of BCTI's common capital
securities, in the Company through the purchase of $15.464 million aggregate
principal amount of Floating Rate Junior Subordinated Debentures (the 2004
"Debentures") issued by the Company. The 2004 Debentures, the sole assets of
BCTI, mature on July 23, 2034 and bear interest at a floating rate, three month
LIBOR plus 2.70%, currently 7.85%.
On April 1, 2005, the Company established Berkshire Capital Trust II, a
Delaware statutory trust, ("BCTII"). The Company owns all the common capital
securities of BCTII. BCTII issued $7.0 million of preferred capital securities
to investors in a private transaction and invested the proceeds, combined with
the proceeds from the sale of BCTII's common capital securities, in the Company
through the purchase of $7.217 million aggregate principal amount of Floating
Rate Junior Subordinated Debentures (the "2005 Debentures") issued by the
Company. The 2005 Debentures, the sole assets of BCTII, mature on May 23, 2035
and bear interest at a floating rate, three month LIBOR plus 1.95%, currently
6.96%. See Note A of Notes to Consolidated Financial Statements for further
discussion of Trust Preferred Securities.
BUSINESS OF THE BANK - GENERAL. The Bank's principal business consists
of gathering deposits from the general public and investing those deposits
primarily in loans, debt obligations issued by the U.S. Government and its
agencies, debt obligations of business corporations, and mortgage-backed
securities. The Bank currently operates from seven deposit-taking offices in New
York City, four deposit-taking offices in Orange and Sullivan Counties, New York
and one deposit-taking office in Ridgefield, NJ.
BRANCH LOCATIONS OF THE BERKSHIRE BANK
DECEMBER 31, 2007
--------------------------------------------------
4 East 39th Street 2 South Church Street
New York, NY Goshen, NY
5 Broadway 214 Harriman Drive
New York, NY Goshen, NY
5010 13th Avenue 80 Route 17M
Brooklyn, NY Harriman, NY
1421 Kings Highway 60 Main Street
Brooklyn, NY Bloomingburg, NY
4917 16th Avenue 1119 Avenue J
Brooklyn, NY Brooklyn, NY
600 Broad Avenue 210 Pinehurst Avenue
Ridgefield, NJ New York, NY 10033
In September 2005, the Bank entered into a Branch Purchase and Deposit
Assumption Agreement (the "Agreement") with the Oritani Savings Bank
("Oritani"), a New Jersey Chartered Savings Bank. Pursuant to the Agreement
which closed in May 2006, the Bank (i) assumed certain commercial checking
account deposit liabilities, (ii) purchased certain fixed assets and the real
property of this Oritani bank branch located in Ridgefield, New Jersey for a
cash purchase price of $850,000 and (iii) opened a branch of The Berkshire Bank
at the Ridgefield, New Jersey location.
In August 2005, the Bank formed Berkshire 1031 Exchange, LLC
("Berkshire 1031"), a wholly owned limited liability company. Berkshire 1031
will act as a qualified intermediary in connection with tax free exchanges under
Section 1031 of the Internal Revenue Code of 1986, as amended. A qualified
intermediary is an individual or business entity that assists owners of property
who wish to exchange their property for property of a "like-kind" in a
transaction that is tax free in whole or part for federal (and in some cases
state) income tax
3
purposes. In accordance with detailed procedures set forth in federal income tax
regulations, Berkshire 1031 will assist the owner in the sale of the owner's
property and the purchase of replacement property so that the transaction
qualifies as a non-taxable exchange of property.
PRINCIPAL LOAN TYPES. The Bank's principal loan types are residential
and commercial mortgage loans and commercial non-mortgage loans, both unsecured
and secured by personal property. The Bank's revenues come principally from
interest on loans and investment securities. The Bank's primary sources of funds
are deposits, borrowings and proceeds from principal and interest payments on
loans and investment securities.
OPERATING PLAN. The Bank's operating plan concentrates on obtaining
deposits from a variety of businesses, professionals and retail customers and
investing those funds in conservatively underwritten loans. Due to the Bank's
underwriting criteria, its deposits have significantly exceeded the level of
satisfactory loans available for investment in recent years. Hence, the Bank
has, in recent years, invested a portion of its available funds in investment,
mortgage-backed and auction rate securities.
MARKET AREA. The Bank draws its customers principally from the New York
City metropolitan area and the Villages of Goshen and Harriman, New York and
their surrounding communities, representing most of Orange County, NY. The Bank
also has a branch in Bloomingburg, New York, just over the border between Orange
and Sullivan Counties. Predominantly rural with numerous small towns, many
residents of Orange and Sullivan Counties work in New York City. Consequently,
the health of the economy in the New York City metropolitan area has, and will
continue to have a direct effect on the economic well being of residents and
businesses in these counties. With the completion of the transaction with
Oritani in May 2006, the Bank's market area expanded into northern New Jersey.
From time to time, the Bank may make loans or accept deposits from outside these
areas, but such transactions generally represent outgrowths of existing local
customer relationships.
COMPETITION. The Bank's principal competitors for deposits are other
commercial banks, savings banks, savings and loan associations and credit unions
in the Bank's market areas, as well as money market mutual funds, insurance
companies, securities brokerage firms and other financial institutions, many of
which are substantially larger in size than the Company. The Bank's competition
for loans comes principally from commercial banks, savings banks, savings and
loan associations, mortgage bankers, finance companies and other institutional
lenders. Many of the institutions which compete with the Bank have much greater
financial and marketing resources than the Bank. The Bank's principal methods of
competition include loan and deposit pricing, maintaining close ties with its
local communities, the quality of the personal service it provides, the types of
business services it provides, and other marketing programs.
OPERATIONS OF THE BANK. Reference is made to the information set forth
in Item 7 herein ("Management's Discussion and Analysis of Financial Condition
and Results of Operations") for information as to various aspects of the Bank's
operations, activities and conditions.
SUBSIDIARY ACTIVITIES. The Bank is permitted under New York State law
and federal law to own subsidiaries for certain limited purposes, generally to
engage in activities which are permissible for a subsidiary of a national bank.
The Bank has two subsidiaries, Berkshire Agency, Inc., a company engaged in the
title insurance agency business, and Berkshire 1031, a company that acts as a
qualified intermediary in connection with tax free exchanges under Section 1031
of the Internal Revenue Service Code.
REGULATION. Berkshire is a bank holding company under federal law and
registered as such with the Federal Reserve. The Bank is a commercial bank
chartered under the laws of New York State. It is subject to regulation at the
state level by the New York Superintendent of Banks and the New York Banking
Board, while at the federal level its primary regulator is the Federal Deposit
Insurance Corporation (the "FDIC").
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Both Berkshire and the Bank are subject to extensive state and federal
regulation of their activities. The following discussion summarizes certain
banking laws and regulations that affect Berkshire and the Bank. Proposals to
change these laws and regulations are frequently proposed in Congress, in the
New York State legislature, and before state and federal bank regulatory
agencies. The likelihood and timing of any changes and the impact such changes
might have on the Company are impossible to determine with any certainty. A
change in applicable laws or regulations, or a change in the way such laws or
regulations are interpreted by regulatory agencies or courts, may have a
material impact on the business, operations and earnings of the Company, the
nature and effect of which cannot be predicted.
BANK HOLDING COMPANY REGULATION. The Federal Reserve is authorized to
make regular examinations of the Company and its nonbank subsidiaries. Under
federal law and Federal Reserve regulations, the activities in which the Company
and its nonbank subsidiaries may engage are limited. The Company may not acquire
direct or indirect ownership or control of more than 5% of the voting shares of
any company, including a bank, without the prior approval of the Federal
Reserve, except as specifically authorized under federal law and Federal Reserve
regulations. The Company, subject to the approval of the Federal Reserve, may
acquire more than 5% of the voting shares of non-banking corporations if those
corporations engage in activities which the Federal Reserve deems to be so
closely related to banking or managing or controlling banks as to be a proper
incident thereto. These limitations also apply to activities in which the
Company engages directly rather than through a subsidiary.
The Federal Reserve has enforcement powers over the Company and its
non-bank subsidiaries. This allows the Federal Reserve, among other things, to
stop activities that represent unsafe or unsound practices or constitute
violations of law, rules, regulations, administrative orders or written
agreements with a federal bank regulator. These powers may be exercised through
the issuance of cease-and-desist orders, the imposition of civil money penalties
or other actions.
FEDERAL RESERVE CAPITAL REQUIREMENTS. The Federal Reserve requires that
the Company, as a bank holding company, must maintain certain minimum ratios of
capital to assets. The Federal Reserve's regulations divide capital into two
categories. Primary capital includes common equity, surplus, undivided profits,
perpetual preferred stock, mandatory convertible instruments, the allowance for
loan and lease losses, contingency and other capital reserves, and minority
interests in equity accounts of consolidated subsidiaries. Secondary capital
includes limited-life preferred stock, subordinated notes and debentures and
certain unsecured long term debt.
The Federal Reserve requires that bank holding companies maintain a
minimum ratio of primary capital to total assets of 5.5% and a minimum level of
total capital (primary plus secondary capital) equal to 6% of total assets. In
calculating capital ratios, the allowance for loan losses, which is a component
of primary capital, is added back in determining total assets. Certain capital
components, such as debt and perpetual preferred stock, are includable as
capital only if they satisfy certain definitional tests.
The Company must also meet a risk-based capital standard. Capital, for
the risk-based capital requirement, is divided into Tier I capital and
Supplementary capital, determined as discussed below in connection with the FDIC
capital requirements imposed on the Bank. The Federal Reserve requires that the
Bank maintain a ratio of total capital (defined as Tier I plus Supplementary
capital) to risk-weighted assets of at least 8%, of which at least 4% must be
Tier I capital. Risk weighted assets are also determined in a manner comparable
to the determination of risk-weighted assets under FDIC regulations as discussed
below.
At December 31, 2007 and 2006, the Company met the definition of a
"well capitalized" bank holding company.
INTER-STATE BANKING. Bank holding companies may generally acquire banks
in any state. Federal law also permits a bank to merge with an out-of-state bank
and convert any offices into branches of the resulting bank if both states have
not opted out of interstate branching; permits a bank to acquire branches from
an out-of-state bank if the law of the state where the branches are located
5
permits the interstate branch acquisition; and permits banks to establish and
operate new interstate branches whenever the host state opts-in to that
authority. Bank holding companies and banks that want to engage in such
activities must be adequately capitalized and managed.
The New York Banking Law generally authorizes interstate branching in
New York as a result of a merger, purchase of assets or similar transaction. An
out of state bank may not first enter New York by opening a new branch in New
York, but once a branch is acquired as described in the preceding sentence,
additional new branches may be opened state wide.
REGULATION OF THE BANK. In general, the powers of the Bank are limited
to the express powers described in the New York Banking Law and powers
incidental to the exercise of those express powers. The Bank is generally
authorized to accept deposits and make loans on terms and conditions determined
to be acceptable to the Bank. Loans may be unsecured, secured by real estate, or
secured by personal property. The Bank may also invest assets in bonds, notes or
other debt securities which are not in default and certain limited classes of
equity securities including certain publicly traded equity securities in an
amount aggregating not more than 2% of assets or 20% of capital. The Bank may
also engage in a variety of other traditional activities for commercial banks,
such as the issuance of letters of credit.
The exercise of these state-authorized powers is limited by FDIC
regulations and other federal laws and regulations. In particular, FDIC
regulations limit the investment activities of state-chartered, FDIC-insured
banks such as the Bank.
Under FDIC regulations, the Bank generally may not directly or
indirectly acquire or retain any equity investment that is not permissible for a
national bank. In addition, the Bank may not directly or indirectly through a
subsidiary, engage as "principal" in any activity that is not permissible for a
national bank unless the FDIC has determined that such activities would pose no
risk to the applicable FDIC insurance fund and the Bank is in compliance with
applicable regulatory capital requirements. FDIC regulations permit real estate
investments under certain circumstances. The Bank does not engage in real estate
investing activity.
LOANS TO ONE BORROWER. With certain exceptions, the Bank may not make
loans or other extensions of credit to a single borrower, or certain related
groups of borrowers, in an aggregate amount in excess of 15% of the Bank's net
worth, plus an additional 10% of the Bank's net worth if such amount is secured
by certain types of readily marketable collateral. In addition, the Bank is not
permitted to make a mortgage loan in excess of 15% of capital stock, surplus
fund and undivided profits.
FDIC CAPITAL REQUIREMENTS. The FDIC requires that the Bank maintain
certain minimum ratios of capital to assets. The FDIC's regulations divide
capital into two tiers. The first tier ("Tier I") includes common equity,
retained earnings, certain non-cumulative perpetual preferred stock (excluding
auction rate issues) and minority interests in equity accounts of consolidated
subsidiaries, minus goodwill and other intangible assets (except mortgage
servicing rights and purchased credit card relationships subject to certain
limitations). Supplementary ("Tier II") capital includes, among other items,
cumulative perpetual and long-term limited-life preferred stock, mandatory
convertible securities, certain hybrid capital instruments, term subordinated
debt and the allowance for loan, subject to certain limitations, less required
deductions.
The FDIC requires that the highest rated banks maintain a Tier I
leverage ratio (Tier I capital to adjusted total assets) of at least 3.0%. All
other banks subject to FDIC capital requirements must maintain a Tier I leverage
ratio of 4.0% to 5.0% or more. As of December 31, 2007 and 2006, the Bank's Tier
I leverage capital ratio was 9.7% and 10.9%, respectively.
The Bank must also meet a risk-based capital standard. The risk-based
standard requires the Bank to maintain total capital (defined as Tier I and
Supplementary capital) to risk-weighted assets of at least 8%, of which at least
4% must be Tier I capital. In determining the amount of risk-weighted assets,
6
all assets, plus certain off-balance sheet assets, are multiplied by a
risk-weight of 0% to 100%, based on the risks the FDIC believes are inherent in
the type of asset. As of December 31, 2007 and 2006, the Bank maintained a 13.9%
and 18.6% Tier I risk-based capital ratio and a 14.5% and 19.3% total risk-based
capital ratio, respectively.
In addition to the foregoing regulatory capital requirements, the FDIC
Improvements Act of 1991 created a "prompt corrective action" framework, under
which decreases in a depository institution's capital category trigger various
supervisory actions. Pursuant to implementing regulations adopted by the FDIC,
for purposes of the prompt corrective action provisions, a state-chartered,
nonmember bank, such as the Bank, is deemed to be well capitalized if it has: a
total risk-based capital ratio of 10% or greater; a Tier I risk-based capital
ratio of 6% or greater; and a leverage ratio of 5% or greater. As of December
31, 2007 and 2006, the Bank met the definition of a "well capitalized" financial
institution.
COMMUNITY REINVESTMENT ACT. The Bank must, under federal law, meet the
credit needs of its community, including low and moderate income segments of its
community. The FDIC is required, in connection with its examination of the Bank,
to assess whether the Bank has satisfied this requirement. Failure to satisfy
this requirement could adversely affect certain applications which the Bank may
make, such as branch applications, merger applications, and applications for
permission to purchase branches. In the case of Berkshire, the Federal Reserve
will assess the record of each subsidiary bank in considering certain
applications by Berkshire. The New York Banking Law contains similar provisions
applicable to the Bank. As of the most recent Community Reinvestment Act
examinations by the FDIC and the New York State Banking Department, the Bank
received "satisfactory" ratings.
DIVIDENDS FROM THE BANK TO THE COMPANY. One source of funds for
Berkshire to pay dividends to its stockholders is dividends from the Bank to
Berkshire. Under the New York Banking Law, the Bank may pay dividends to
Berkshire, without regulatory approval, equal to its net profits for the year in
which the payment is made, plus retained net profits for the two previous years,
subject to certain limits not generally relevant. The Bank's retained net
profits for the 2006 and 2007 calendar years totaled approximately $11.93
million.
Under federal law, the Bank may not make any capital distribution to
Berkshire, including any dividend or repurchase of the Bank's stock, if, after
making such distribution, the Bank fails to meet the required minimum capital
ratio requirements discussed below. The FDIC may prohibit the Bank from paying
dividends if, in its opinion, the payment of dividends would constitute an
unsafe or unsound practice.
TRANSACTIONS WITH RELATED PARTIES. The Company, its direct non-banking
subsidiaries and other companies controlled by stockholders who control the
Company are affiliates, within the meaning of the Federal Reserve Act, of the
Bank and its subsidiaries. The Bank's authority to engage in transactions with
its "affiliates" is limited by Sections 23A and 23B of the Federal Reserve Act.
Section 23A limits the aggregate amount of transactions with any individual
affiliate to 10% of the capital and surplus of the Bank and also limits the
aggregate amount of transactions with all affiliates to 20% of the Bank's
capital and surplus. Extensions of credit to affiliates must be secured by
certain specified collateral, and the purchase of low quality assets from
affiliates is generally prohibited. Section 23B provides that certain
transactions with affiliates, including loans and asset purchases, must be on
terms and under circumstances, including credit standards, that are at least as
favorable to the Bank as those prevailing at the time for comparable
transactions with non-affiliated companies. In the absence of comparable
transactions, such transactions may only occur under terms and circumstances,
including credit standards, that in good faith would be offered to or would
apply to non-affiliated companies.
In accordance with banking regulations, the Bank may make loans to its
and the Company's directors, executive officers, and 10% stockholders, as well
as to entities controlled by them, subject to specific federal and state limits.
Among other things, these loans must (a) be made on terms that are substantially
the same as, and follow credit underwriting procedures that are not less
stringent
7
than, those prevailing for comparable transactions with unaffiliated persons and
that do not involve more than the normal risk of repayment or present other
unfavorable features and (b) not exceed certain limitations on the amount of
credit extended to such persons, individually and in the aggregate, which limits
are based, in part, on the amount of the Bank's capital. In addition, extensions
of credit in excess of certain limits must be approved by the Bank's Board of
Directors. However, the Bank may make loans to executive officers, directors and
principal stockholders on preferential terms, provided the extension of credit
is made pursuant to a benefit or compensation program of the Bank that is widely
available to employees of the Bank or its affiliates and does not give
preference to any insider over other employees of the Bank or affiliate. The
Bank has no such benefit or compensation programs.
ENFORCEMENT. The FDIC and the Banking Department have enforcement
authority over the Bank. The Superintendent may order the Bank to appear and
explain an apparent violation of law, to discontinue unauthorized or unsafe
practices and to keep prescribed books and accounts. If any director or officer
of the Bank has violated any law, or has continued unauthorized or unsafe
practices in conducting the business of the Bank after having been notified by
the Superintendent to discontinue such practices, the New York Banking Board may
remove the individual from office after notice and an opportunity to be heard.
The Superintendent also may take over control of the Bank under specified
statutory criteria.
The FDIC's enforcement authority includes, among other things, the
ability to assess civil money penalties, to issue cease and desist orders and to
remove directors and officers. As indicated above, the FDIC is required to take
prompt action to correct deficiencies in banks which do not satisfy specified
FDIC capital ratio requirements. Dividends, other capital distributions or the
payment of management fees to any controlling person are prohibited if,
following such distribution or payment, a bank would be undercapitalized. An
undercapitalized bank must file a plan to restore its capital within 45 days
after being notified that it is undercapitalized. Undercapitalized,
significantly undercapitalized and critically undercapitalized institutions are
subject to increasing prohibitions on permitted activities, and increasing
levels of regulatory supervision, based upon the severity of their capital
problems. The FDIC is required to monitor closely the condition of an
undercapitalized bank. Enforcement action taken by the FDIC can escalate to the
appointment of a conservator or receiver of a critically undercapitalized bank.
INSURANCE OF ACCOUNTS. Deposit insurance premiums payable to the FDIC
are based upon the perceived risk of the institution to the FDIC insurance fund.
The FDIC assigns an institution to one of three capital categories: (a) well
capitalized, (b) adequately capitalized or (c) undercapitalized. The FDIC also
assigns an institution to one of three supervisory categories based on an
evaluation by the institution's primary federal regulator and information that
the FDIC considers relevant to the institution's financial condition and the
risk posed to the deposit insurance funds. Deposit insurance premiums depend on
an institution's capital and supervisory categories. At present, the Bank pays
no deposit insurance premium based upon its risk-based categorization.
However, the Bank must pay a share of the cost of the bonds issued in
the late 1980s to recapitalize the now defunct Federal Savings and Loan
Insurance Corporation. The Bank must pay an annual assessment for this purpose,
which for fiscal 2007 and 2006 was equal to 0.0122% and 0.0127%, respectively,
of its insured deposits and which is recorded as a deposit insurance premium
expense for financial statement purposes. Beginning in 2008, the assessment was
revised to 0.0507% of the Bank's insured deposits.
RESERVE REQUIREMENTS. The Bank must maintain non-interest-earning
reserves against its transaction accounts (primarily NOW and regular checking
accounts). The Bank is generally able to satisfy reserve requirements with cash
on hand and other non-interest bearing deposits which it maintains for other
purposes, so the reserve requirements do not impose a material financial burden
on the Bank.
GOVERNMENTAL POLICIES. Our earnings are significantly affected by the
monetary and fiscal policies of governmental authorities, including the Federal
Reserve. Among the instruments of monetary policy used by the Federal Reserve
8
to implement these objectives are open-market operations in U.S. Government
securities and Federal funds, changes in the discount rate on member bank
borrowings and changes in reserve requirements against member bank deposits.
These instruments of monetary policy are used in varying combinations to
influence the overall level of bank loans, investments and deposits, and the
interest rates charged on loans and paid for deposits. The Federal Reserve
frequently uses these instruments of monetary policy, especially its open-market
operations and the discount rate, to influence the level of interest rates and
to affect the strength of the economy, the level of inflation or the price of
the dollar in foreign exchange markets. The monetary policies of the Federal
Reserve have had a significant effect on the operating results of banking
institutions in the past and are expected to continue to do so in the future. It
is not possible to predict the nature of future changes in monetary and fiscal
policies, or the effect which they may have on our business and earnings.
PERSONAL HOLDING COMPANY STATUS. For the fiscal years ended December
31, 2007, 2006 and 2005, the Company has been deemed to be a Personal Holding
Company (a "PHC"), as defined in the Internal Revenue Code. As a PHC, we may be
required to pay an additional income tax or issue a dividend to our shareholders
in an amount based upon the PHC Internal Revenue Code formulas, which is
primarily based upon net income. No such dividend was required to be paid in
fiscal 2007, 2006 and 2005. (See Dividends in Item 5).
EMPLOYEES. On March 21, 2008, Berkshire had one full time employee and
the Bank employed approximately 100 full time and 5 part time employees. The
Bank's employees are not represented by a collective bargaining unit, and the
Bank considers its relationship with its employees to be good.
ITEM 1A. RISK FACTORS.
Our business faces significant risks. These risks include those
described below and may include additional risks and uncertainties not presently
known to us or that we currently deem immaterial. Our business, financial
condition and results of operations could be materially adversely affected by
any of these risks, and the trading price of our common stock could decline.
WE OPERATE IN THE HIGHLY COMPETITIVE BANKING INDUSTRY AND THERE CAN BE NO
ASSURANCE THAT WE WILL BE ABLE TO COMPETE SUCCESSFULLY.
Our ability to maintain our history of strong financial performance and
return on investment to shareholders may depend in part on our ability to expand
our scope of available financial services as needed to meet the needs and
demands of our customers. Our business model focuses on using superior customer
service to provide traditional banking services to a growing customer base.
However, we operate in an increasingly competitive environment in which our
competitors now include securities dealers, brokers, mortgage bankers,
investment advisors and finance and insurance companies who seek to offer
one-stop financial services to their customers that may include services that we
have not been able or allowed to offer to our customers in the past. This
increasingly competitive environment is primarily a result of changes in
regulation, changes in technology and product delivery systems and the
accelerating pace of consolidation among financial services providers. We cannot
assure you that we will be able to continue to compete successfully in this
environment without expanding the scope of financial services we provide, or
that if we need to expand the scope of services that we provide, that we will be
able to do so successfully.
OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO COMPETE EFFECTIVELY IN A HIGHLY
COMPETITIVE MARKET AND GEOGRAPHIC AREA.
We face substantial competition in all phases of our operations from a
variety of different competitors. We encounter competition from other commercial
banks, savings and loan associations, mutual savings banks, credit unions and
other financial institutions. Our competitors, including credit unions, consumer
finance companies, factors, insurance companies and money market mutual funds,
compete with lending and deposit-gathering services offered by us. There is very
strong competition for financial services in the New York state areas in which
we currently conduct our business. This geographic area includes offices of many
of the largest financial institutions in the world. Many of those competing
institutions have much greater financial and marketing resources than we have.
9
Due to their size, many competitors can achieve larger economies of scale and as
a result may offer a broader range of products and services than we do. If we
are unable to offer competitive products and services, our earnings may be
negatively affected. Some of the financial services organizations with which we
compete are not subject to the same degree of regulation as is imposed on bank
holding companies like ourselves and on federally insured financial institutions
like our banking subsidiary, The Berkshire Bank. As a result, these nonbank
competitors have certain advantages over us in accessing funding and in
providing various services. The banking business in our current primary market
area is very competitive, and the level of competition we face may increase
further, which may limit our asset growth and profitability.
ECONOMIC CONDITIONS EITHER NATIONALLY OR LOCALLY IN AREAS IN WHICH OUR
OPERATIONS ARE CONCENTRATED MAY BE LESS FAVORABLE THAN EXPECTED.
Deterioration in local, regional, national or global economic
conditions could result in, among other things, an increase in loan
delinquencies, a decrease in property values, a change in housing turnover rate
or a reduction in the level of bank deposits. Particularly, a weakening of the
real estate or employment market in our primary market areas could result in an
increase in the number of borrowers who default on their loans and a reduction
in the value of the collateral securing their loans, which in turn could have an
adverse effect on our profitability. Substantially all of our real estate loans
are collateralized by properties located in these market areas, and
substantially all of our loans are made to borrowers who live in and conduct
business in these market areas. Any material economic deterioration in these
market areas could have an adverse impact on our profitability.
CHANGES IN INTEREST RATES COULD REDUCE OUR INCOME AND CASH FLOWS.
Our income and cash flow and the value of our assets and liabilities
depend to a great extent on the difference between the interest rates earned on
interest-earning assets such as loans and investment securities, and the
interest rates paid on interest-bearing liabilities such as deposits and
borrowings. These rates are highly sensitive to many factors which are beyond
our control, including general economic conditions and policies of various
governmental and regulatory agencies, in particular, the Board of Governors of
the Federal Reserve System. Changes in monetary policy, including changes in
interest rates, will influence the origination of loans, the returns on our
portfolio of investment securities and the amounts paid on deposits. If the rate
of interest we pay on deposits and other borrowings increases more than the rate
of interest we earn on loans and other investments, our net interest income, and
therefore our earnings, could be adversely affected. Our earnings could also be
adversely affected if the rates on our loans and other investments fall more
quickly than those on our deposits and other borrowings.
DUE TO THE RECENT DOWNTURN IN THE MARKET, CERTAIN OF THE INVESTMENT SECURITIES
WE OWN MAY TAKE LONGER TO AUCTION THAN INITIALLY ANTICIPATED.
Our portfolio of investment securities includes marketable investment
grade auction rate securities. Recently, certain auction rate securities failed
to auction due to market imbalances. As a result of this failure, the fair value
of these securities, while maintaining their investment grade rating and
interest payments, could be negatively impacted in the future. We have the
ability to hold these available for sale securities to maturity, (predominately
20 years after December 31, 2007) thereby recovering our investment. While we
believe that such negative impact would be temporary due to market conditions
and that our carrying values are appropriate, there are no assurances that a
successful auction will occur or that we can sell these securities outside the
auction process, if necessary, without sustaining a loss.
WE OPERATE IN A HIGHLY REGULATED ENVIRONMENT; CHANGES IN LAWS AND REGULATIONS
AND ACCOUNTING PRINCIPLES MAY ADVERSELY AFFECT US.
We are subject to extensive state and federal regulation, supervision,
and legislation which govern almost all aspects of our operations. These laws
may change from time to time and are primarily intended for the protection of
customers, depositors, and the deposit insurance funds. The impact of any
changes to these laws may negatively impact our ability to expand our services
and to increase the value of our business. Regulatory authorities have extensive
discretion in the exercise of their supervisory and enforcement powers. They
may,
10
among other things, impose restrictions on the operation of a banking
institution, the classification of assets by such institution and such
institution's allowance for loan losses. Regulatory and law enforcement
authorities also have wide discretion and extensive enforcement powers under
various consumer protection, civil rights and other laws, including the
Gramm-Leach-Blilely Act, the Bank Secrecy Act, the Truth-in-Lending Act, the
Equal Credit Opportunity Act, the Fair Housing Act and the Real Estate
Settlement Procedures Act. These laws also permit private individual and class
action lawsuits and provide for the recovery of attorneys fees in certain
instances. Any changes to these laws or any applicable accounting principles may
negatively impact our results of operations and financial condition. While we
cannot predict what effect any presently contemplated or future changes in the
laws or regulations or their interpretations would have, these changes could be
materially adverse to our investors and stockholders.
WE ARE REQUIRED TO MAINTAIN AN ALLOWANCE FOR LOAN LOSSES. THESE RESERVES ARE
BASED ON MANAGEMENT'S JUDGMENT AND MAY HAVE TO BE ADJUSTED IN THE FUTURE. ANY
ADJUSTMENT TO THE ALLOWANCE FOR LOAN LOSSES, WHETHER DUE TO REGULATORY CHANGES,
ECONOMIC CONDITIONS OR OTHER FACTORS, MAY AFFECT OUR FINANCIAL CONDITION AND
EARNINGS.
We maintain an allowance for loan losses at a level believed adequate
by management to absorb losses specifically identifiable and inherent in the
loan portfolio. In conjunction with an internal loan review function that
operates independently of the lending function, management monitors the loan
portfolio to identify risks on a timely basis so that an appropriate allowance
can be maintained. Based on an evaluation of the loan portfolio, management
presents a periodic review of the loan loss reserve to the board of directors of
the Bank, indicating any changes in the reserve since the last review and any
recommendations as to adjustments in the reserve. In making its evaluation, in
addition to the factors discussed below, management considers the results of
recent regulatory examinations, which typically include a review of the
allowance for loan losses as an integral part of the examination process.
In establishing the allowance, management evaluates individual large
classified loans and nonaccrual loans, and determines an aggregate reserve for
those loans based on that review. An allowance for the remainder of the loan
portfolio is also determined based on historical loss experience within the
components of the portfolio. These allocations may be modified if current
conditions indicate that loan losses may differ from historical experience,
based on economic factors and changes in portfolio mix and volume.
In addition, a portion of the allowance is established for losses
inherent in the loan portfolio which have not been identified by the more
quantitative processes described above. This determination inherently involves a
higher degree of subjectivity, and considers risk factors that may not have yet
manifested themselves in historical loss experience. Those factors include
changes in levels and trends of charge-offs, delinquencies, and nonaccrual
loans, trends in volume and terms of loans, changes in underwriting standards
and practices, portfolio mix, tenure of loan officers and management, entrance
into new geographic markets, changes in credit concentrations, and national and
local economic trends and conditions. While the allowance for loan losses is
maintained at a level believed to be adequate by management for estimated losses
in the loan portfolio, determination of the allowance is inherently subjective,
as it requires estimates, all of which may be susceptible to significant change.
Changes in these estimates may impact the provisions charged to expense in
future periods. Federal and state regulatory authorities, as an integral part of
their examination process, review our loans and allowance for loan losses. We
cannot assure you that we will not increase the allowance for loan losses or the
regulators will not require us to increase this allowance. Either of these
occurrences could negatively impact Berkshire Bancorp's results of operations.
IT MAY BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE US AND THIS COULD DEPRESS OUR
COMMON STOCK PRICE.
Under our amended and restated certificate of incorporation, we have
authorized 2,000,000 shares of preferred stock, which the board of directors may
issue with terms, rights, preferences and designations as the board of directors
may determine and without any vote of the shareholders, unless otherwise
required by law. Issuing the preferred stock, depending upon the rights,
preferences and
11
designations set by the board of directors, may delay, deter, or prevent a
change in control of the Company.
In addition, we have authorized 10,000,000 shares of common stock of
which approximately 7,700,000 shares have been issued and approximately
7,000,000 shares are outstanding. The price of our common stock may be volatile
at times since our common stock is thinly traded and one individual owns or
controls more than 50% of our outstanding shares. It may be difficult for a
stockholder to sell a significant number of shares at a time and at a price of
their choosing or for a third party to purchase sufficient shares on the open
market to cause a change in control of the Company, all of which could depress
the price of Berkshire Bancorp's common stock.
In addition, federal and state banking laws may restrict the ability of
the stockholders to approve a merger or business combination or obtain control
of the Company. This may tend to make it more difficult for shareholders to
replace existing management or may prevent shareholders from receiving a premium
for their shares of our common stock.
OUR COMMON STOCK IS NOT INSURED BY ANY GOVERNMENTAL AGENCY AND, THEREFORE,
INVESTMENT IN THEM INVOLVES RISK.
Our securities are not deposit accounts or other obligation of any
bank, and are not insured by the FDIC, or any other governmental agency, and are
subject to investment risk, including the possible loss of principal.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not Applicable
ITEM 2. PROPERTIES.
The following are Berkshire's and the Bank's principal facilities as of
March 21, 2008:
Approximate Approximate
Floor Area Annual Lease
Location Operations (Sq. Ft.) Rent Expiration
------------ ----------------- --------- ---------- ----------
New York, NY Executive Offices 1,500 $ 18,000 (1)(3)
New York, NY Main Bank Office
and Bank Branch 9,729 Owned March 2013
Brooklyn, NY Bank Branch 4,500 $ 200,418 March 2013
Brooklyn, NY Bank Branch 2,866 $ 59,130 March 2013
Brooklyn, NY Bank Branch 2,592 $ 108,212 December 2012
Brooklyn, NY Bank Branch 1,640 $ 72,000 June 2015
New York, NY Bank Branch 9,924 $ 353,315 June 2010 (2)(3)
New York, NY Bank Branch 3,300 $ 60,000 November 2016 (2)(3)
Goshen, NY Bank Branch 10,680 Owned
Harriman, NY Bank Branch 1,623 Owned
Bloomingburg, NY Bank Branch 1,530 $ 20,871 August 2010
Ridgefield, NJ Bank Branch 6,120 Owned
---------------
(1) Rented on a month to month basis from a company affiliated with Mr.
Moses Marx, a director of the Company.
(2) Leased from a company affiliated with Mr. Marx, a director of the
Company.
(3) Management believes the annual rent paid is comparable to the annual
rent that would be paid to non-affiliated parties in a similar
commercial transaction for similar commercial space.
ITEM 3. LEGAL PROCEEDINGS.
In the ordinary course of operations, the Bank is a party to routine
litigation involving claims incidental to its banking business. Management
believes that no current litigation, threatened or pending, to which we or our
assets are a party, poses a substantial likelihood of potential loss or exposure
which would have a material adverse effect on the financial condition or results
of our operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not Applicable.
12
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES.
The Company's Common Stock trades on the Nasdaq Global Market under the
symbol BERK. The following table sets forth, for the periods indicated, the high
and low sales prices for the Company's Common Stock as reported by NASDAQ.
FISCAL YEAR ENDED DECEMBER 31, 2007 HIGH LOW
----------------------------------- ------ ------
January 1, 2007 to March 31, 2007 16.60 15.54
April 1, 2007 to June 30, 2007 16.34 14.90
July 1, 2007 to September 30, 2007 18.23 14.86
October 1, 2007 to December 31, 2007 16.49 14.89
FISCAL YEAR ENDED DECEMBER 31, 2006 HIGH LOW
----------------------------------- ------ ------
January 1, 2006 to March 31, 2006 17.35 14.82
April 1, 2006 to June 30, 2006 17.23 15.18
July 1, 2006 to September 30, 2006 17.00 15.31
October 1, 2006 to December 31, 2006 17.12 15.14
As of the close of business on March 20, 2008, there were 1,035 holders
of record of the Company's Common Stock.
DIVIDENDS
For the fiscal years ended December 31, 2007, 2006 and 2005, the
Company has been deemed to be a PHC, as defined in the Internal Revenue Code. As
a PHC, we may be required to pay an additional income tax or issue a dividend to
our shareholders in an amount based upon applicable Internal Revenue Code
formulas, which is primarily based upon net income. No such dividend was
required to be paid in fiscal 2007, 2006 and 2005.
On March 23, 1999, the Board of Directors adopted a policy of paying
regular cash dividends in respect of the Common Stock of the Company, payable in
equal semi-annual installments. Pursuant to said policy, the Board of Directors
declared and the Company paid cash dividends as follows:
PER SHARE
DECLARATION DATE RECORD DATE PAYMENT DATE AMOUNT
------------------- ------------------ ----------------- ------------
March 21, 2005 April 22, 2005 April 29, 2005 $.07
October 7, 2005 October 21, 2005 October 28, 2005 $.08
March 9, 2006 April 18, 2006 April 27, 2006 $.08
October 10, 2006 October 20, 2006 October 27, 2006 $.08
April 2, 2007 April 18, 2007 April 26, 2007 $.09
October 3, 2007 October 18, 2007 October 25, 2007 $.09
The declaration, payment and amount of such dividends in the future are
within the discretion of the Board of Directors and will depend upon our
earnings, capital requirements, financial condition and other relevant factors.
On May 15, 2003, The Company's Board of Directors authorized the
purchase of up to an additional 450,000 shares of its Common Stock in the open
market, from time to time, depending upon prevailing market conditions, thereby
increasing the maximum number of shares which may be purchased by the Company
from 1,950,000 shares of Common Stock to 2,400,000 shares of Common Stock. Since
1990 through December 31, 2006, the Company has purchased a total of 1,898,909
shares of its Common Stock. During fiscal year 2007 we did not purchase any
shares, and at December 31, 2007 there were 501,091 shares of Common Stock which
may yet be purchased under our stock repurchase plan.
EQUITY COMPENSATION PLANS
See Part III, Item 12 for information concerning the Company's equity
compensation plans.
13
ITEM 6. SELECTED FINANCIAL DATA
Not Applicable
ITEM 7. MANAGEMENTS' DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
The following discussion and analysis is intended to provide a better
understanding of the consolidated financial condition and results of operations
of Berkshire Bancorp Inc. and subsidiaries for the fiscal years ended December
31, 2007, 2006 and 2005. All references to earnings per share, unless stated
otherwise, refer to earnings per diluted share. The discussion should be read in
conjunction with the consolidated financial statements and related notes (Notes
located in Item 8 herein). Reference is also made to Part I, Item 1 "Business"
herein.
SEGMENTS
Management has determined that the Company through its wholly owned
bank subsidiary, the Bank, operates in one business segment, community banking.
The Bank's principal business activity consists of gathering deposits from the
general public and investing those deposits in residential and commercial
mortgage loans and commercial non-mortgage loans, both unsecured and secured by
personal property. In addition, the Bank invests those deposits in debt
obligations issued by the U.S. Government, its agencies, business corporations
and mortgage-backed securities.
GENERAL
TRUST PREFERRED SECURITIES. As of May 18 2004, the Company established BCTI. The
Company owns all the common capital securities of BCTI. BCTI issued $15.0
million of preferred capital securities to investors in a private transaction
and invested the proceeds, combined with the proceeds from the sale of BCTI's
common capital securities, in the Company through the purchase of $15.464
million aggregate principal amount of the Floating Rate Junior Subordinated
Debentures issued by the Company. The 2004 Debentures, the sole assets of BCTI,
mature on July 23, 2034 and bear interest at a floating rate, three month LIBOR
plus 2.70%, currently 7.85%.
On April 1, 2005, the Company established BCTII. The Company owns all
the common capital securities of BCTII. BCTII issued $7.0 million of preferred
capital securities to investors in a private transaction and invested the
proceeds, combined with the proceeds from the sale of BCTII's common capital
securities, in the Company through the purchase of $7.217 million aggregate
principal amount of the 2005 Debentures issued by the Company. The 2005
Debentures, the sole assets of BCTII, mature on May 23, 2035 and bear interest
at a floating rate, three month LIBOR plus 1.95%, currently 6.96%. See Note A of
Notes to Consolidated Financial Statements for a further discussion of Trust
Preferred Securities.
BRANCH PURCHASE
In September 2005, the Bank entered into an Agreement with Oritani, a
New Jersey Chartered Savings Bank. Pursuant to the Agreement, which closed on
May 12, 2006, the Bank (i) assumed certain commercial checking account deposit
liabilities and (ii) purchased certain fixed assets and the real property of
this Oritani bank branch located in Ridgefield, New Jersey for a cash purchase
price of $850,000. Following the closing of the transaction, the Bank opened a
branch of The Berkshire Bank at the Ridgefield, New Jersey location.
NEW SUBSIDIARY
In August 2005, the Bank formed Berkshire 1031, a wholly owned limited
liability company. Berkshire 1031 will act as a qualified intermediary in
connection with tax free exchanges under Section 1031 of the Internal Revenue
Code of 1986, as amended. A qualified intermediary is an individual or business
entity that assists owners of property who wish to exchange their property for
property of a "like-kind" in a transaction that is tax free in whole or part for
federal (and in some cases state) income tax purposes. In accordance with
detailed procedures set forth in federal income tax regulations, Berkshire 1031
14
will assist the owner in the sale of the owner's property and the purchase of
replacement property so that the transaction qualifies as a non-taxable exchange
of property.
CRITICAL ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
The accounting and reporting policies of the Company conform with
accounting principles generally accepted in the United States of America and
general practices within the financial services industry. The preparation of
financial statements in conformity with accounting principles generally accepted
in the United States of America requires management to make estimates and the
assumptions that affect the amounts reported in the financial statements and the
accompanying notes. Actual results could differ from those estimates.
The Company considers that the determination of the allowance for loan
losses involves a higher degree of judgment and complexity than any of its other
significant accounting policies. The allowance for loan losses is calculated
with the objective of maintaining a reserve level believed by management to be
sufficient to absorb estimated credit losses. Management's determination of the
adequacy of the allowance is based on periodic evaluations of the loan portfolio
and other relevant factors. However, this evaluation is inherently subjective as
it requires material estimates, including, among others, expected default
probabilities, loss given default, the amounts and timing of expected future
cash flows on impaired loans, mortgages, and general amounts for historical loss
experience. The process also considers economic conditions, uncertainties in
estimating losses and inherent risks in the loan portfolio. All of these factors
may be susceptible to significant change. To the extent actual outcomes differ
from management estimates, additional provisions for loan losses may be required
that would adversely impact earnings in future periods.
With the adoption of Statement of Financial Accounting Standards
("SFAS") No. 142 ("SFAS No. 142") on January 1, 2002, the Company discontinued
the amortization of goodwill resulting from acquisitions. Goodwill is now
subject to impairment testing at least annually to determine whether write-downs
of the recorded balances are necessary. The Company tests for impairment based
on the goodwill maintained at the Bank. A fair value is determined for each
reporting unit based on at least one of three various market valuation
methodologies. If the fair values of the reporting units exceed their book
values, no write-down of recorded goodwill is necessary. If the fair value of
the reporting unit is less, an expense may be required on the Company's books to
write down the related goodwill to the proper carrying value. As of December 31,
2007, the Company completed its annual testing, which determined that no
impairment charge was necessary.
The Company recognizes deferred tax assets and liabilities for the
future tax effects of temporary differences, net operating loss carryforwards
and tax credits. Deferred tax assets are subject to management's judgment based
upon available evidence that future realization is more likely than not. If
management determines that the Company may be unable to realize all or part of
net deferred tax assets in the future, a direct charge to income tax expense may
be required to reduce the recorded value of the net deferred tax asset to the
expected realizable amount.
15
DISCUSSION OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
FISCAL YEAR ENDED DECEMBER 31, 2007 COMPARED TO FISCAL YEAR ENDED
DECEMBER 31, 2006. Net income was $5.35 million, or $.76 per diluted share, for
the fiscal year ended December 31, 2007, compared to $4.88 million, or $.70 per
diluted share, for the fiscal year ended December 31, 2006. Net loans and total
assets increased by approximately 17% and 18%, respectively, and investment
securities increased by approximately 16%. Stockholders' equity increased by
approximately 7% to $124.26 million in fiscal 2007 from $115.78 million in
fiscal 2006.
FISCAL YEAR ENDED DECEMBER 31,
------------------------------------------------------
2007 2006 %
INC/(DEC)
(In millions, except per share data and percentages)
TOTAL ASSETS $1,120.5 $948.7 18%
Loans, net 430.6 367.2 17%
Investment Securities 599.4 515.2 16%
TOTAL LIABILITIES 996.3 832.9 20%
Deposits 853.2 681.5 25%
Borrowings 131.1 138.1 (5)%
STOCKHOLDERS' EQUITY 124.3 115.8 7%
TOTAL INCOME 60.2 51.9 16%
Interest Income 58.5 48.2 21%
TOTAL EXPENSE 52.1 42.8 22%
Interest Expense 37.8 29.2 29%
Net Interest Income 20.7 19.0 9%
NET INCOME 5.4 4.9 10%
Diluted Income Per Share .76 .70 9%
BANK BRANCHES 12 11 -
16
FISCAL YEAR ENDED DECEMBER 31, 2006 COMPARED TO FISCAL YEAR ENDED
DECEMBER 31, 2005. Net income was $4.88 million, or $.70 per diluted share, for
the fiscal year ended December 31, 2006, compared to $5.54 million, or $.80 per
diluted share, for the fiscal year ended December 31, 2005. Net loans increased
by approximately 20%. Investment securities and total assets decreased by
approximately 14% and 3%, respectively.
FISCAL YEAR ENDED DECEMBER 31,
------------------------------------------------------
2006 2005 %
INC/(DEC)
(In millions, except per share data and percentages)
TOTAL ASSETS $948.7 $977.7 (3)%
Loans, net 367.2 305.9 20%
Investment Securities 515.2 600.0 (14)%
TOTAL LIABILITIES 832.9 868.7 (4)%
Deposits 681.5 680.3 0%
Borrowings 138.1 178.9 (23)%
STOCKHOLDERS' EQUITY 115.8 109.0 6%
TOTAL INCOME 51.9 46.3 12%
Interest Income 48.2 45.1 7%
TOTAL EXPENSE 42.8 35.5 21%
Interest Expense 29.2 22.4 30%
Net Interest Income 19.0 22.7 (16)%
NET INCOME 4.9 5.5 (11)%
Diluted Income Per Share .70 .80 (13)%
BANK BRANCHES 11 10 -
NET INTEREST INCOME
Net interest income, represents the difference between total interest
income earned on earning assets and total interest expense paid on
interest-bearing liabilities. The amount of interest income is dependent upon
many factors including: (i) the amount of interest-earning assets that the
Company can maintain based upon its funding sources; (ii) the relative amounts
of interest-earning assets versus interest-bearing liabilities; and (iii) the
difference between the yields earned on those assets and the rates paid on those
liabilities. Non-performing loans adversely affect net interest income because
they must still be funded by interest-bearing liabilities, but they do not
provide interest income. Furthermore, when we designate an asset as non-
performing, all interest which has been accrued but not actually received is
deducted from current period income, further reducing net interest income.
17
The Company's average balances, interest, and average yields are set forth on
the following table (in thousands, except percentages):
TWELVE MONTHS ENDED TWELVE MONTHS ENDED
DECEMBER 31, 2007 DECEMBER 31, 2006
---------------------------------------- ----------------------------------------
INTEREST INTEREST
AVERAGE AND AVERAGE AVERAGE AND AVERAGE
BALANCE DIVIDENDS YIELD/RATE BALANCE DIVIDENDS YIELD/RATE
------- --------- ---------- ------- --------- ----------
INTEREST-EARNING ASSETS:
Loans (1) $ 389,520 $ 29,804 7.65% $ 327,210 $ 23,844 7.29%
Investment securities 558,742 27,178 4.86 550,443 24,027 4.37
Other (2)(5) 31,678 1,553 4.90 8,509 350 4.11
---------- -------- ---- --------- -------- ----
Total interest-earning assets 979,940 58,535 5.97 886,162 48,221 5.44
Noninterest-earning assets 46,070 ---- 46,882 ----
---------- ---------
Total Assets $1,026,010 $ 933,044
========== =========
INTEREST-BEARING LIABILITIES:
Interest bearing deposits 291,049 10,338 3.55 206,745 5,283 2.56
Time deposits 449,754 21,745 4.83 410,729 17,276 4.21
Other borrowings 103,112 5,710 5.54 144,722 6,627 4.58
---------- -------- ---- --------- -------- ----
Total interest-bearing
liabilities 843,915 37,793 4.48 762,196 29,186 3.83
-------- ---- -------- ----
Demand deposits 50,647 47,890
Noninterest-bearing liabilities 12,285 9,731
Stockholders' equity (5) 119,163 113,227
---------- ---------
Total liabilities and
stockholders' equity $1,026,010 $ 933,044
========== =========
Net interest income $ 20,742 $ 19,035
======== ========
Interest-rate spread (3) 1.49% 1.61%
==== ====
Net interest margin (4) 2.12% 2.15%
==== ====
Ratio of average interest-earning
assets to average interest bearing
liabilities 1.16 1.16
========== =========
DECEMBER 31, 2005
---------------------------------------
INTEREST
AVERAGE AND AVERAGE
BALANCE DIVIDENDS YIELD/RATE
------- --------- ----------
INTEREST-EARNING ASSETS:
Loans (1) $ 287,178 $ 19,399 6.76%
Investment securities 648,829 25,355 3.91
Other (2)(5) 10,765 302 2.81
--------- -------- ----
Total interest-earning assets 946,772 45,056 4.76
Noninterest-earning assets 44,497 ----
---------
Total Assets $ 991,269
=========
INTEREST-BEARING LIABILITIES:
Interest bearing deposits 264,130 4,639 1.76
Time deposits 338,834 9,552 2.82
Other borrowings 225,657 8,208 3.64
--------- -------- ----
Total interest-bearing
liabilities 828,621 22,399 2.70
-------- ----
Demand deposits 44,739
Noninterest-bearing liabilities 8,310
Stockholders' equity (5) 109,599
---------
Total liabilities and
stockholders' equity $ 991,269
=========
Net interest income $ 22,657
========
Interest-rate spread (3) 2.06%
====
Net interest margin (4) 2.39%
====
Ratio of average interest-earning
assets to average interest bearing
liabilities 1.14
=========
----------------------
(1) Includes nonaccrual loans.
(2) Includes interest-bearing deposits, federal funds sold and securities
purchased under agreements to resell.
(3) Interest-rate spread represents the difference between the average
yield on interest-earning assets and the average cost of interest
bearing liabilities.
(4) Net interest margin is net interest income as a percentage of average
interest-earning assets.
(5) Average balances for Berkshire Bancorp Inc. (parent only) have been
calculated on a monthly basis.
18
Changes in net interest income may also be analyzed by segregating the
volume and rate components of interest income and interest expense. The
following tables set forth certain information regarding changes in interest
income and interest expense of the Company for the years indicated. For each
category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (1) changes in rate (change
in rate multiplied by prior volume), (2) changes in volume (changes in volume
multiplied by prior rate) and (3) changes in rate-volume (change in rate
multiplied by change in volume) (in thousands):
TWELVE MONTHS ENDED DECEMBER 31, 2007
VERSUS
TWELVE MONTHS ENDED DECEMBER 31, 2006
INCREASE (DECREASE) DUE TO
--------------------------------------------------
Rate Volume Total
--------------- --------------- --------------
Interest-earning assets:
Loans $ 1,228 $ 4,732 $ 5,960
Investment securities 2,777 374 3,151
Other 79 1,124 1,203
------- ------- -------
Total 4,084 6,230 10,314
------- ------- -------
Interest-bearing
liabilities:
Deposit accounts:
Interest bearing deposits 2,461 2,594 5,055
Time deposits 2,717 1,752 4,469
Other borrowings 1,220 (2,137) (917)
------- ------- -------
Total 6,398 2,209 8,607
------- ------- -------
Net interest income $(2,314) $ 4,021 $ 1,707
======= ======= =======
TWELVE MONTHS ENDED DECEMBER 31, 2006
VERSUS
TWELVE MONTHS ENDED DECEMBER 31, 2005
INCREASE (DECREASE) DUE TO
--------------------------------------------------
Rate Volume Total
--------------- --------------- --------------
Interest-earning assets:
Loans $ 1,600 $ 2,845 $ 4,445
Investment securities 2,723 (4,051) (1,328)
Other 120 (72) 48
------- ------- -------
Total 4,443 (1,278) 3,165
------- ------- -------
Interest-bearing
liabilities:
Deposit accounts:
Interest bearing deposits 1,802 (1,158) 644
Time deposits 5,400 2,324 7,724
Other borrowings 1,805 (3,386) (1,581)
------- ------- -------
Total 9,007 (2,220) 6,787
------- ------- -------
Net interest income $(4,564) $ 942 $(3,622)
======= ======= =======
19
PROVISION FOR LOAN LOSSES.
The allowance for loan losses is the estimated amount considered
necessary to cover credit losses inherent in the loan portfolio at the balance
sheet date. The allowance is established through the provision for loan losses
that is charged against income. In determining the allowance for loan losses,
management makes significant estimates and therefore has identified the
allowance as a critical accounting policy. The methodology for determining the
allowance for loan losses is considered a critical accounting policy by
management due to the high degree of judgment involved, the subjectivity of the
assumptions utilized, and the potential for changes in the economic environment
that could result in changes to the amount of the recorded allowance for loan
losses.
The allowance for loan losses has been determined in accordance with
accounting principles generally accepted in the United States of America,
principally Statement of Financial Accounting Standard ("SFAS") No. 5,
"Accounting for Contingencies" and SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan, an amendment to FASB Statements No. 5 and 15," as amended.
Under the above accounting principles, we are required to maintain an allowance
for probable losses at the balance sheet date. We are responsible for the timely
and periodic determination of the amount of the allowance required. Management
believes that the allowance for loan losses is adequate to cover specifically
identifiable losses, as well as estimated losses inherent in our portfolio for
which certain losses are probable but not specifically identifiable.
Management performs a quarterly evaluation of the adequacy of the
allowance for loan losses. The analysis of the allowance for loan losses has two
components: specific and general allocations. Specific allocations are made for
loans determined to be impaired. Impairment is measured by determining the
present value of expected future cash flows or, as a practical expedient for
collateral-dependent loans, the fair value of the collateral adjusted for market
conditions and selling expenses. The Bank considers its investment in
one-to-four family real estate loans and consumer loans to be smaller balance
homogeneous loans and therefore excluded from separate identification for
evaluation of impairment. These homogeneous loan groups are evaluated for
impairment on a collective basis under SFAS No. 5, "Accounting for
Contingencies".
The general allocation is determined by segregating the remaining loans
by type of loan, risk weighting (if applicable) and payment history. Management
also analyzes historical loss experience, delinquency trends, general economic
conditions, geographic concentrations, and industry and peer comparisons. This
analysis establishes factors that are applied to the loan segments to determine
the amount of the general allocations. This evaluation is inherently subjective
as it requires material estimates that may be susceptible to significant
revisions based upon changes in economic and real estate market conditions.
Actual loan losses may be significantly more than the allowance for loan losses
management has established which could have a material negative effect on the
Company's financial results.
On a quarterly basis, the Bank's management committee reviews the
current status of various loan assets in order to evaluate the adequacy of the
allowance for loan losses. In this evaluation process, specific loans are
analyzed to determine their potential risk of loss. This process includes all
loans, concentrating on non-accrual and classified loans. Each non-accrual or
classified loan is evaluated for potential loss exposure. Any shortfall results
in a recommendation of a specific allowance if the likelihood of loss is
evaluated as probable. To determine the adequacy of collateral on a particular
loan, an estimate of the fair market value of the collateral is based on the
most current appraised value available. This appraised value is then reduced to
reflect estimated liquidation expenses.
The Company's primary lending emphasis has been the origination of
commercial and residential mortgages and commercial and consumer loans and lines
of credit. The bank also originates home equity loans and home equity lines of
credit. These activities resulted in a loan concentration in commercial and
residential mortgages. As a substantial amount of our loan portfolio is
collateralized by real estate, appraisals of the underlying value of property
securing loans are critical in determining the amount of the allowance required
20
for specific loans. Assumptions for appraisal valuations are instrumental in
determining the value of properties. Overly optimistic assumptions or negative
changes to assumptions could significantly impact the valuation of a property
securing a loan and the related allowance determined. The assumptions supporting
such appraisals are carefully reviewed by management to determine that the
resulting values reasonably reflect amounts realizable on the related loans.
Based on the composition of our loan portfolio, management believes the primary
risks are increases in interest rates, a decline in the economy, generally, and
a decline in real estate market values in the New York metropolitan area. Any
one or combination of these events may adversely affect our loan portfolio
resulting in increased delinquencies, loan losses and future levels of loan loss
provisions. Management believes the allowance for loan losses reflects the
inherent credit risk in our portfolio, the level of our non-performing loans and
our charge-off experience.
Although management believes that we have established and maintained
the allowance for loan losses at adequate levels, additions may be necessary if
future economic and other conditions differ substantially from the current
operating environment. Although management uses the best information available,
the level of the allowance for loan losses remains an estimate that is subject
to significant judgment and short-term change. In addition, the Federal Deposit
Insurance Corporation, New York State Banking Department, and other regulatory
bodies, as an integral part of their examination process, will periodically
review our allowance for loan losses. Such agencies may require us to recognize
adjustments to the allowance based on its judgments about information available
to them at the time of their examination.
For the fiscal years ended December 31, 2007 and 2006, we charged-off
loans of zero and $42,000, respectively, and recovered loans of $56,000 and
$137,000, respectively. All amounts recovered in fiscal 2007 and 2006 were
returned to the allowance for loan losses.
21
RESULTS OF OPERATIONS FISCAL YEAR ENDED DECEMBER 31, 2007 COMPARED TO FISCAL
YEAR ENDED DECEMBER 31, 2006.
GENERAL. References to per share amounts below, unless stated otherwise, refer
to diluted shares.
NET INCOME. Net income for the fiscal year ended December 31, 2007 was $5.35
million, or $.76 per share, as compared to $4.88 million, or $.70 per share, for
the fiscal year ended December 31, 2006.
The Company's net income is largely dependent on interest rate levels,
the demand for the Company's loan and deposit products and the strategies
employed to manage the interest rate and other risks inherent in the banking
business. The difference between the yield on short-term, 3 month U.S. Treasury
Notes, and long-term, 10 year U.S. Treasury Bonds, referred to as the yield
curve is at historic lows. Inflation fighting actions taken by the Federal
Reserve Board during 2007 have moved short-term rates up while long-term rates
have remained relatively flat. The Company's rising cost of funds in 2007, the
rates paid on deposits and borrowings, has not been matched by the ability to
safely increase the yields on interest-earning assets.
NET INTEREST INCOME. The Company's primary source of revenue is net interest
income, or the difference between interest income on earning assets, such as
loans and investment securities, and interest expense on interest-bearing
liabilities such as deposits and borrowings.
For the fiscal year ended December 31, 2007, net interest income
increased by approximately $1.70 million to $20.74 million from $19.04 million
for the fiscal year ended December 31, 2006. The year over year increase in net
interest income was the result of the $93.78 million increase in the average
amount of total interest-earning assets, including $62.31 million increase in
the average amount of higher yielding loans as a percentage of total
interest-earning assets, the 53 basis point increase in the average yields
earned on total interest-earning assets and the $41.61 million decrease in the
average amount of borrowed funds during fiscal 2007 compared to 2006. Partially
offsetting these factors was the $123.60 million increase in interest-bearing
and time deposits, and the 65 basis point increase in the average rates paid on
the average amount of total interest-bearing liabilities during fiscal 2007
compared to fiscal 2006.
The Company's interest-rate spread, the difference between the average
yield on interest-earning assets and the average cost of interest-bearing
liabilities, narrowed by 12 basis points to 1.49% during fiscal 2007 from 1.61%
during fiscal 2006.
NET INTEREST MARGIN. Net interest margin declined by 3 basis points to 2.12%
during fiscal 2007 from 2.15% during fiscal 2006. We seek to secure and retain
customer deposits with competitive products and rates, and to make strategic use
of the prevailing interest rate environment to borrow funds at what we believe
to be attractive rates. We invest such deposits and borrowed funds in a prudent
mix of fixed rate and adjustable rate loans, investment securities and
short-term interest-earning assets which provided an aggregate average yield of
5.97% and 5.44% in fiscal 2007 and 2006, respectively. The small decrease in net
interest margin is primarily due to the substantial increase in the average
amount of total interest-earning assets during the fiscal year ended December
31, 2007.
The average amount of loans increased by $62.31 million to $389.52
million during fiscal 2007 from $327.21 million during fiscal 2006, and the
average yield on such loans increased by 36 basis points to 7.65% in fiscal 2007
from 7.29% in fiscal 2006. The average amount of investment securities increased
by $8.30 million to $558.74 million in fiscal 2007 from $550.44 million in
fiscal 2006. The average yield on investment securities improved by 49 basis
points, to 4.86% in 2007 from 4.37% in 2006. The average amount of other
interest-earning assets, primarily cash and short-term investments, increased by
$23.16 million to $31.68 million in 2007 from $8.52 million in 2006 and returned
an average yield of 4.90% and 4.11% during the fiscal years ended December 31,
2007 and 2006, respectively.
22
INTEREST INCOME. Total interest income for the fiscal year ended December 31,
2007 increased by $10.32 million, or 21.42%, to $58.54 million from $48.22
million for the fiscal year ended December 31, 2006. The increase in interest
income in fiscal 2007 was primarily due to the increase in the average yields
earned on interest-earning assets and the increase in the average amount of
total interest-earning assets. Loans contributed $29.80 million of interest
income in fiscal 2007, an increase of $5.96 million from the $23.84 million of
interest income contributed in fiscal 2006. Investment securities contributed
$27.18 million of interest income in fiscal 2007, a increase of $3.15 million
from the $24.03 million of interest income earned on securities in fiscal 2006.
FISCAL 2007 FISCAL 2006
--------------------------- --------------------------
INTEREST % OF INTEREST % OF
INCOME TOTAL INCOME TOTAL
(In thousands, except percentages)
Loans $29,804 50.92% $23,844 49.45%
Investment Securities 27,178 46.43 24,027 49.82
Other 1,553 2.65 350 0.73
------- ------ ------- ------
Total Interest Income $58,535 100.00% $48,221 100.00%
Loans, which are inherently risky and therefore command a higher return
than our conservative portfolio of investment securities, grew to 39.75% of our
total average interest-earning assets in fiscal 2007 from 36.92% in fiscal 2006.
While we actively seek to originate new loans with qualified borrowers who meet
the Bank's underwriting standards, our long-term strategy has been to maintain
those standards, sacrificing some current income to avoid possible large future
losses in the loan portfolio.
FISCAL 2007 FISCAL 2006
----------------------- ---------------------
AVERAGE % OF AVERAGE % OF
AMOUNT TOTAL AMOUNT TOTAL
(In thousands, except percentages)
Loans $389,520 39.75% $327,210 36.92%
Investment Securities 558,742 57.02 550,443 62.12
Other 31,678 3.23 8,509 .96
-------- ------ -------- ------
Total Interest-Earning Assets $979,940 100.00% $886,162 100.00%
INTEREST EXPENSE. Total interest expense for the fiscal year ended December 31,
2007 increased by $8.60 million, or 29.46%, to $37.79 million from $29.19
million for the fiscal year ended December 31, 2006. The increase in interest
expense was primarily due to the increase in the average rate paid on such
liabilities, 4.48% and 3.83% in fiscal years 2007 and 2006, respectively, and
the $81.72 million increase in the average amount of total interest-bearing
liabilities during fiscal year 2007. Partially offsetting these factors was the
$41.61 million decrease in the average amount of other borrowings which carry
the highest average rate of all interest-bearing liabilities. As short-term
rates moved higher during fiscal year 2007, interest expense increased as we
priced our deposit products to meet the competition and the adjustable rates
paid on other borrowings increased as well. In April 2005 and May 2004, we sold
$7.22 million and $15.46 million, respectively, of floating rate junior
subordinated debentures which mature in 2035 and 2034, respectively. The net
proceeds of said sales were used to augment the Bank's capital. The interest
expense on these debentures, which is included in other borrowings, was $1.83
million and $1.77 million during fiscal 2007 and 2006, respectively.
FISCAL 2007 FISCAL 2006
--------------------------- --------------------------
INTEREST % OF INTEREST % OF
EXPENSE TOTAL EXPENSE TOTAL
(In thousands, except percentages)
Interest-Bearing Deposits $ 10,338 27.35% $ 5,283 18.10%
Time Deposits 21,745 57.54 17,276 59.19
Other Borrowings 5,710 15.11 6,627 22.71
-------- ------ -------- ------
Total Interest Expense $ 37,793 100.00% $29,186 100.00%
23
FISCAL 2007 FISCAL 2006
---------------------- ---------------------
AVERAGE % OF AVERAGE % OF
AMOUNT TOTAL AMOUNT TOTAL
(In thousands, except percentages)
Interest-Bearing Deposits $291,049 34.49% $206,745 27.12%
Time Deposits 449,754 53.29 410,729 53.89
Other Borrowings 103,112 12.22 144,722 18.99
-------- ------ -------- ------
Total Interest-Bearing Liabilities $843,915 100.00% $762,196 100.00%
NON-INTEREST INCOME. Non-interest income consists primarily of realized gains on
sales of marketable securities and service fee income. For the fiscal year ended
December 31, 2007, total non-interest income decreased by $2.03 million to $1.66
million from $3.69 million for the fiscal year ended December 31, 2006. In 2006,
we recorded gains of $2.34 million on the sales and issuer redemptions of
investment securities. In 2007, such gains amounted to $86,000. Service charges
on deposit accounts increased by $70,000 and other income increased by $146,000.
FISCAL 2007 FISCAL 2006
---------------------- ------------------------
NON-INTEREST % OF NON-INTEREST % OF
INCOME TOTAL INCOME TOTAL
(In thousands, except percentages)
Service Charges on Deposits $ 658 39.66% $ 588 15.92%
Investment Securities gains 86 5.18 2,336 63.26
Other 915 55.16 769 20.82
------ ------ ------ ------
Total Non-Interest Income $1,659 100.00% $3,693 100.00%
NON-INTEREST EXPENSE. Non-interest expense includes salaries and employee
benefits, occupancy and equipment expenses, legal and professional fees and
other operating expenses associated with the day-to-day operations of the
Company. Total non-interest expense for the year ended December 31, 2007
increased by approximately $740,000, or 5.45%, to $14.32 million from $13.58
million for the year ended December 31, 2006. The largest component of
non-interest expense are salaries and employee benefits which increased by
$490,000 to $8.97 million in fiscal 2007 from $8.48 million in fiscal 2006. The
increase is primarily due to the addition of personnel in our internal control
and compliance departments.
FISCAL 2007 FISCAL 2006
---------------------- ------------------------
NON-INTEREST % OF NON-INTEREST % OF
EXPENSE TOTAL EXPENSE TOTAL
(In thousands, except percentages)
Salaries and Employee Benefits $ 8,971 62.66% $ 8,481 62.44%
Net Occupancy Expense 2,050 14.32 1,961 14.44
Equipment Expense 80 0.56 108 0.80
FDIC Assessment 86 0.60 85 0.63
Data Processing Expense 417 2.91 366 2.69
Other 2,714 18.95 2,581 19.00
------- ------ ------- ------
Total Non-Interest Expense $14,318 100.00% $13,582 100.00%
PROVISION FOR INCOME TAX. During the years ended December 31, 2007 and 2006, we
recorded income tax expense of $2.37 million and $3.86 million, respectively.
The tax provisions for federal, state and local taxes recorded for 2007 and 2006
represent effective tax rates of 30.72% and 44.14%, respectively. The decline in
the effective tax rate in 2007 compared to 2006 is primarily due to the Bank's
investment in certain securities which carry a larger tax benefit because of
their dividend payments.
24
RESULTS OF OPERATIONS FISCAL YEAR ENDED DECEMBER 31, 2006 COMPARED TO FISCAL
YEAR ENDED DECEMBER 31, 2005.
GENERAL. References to per share amounts below, unless stated otherwise, refer
to diluted shares.
NET INCOME. Net income for the fiscal year ended December 31, 2006 was $4.88
million, or $.70 per share, as compared to $5.54 million, or $.80 per share, for
the fiscal year ended December 31, 2005.
The Company's net income is largely dependent on interest rate levels,
the demand for the Company's loan and deposit products and the strategies
employed to manage the interest rate and other risks inherent in the banking
business. The difference between the yield on short-term, 3 month U.S. Treasury
Notes, and long-term, 10 year U.S. Treasury Bonds, referred to as the yield
curve is at historic lows. Inflation fighting actions taken by the Federal
Reserve Board have moved short-term rates up while long-term rates have remained
relatively flat. The Company's rising cost of funds in 2006 on deposits and
borrowings has not been matched by the ability to increase the yields on assets.
NET INTEREST INCOME. For the fiscal year ended December 31, 2006, net interest
income decreased by $3.62 million to $19.04 million from $22.66 million for the
fiscal year ended December 31, 2005. The year over year decrease in net interest
income was the result of the 113 basis point increase in the average rate paid
on interest-bearing liabilities to 3.83% in 2006 from 2.70% in 2005 and the
smaller, 68 basis point increase in the average yield earned on interest-earning
assets to 5.44% in 2006 from 4.76% in 2005. Also contributing to the decrease in
net interest income was the $60.61 million decrease in the average amount of
interest-earning assets to $886.16 million in 2006 from $946.77 million in 2005.
Partially offsetting these factors was the $66.43 million decrease in the
average amount of interest-bearing liabilities to $762.20 million in 2006 from
$828.62 million in 2005.
The Company's interest-rate spread narrowed by 45 basis points to 1.61%
in 2006 from 2.06% in 2005. This decline is primarily due to the change in
deposit mix, the $71.90 million increase in higher cost CD's and the $57.39
million decrease in lower cost, non-maturity deposit accounts in 2006 compared
to 2005. If the current rate environment continues, we expect to see continued
pressure on the Company's interest-rate spread and net interest income.
NET INTEREST MARGIN. Net interest margin declined by 24 basis points to 2.15% in
fiscal 2006 from 2.39% in fiscal 2005. We seek to secure and retain customer
deposits with competitive products and rates, while making strategic use of the
prevailing interest rate environment to borrow funds at what we believe to be
attractive rates. We invest such deposits and borrowed funds in a prudent mix of
fixed rate and adjustable rate loans, investment securities and short-term
interest-earning assets which provide an aggregate average yield of 5.44% and
4.76% in fiscal 2006 and 2005, respectively. The decrease in net interest margin
is primarily due to the decrease in net interest income, partially offset by the
decrease in average interest-earning assets.
The average amount of loans increased by $40.03 million to $327.21
million in 2006 from $287.18 million in 2005, and the average yield on such
loans increased by 53 basis points to 7.29% in fiscal 2006 from 6.76% in fiscal
2005. The average amount of investment securities decreased by $98.39 million to
$550.44 million in fiscal 2006 from $648.83 million in fiscal 2005. The average
yield on investment securities improved by 46 basis points, to 4.37% in 2006
from 3.91% in 2005. The average amount of other interest-earning assets,
primarily cash and short-term investments, decreased by $2.26 million to $8.51
million in 2006 from $10.77 million in 2005 and returned an average yield of
4.11% and 2.81% in fiscal 2006 and 2005, respectively.
INTEREST INCOME. Total interest income for the fiscal year ended December 31,
2006 increased by $3.17 million, or 7.02%, to $48.22 million from $45.06 million
for the fiscal year ended December 31, 2005. The increase in interest income was
primarily due to the increase in the yields on interest-earning assets,
partially offset by the decrease in the average amount of total interest-earning
assets. Loans contributed $23.84 million of interest income in fiscal 2006, an
increase of $4.44 million from the $19.40 million of interest income contributed
in fiscal
25
2005. Investment securities contributed $24.03 million of interest income in
fiscal 2006, a decrease of $1.33 million from the $25.36 million of interest
income earned on securities in fiscal 2005.
FISCAL 2006 FISCAL 2005
--------------------------- --------------------------
INTEREST % OF INTEREST % OF
INCOME TOTAL INCOME TOTAL
(In thousands, except percentages)
Loans $23,844 49.45% $19,399 43.06%
Investment Securities 24,027 49.82 25,355 56.27
Other 350 0.73 302 0.67
------- ------ ------- ------
Total Interest Income $48,221 100.00% $45,056 100.00%
Loans, which are inherently risky and therefore command a higher return
than our conservative portfolio of investment securities, grew to 36.92% of our
total average interest-earning assets in fiscal 2006 from 30.33% in fiscal 2005.
While we actively seek to originate new loans with qualified borrowers who meet
the Bank's underwriting standards, our strategy has been to maintain those
standards, sacrificing some current income to avoid possible large future losses
in the loan portfolio.
FISCAL 2006 FISCAL 2005
----------------------- ---------------------
AVERAGE % OF AVERAGE % OF
AMOUNT TOTAL AMOUNT TOTAL
(In thousands, except percentages)
Loans $327,210 36.92% $287,178 30.33%
Investment Securities 550,443 62.12 648,829 68.53
Other 8,509 0.96 10,765 1.14
-------- ------ -------- ------
Total Interest-Earning Assets $886,162 100.00% $946,772 100.00%
INTEREST EXPENSE. Total interest expense for the fiscal year ended December 31,
2006 increased by $6.79 million, or 30.30%, to $29.19 million from $22.40
million for the fiscal year ended December 31, 2005. The increase in interest
expense was due to the increase in the average rate paid on such liabilities,
3.83% and 2.70% in fiscal years 2006 and 2005, respectively, partially offset by
the decrease in the average amount of interest-bearing liabilities. As
short-term rates moved higher during 2006, interest expense increased as we
priced our deposit products to meet the competition and the adjustable rates
paid on other borrowings increased as well. In April 2005 and May 2004, we sold
$7.22 million and $15.46 million, respectively, of floating rate junior
subordinated debentures which mature in 2035 and 2034, respectively. The net
proceeds were used to augment the Bank's capital. The interest expense on these
debentures, which are included in other borrowings, was $1.77 million and $1.27
million during fiscal 2006 and 2005, respectively.
FISCAL 2006 FISCAL 2005
--------------------------- --------------------------
INTEREST % OF INTEREST % OF
EXPENSE TOTAL EXPENSE TOTAL
(In thousands, except percentages)
Interest-Bearing Deposits $ 5,283 18.10% $ 4,639 20.71%
Time Deposits 17,276 59.19 9,552 42.64
Other Borrowings 6,627 22.71 8,208 36.65
------- ------ ------- ------
Total Interest Expense $29,186 100.00% $22,399 100.00%
26
FISCAL 2006 FISCAL 2005
---------------------- ---------------------
AVERAGE % OF AVERAGE % OF
AMOUNT TOTAL AMOUNT TOTAL
(In thousands, except percentages)
Interest-Bearing Deposits $206,745 27.12% $264,130 31.88%
Time Deposits 410,729 53.89 338,834 40.89
Other Borrowings 144,722 18.99 225,657 27.23
-------- ------ -------- ------
Total Interest-Bearing Liabilities $762,196 100.00% $828,621 100.00%
NON-INTEREST INCOME. Non-interest income consists primarily of realized gains on
sales of marketable securities and service fee income. For the fiscal year ended
December 31, 2006, total non-interest income increased by $2.48 million to $3.69
million from $1.21 million for the fiscal year ended December 31, 2005. In 2006,
we recorded gains of $2.34 million on the sales and issuer redemptions of
investment securities. In 2005, such gains amounted to $4,000. Service charges
on deposit accounts were flat and other income increased by $156,000.
FISCAL 2006 FISCAL 2005
---------------------- ------------------------
NON-INTEREST % OF NON-INTEREST % OF
INCOME TOTAL INCOME TOTAL
(In thousands, except percentages)
Service Charges on Deposits $ 588 15.92% $ 589 48.84%
Investment Securities gains 2,336 63.26 4 0.33
Other 769 20.82 613 50.83
------ ------ ------ ------
Total Non-Interest Income $3,693 100.00% $1,206 100.00%
NON-INTEREST EXPENSE. Non-interest expense includes salaries and employee
benefits, occupancy and equipment expenses, legal and professional fees and
other operating expenses associated with the day-to-day operations of the
Company. Total non-interest expense for the year ended December 31, 2006
increased by $443,000, or 3.37%, to $13.58 million from $13.14 million for the
year ended December 31, 2005. The largest component of non-interest expense are
salaries and employee benefits which increased by $479,000 to $8.48 million in
fiscal 2006 from $8.00 million in fiscal 2005. The increase is due to the
addition of personnel in our internal control and compliance departments.
FISCAL 2006 FISCAL 2005
---------------------- ------------------------
NON-INTEREST % OF NON-INTEREST % OF
EXPENSE TOTAL EXPENSE TOTAL
(In thousands, except percentages)
Salaries and Employee Benefits $ 8,481 62.44% $ 8,002 60.90%
Net Occupancy Expense 1,961 14.44 1,728 13.15
Equipment Expense 108 0.80 397 3.02
FDIC Assessment 85 0.63 272 2.07
Data Processing Expense 366 2.69 198 1.51
Other 2,581 19.00 2,542 19.35
------- ------ ------- ------
Total Non-Interest Expense $13,582 100.00% $13,139 100.00%
PROVISION FOR INCOME TAX. During the years ended December 31, 2006 and 2005, we
recorded income tax expense of $3.86 million and $5.00 million, respectively.
The tax provisions for federal, state and local taxes recorded for 2006 and 2005
represent effective tax rates of 44.14% and 47.45%, respectively.
INVESTMENT ACTIVITIES
GENERAL. The investment policy of the Bank is designed primarily to
provide satisfactory yields while maintaining adequate liquidity, a balance of
high quality, diversified investments, and minimal risk. The Bank does not, as a
rule, invest in equity securities. The largest component of the Bank's
securities investments, representing more than 50% of total investment
securities, are debt securities issued by U.S. Government agencies including the
Federal Home Loan Mortgage Corporation (Freddie Mac), the Federal National
Mortgage Association (Fannie Mae) or the Government National Mortgage
Association
27
(Ginnie Mae). The remainder of the Bank's debt securities investments are
primarily short term debt securities issued by the United States or its
agencies. The Bank maintains a small portfolio of less than $4 million of
high-yield corporate debt securities. Recognizing the higher credit risks of
these securities, the Bank underwrites these securities in a manner similar to
its loan underwriting procedures.
At December 31, 2007, our portfolio of investment securities included
approximately $185 million of auction rate securities. These investments have
high credit quality ratings of AA or AAA and are fully collateralized by bonds
and other financial instruments. Auction rate securities are generally long-term
debt instruments that provide liquidity through a Dutch auction process that
resets the applicable interest rate at pre-determined calendar intervals,
generally every 28 days.
Recent uncertainties in the credit markets have negatively impacted
our ability to liquidate, if necessary, investments in auction rate securities
because, in recent auctions, the amount of securities submitted for sale has
exceeded the amount of purchase orders. We are not certain as to when the
liquidity issues relating to these investments will improve; however, we have
the ability to hold these available for sale securities to maturity,
(predominately 20 years after December 31, 2007) recovering our investment. As a
result of the recent auction failures beginning in February 2008, the fair value
of these securities, while maintaining their investment grade rating and
interest payments, could be negatively impacted at a later time. Were this to
occur, we may be required to reflect a write-down of certain of our auction rate
securities in future periods as a charge to earnings if any of our auction rate
securities are deemed to be other-than-temporarily impaired. Such impairment
charge would be recorded as other expense and could be material to our results
of operations.
Based on our expected operating cash flows, and our other sources of
cash, we do not expect the potential lack of liquidity in these investments to
affect our ability to execute our current business plan.
As required by SFAS No. 115, securities are classified into three
categories: trading, held-to-maturity and available-for-sale. Securities that
are bought and held principally for the purpose of selling them in the near term
are classified as trading securities and are reported at fair value with
unrealized gains and losses included in trading account activities in the
statement of income. Securities that the Bank has the positive intent and
ability to hold to maturity are classified as held-to-maturity and reported at
amortized cost. All other securities are classified as available-for-sale.
Available-for-sale securities are reported at fair value with unrealized gains
and losses included, on an after-tax basis, as a separate component of net
worth. The Bank does not have a trading securities portfolio and has no current
plans to maintain such a portfolio in the future. The Bank generally classifies
all newly purchased debt securities as available for sale in order to maintain
the flexibility to sell those securities if the need arises. The Bank has a
limited portfolio of securities classified as held to maturity, represented
principally by securities purchased a number of years ago.
FEDERAL HOME LOAN BANK STOCK. The Bank owns stock of the Federal Home
Loan Bank of New York (the "FHLBNY") which is necessary for it to be a member of
the FHLBNY. Membership requires the purchase of stock equal to 1% of the Bank's
residential mortgage loans. If the Bank borrows from the FHLBNY, the Bank must
own stock at least equal to 5% of its borrowings.
28
The following table sets forth the cost and fair value of
available-for-sale and held-to-maturity securities as of the dates indicated:
DECEMBER 31,
------------------------------------------------------------------------------------
2007 2006 2005
----------------------- ----------------------- -----------------------
COST FAIR COST FAIR COST FAIR
VALUE VALUE VALUE
-------- -------- -------- -------- -------- --------
(In thousands)
AVAILABLE-FOR-SALE
U.S. Treasury Notes $ -- $ -- $ 5,002 $ 4,990 $ 14,985 $ 14,899
U.S. Government Agencies 272,789 272,318 322,986 317,164 448,196 439,645
Mortgage-backed securities 53,886 53,057 67,472 65,853 81,681 79,686
Corporate notes 71,147 67,601 44,366 44,038 54,590 52,304
Municipal securities 1,973 3,004 5,698 7,187 1,972 2,306
Auction rate securities 184,597 184,597 71,500 71,500 -- --
Marketable equity
securities and other 18,698 18,384 3,919 4,066 10,351 10,570
-------- -------- -------- -------- -------- --------
Total $603,090 $598,961 $520,943 $514,798 $611,775 $599,410
======== ======== ======== ======== ======== ========
HELD-TO-MATURITY
U.S. Government Agencies $ 395 $ 405 $ 433 $ 436 $ 562 $ 573
======== ======== ======== ======== ======== ========
The following tables summarize the Company's available-for-sale and
held- to-maturity securities:
DECEMBER 31, 2007
--------------------------------------
WEIGHTED
AVERAGE
YIELD COST FAIR VALUE
-------- -------- ----------
(Dollars in thousands)
AVAILABLE-FOR-SALE
U.S. Government Agencies Obligations
Due within one year 4.02% $ 39,997 $ 39,877
Due after one year through five years 4.31 161,079 160,789
Due after five years through ten years 4.99 68,684 68,691
Due after ten years 6.51 3,029 2,961
-------- --------
272,789 272,318
-------- --------
Municipal Obligations
Due after ten years 9.41 1,973 3,004
-------- --------
1,973 3,004
-------- --------
Mortgage-backed securities
Due after one year through five years 4.55 4,606 4,517
Due after five years through ten years 4.10 8,650 8,445
Due after ten years 5.37 40,630 40,095
-------- --------
53,886 53,057
-------- --------
Corporate Notes
Due within one year 4.84 36,695 36,426
Due after one year through five years 6.95 8,146 8,098
Due after five years through ten years 4.07 8,476 5,561
Due after ten years 6.71 17,830 17,516
-------- --------
71,147 67,601
-------- --------
Auction rate and other securities
Common Stocks 0.22 1,681 1,386
Preferred Stocks 6.38 184,838 184,824
Money market funds 4.88 14,658 14,653
Federal Home Loan Bank Stock 8.05 2,118 2,118
-------- --------
203,295 202,981
-------- --------
$603,090 $598,961
======== ========
29
HELD-TO-MATURITY
U.S. Government Agencies Obligations
Due after five years through ten years 5.75 16 16
Due after ten years 6.53 379 389
-------- --------
$ 395 $ 405
======== ========
LOAN PORTFOLIO
LOAN PORTFOLIO COMPOSITION. The Company's loans consist primarily of
mortgage loans secured by residential and non-residential properties as well as
commercial loans which are either unsecured or secured by personal property
collateral. Most of the Company's loans are either made to individuals or
personally guaranteed by the principals of the business to which the loan is
made. At December 31, 2007, 2006 and 2005, the Company had total loans, net of
unearned income of $434.79 million, $370.92 million and $309.23 million,
respectively, and an allowance for loan losses of $4.18 million, $3.77 million
and $3.27 million, respectively. From time to time, the Bank may originate
residential mortgage loans, sell them on the secondary market, normally
recognizing fee income in connection with the sale.
Interest rates on loans are affected by the demand for loans, the
supply of money available for lending, credit risks, the rates offered by
competitors and other conditions. These factors are in turn affected by, among
other things, economic conditions, monetary policies of the federal government,
and legislative tax policies.
In order to manage interest rate risk, the Bank focuses its efforts on
loans with interest rates that adjust based upon changes in the prime rate or
changes in United States Treasury or similar indices. Generally, credit risks on
adjustable-rate loans are somewhat greater than on fixed-rate loans primarily
because, as interest rates rise, so do borrowers' payments, increasing the
potential for default. The Bank seeks to impose appropriate loan underwriting
standards in order to protect against these and other credit related risks
associated with its lending operations.
In addition to analyzing the income and assets of its borrowers when
underwriting a loan, the Bank obtains independent appraisals on all material
real estate in which the Bank takes a mortgage. The Bank generally obtains title
insurance in order to protect against title defects on mortgaged property.
COMMERCIAL AND MORTGAGE LOANS. The Bank originates commercial mortgage
loans secured by office buildings, retail establishments, multi-family
residential real estate and other types of commercial property. Substantially
all of the properties are located in the New York City metropolitan area.
The Bank generally makes commercial mortgage loans with loan to value
ratios not to exceed 75% and with terms to maturity that do not exceed 15 years.
Loans secured by commercial properties generally involve a greater degree of
risk than one- to four-family residential mortgage loans. Because payments on
such loans are often dependent on successful operation or management of the
properties, repayment may be subject, to a greater extent, to adverse conditions
in the real estate market or the economy. The Bank seeks to minimize these risks
through its underwriting policies. The Bank evaluates the qualifications and
financial condition of the borrower, including credit history, profitability and
expertise, as well as the value and condition of the underlying property. The
factors considered by the Bank include net operating income; the debt coverage
ratio (the ratio of cash net income to debt service); and the loan to value
ratio. When evaluating the borrower, the Bank considers the financial resources
and income level of the borrower, the borrower's experience in owning or
managing similar property and the Bank's lending experience with the borrower.
The Bank's policy requires borrowers to present evidence of the ability to repay
the loan without having to resort to the sale of the mortgaged property. The
Bank also seeks to focus its commercial mortgage loans on loans to companies
with operating businesses, rather than passive real estate investors.
30
COMMERCIAL LOANS. The Bank makes commercial loans to businesses for
inventory financing, working capital, machinery and equipment purchases,
expansion, and other business purposes. These loans generally have higher yields
than mortgages loans, with maturities of one year, after which the borrower's
financial condition and the terms of the loan are re-evaluated. At December 31,
2007 and 2006, approximately $76.13 million and $63.33 million, respectively, or
17.4% and 17.0%, respectively, of the Company's total loan portfolio consisted
of such loans.
Commercial loans tend to present greater risks than mortgage loans
because the collateral, if any, tends to be rapidly depreciable, difficult to
sell at full value and is often easier to conceal. In order to limit these
risks, the Bank evaluates these loans based upon the borrower's ability to repay
the loan from ongoing operations. The Bank considers the business history of the
borrower and perceived stability of the business as important factors when
considering applications for such loans. Occasionally, the borrower provides
commercial or residential real estate collateral for such loans, in which case
the value of the collateral may be a significant factor in the loan approval
process.
RESIDENTIAL MORTGAGE LOANS (1 TO 4 FAMILY LOANS). The Bank makes
residential mortgage loans secured by first liens on one-to-four family
owner-occupied or rental residential real estate. At December 31, 2007 and 2006,
approximately $145.65 million and $143.62 million, respectively, or 33% and 39%,
respectively, of the Company's total loan portfolio consisted of such loans. The
Company offers both adjustable rate mortgages ("ARMS") and fixed-rate mortgage
loans. The relative proportion of fixed-rate loans versus ARMs originated by the
Bank depends principally upon current customer preference, which is generally
driven by economic and interest rate conditions and the pricing offered by the
Bank's competitors. At December 31, 2007 and 2006, approximately 10% and 14%,
respectively, of the Bank's residential one-to-four family owner-occupied first
mortgage portfolio were ARMs and approximately 90% and 86%, respectively, were
fixed-rate loans. The percentage represented by fixed-rate loans tends to
increase during periods of low interest rates. The ARMs generally carry annual
caps and life-of-loan ceilings, which limit interest rate adjustments.
The Bank's residential loan underwriting criteria are generally
comparable to those required by the Federal National Mortgage Association
("FNMA") and other major secondary market loan purchasers. Generally, ARM credit
risks are somewhat greater than fixed-rate loans primarily because, as interest
rates rise, the borrowers' payments rise, increasing the potential for default.
The Bank's teaser rate ARMs (ARMs with low initial interest rates that are not
based upon the index plus the margin for determining future rate adjustments)
were underwritten based on the payment due at the fully-indexed rate.
In addition to verifying income and assets of borrowers, the Bank
obtains independent appraisals on all residential first mortgage loans and title
insurance is required at closing. Private mortgage insurance is required on all
loans with a loan-to-value ratio in excess of 80% and the Bank requires real
estate tax escrows on such loans. Real estate tax escrows are voluntary on
residential mortgage loans with loan-to-value ratios of 80% or less.
Fixed-rate residential mortgage loans are generally originated by the
Bank for terms of 15 to 30 years. Although 30 year fixed-rate mortgage loans may
adversely affect our net interest income in periods of rising interest rates,
the Bank originates such loans to satisfy customer demand. Such loans are
generally originated at initial interest rates which exceed the fully indexed
rate on ARMs offered at the same time. Fixed-rate residential mortgage loans
originated by the Bank generally include due-on-sale clauses, which permit the
Bank to demand payment in full if the borrower sells the property without the
Bank's consent. Due-on-sale clauses are an important means of adjusting the
rates on the Bank's fixed-rate mortgage loan portfolio, and the Bank will
generally exercise its rights under these clauses if necessary to maintain
market yields.
ARMs originated in recent years have interest rates that adjust
annually based upon the movement of the one year treasury bill constant maturity
index, plus a margin of 2.00% to 2.75%. These loans generally have a maximum
interest rate adjustment of 2% per year, with a lifetime maximum interest rate
adjustment, measured from the initial interest rate, of 5.5% or 6.0%.
31
The Bank offers a variety of other loan products including residential
single family construction loans to persons who intend to occupy the property
upon completion of construction, home equity loans secured by junior mortgages
on one-to-four family owner-occupied residences, and short-term fixed-rate
consumer loans either unsecured or secured by monetary assets such as bank
deposits and marketable securities or personal property. At December 31, 2007
and 2006, the Company's loan portfolio was comprised of $300.3 million and
$238.4 million, respectively, or 68.8% and 64.1%, respectively, of other loan
products.
ORIGINATION OF LOANS. Loan originations can be attributed to
depositors, retail customers, phone inquiries, advertising, the efforts of the
Bank's loan officers, and referrals from other borrowers, real estate brokers
and builders. The Bank originates loans primarily through its own efforts,
occasionally obtaining loan opportunities as a result of referrals from loan
brokers.
At December 31, 2007, the Bank was generally not permitted to make
loans to one borrower in excess of approximately $15.67 million, with an
additional amount of approximately $10.45 million being permitted if secured by
readily marketable collateral. The Bank was also not permitted to make any
single loan in an amount in excess of approximately $15.67 million. At December
31, 2007, the Bank was in compliance with these standards.
DELINQUENCY PROCEDURES. When a borrower fails to make a required
payment on a loan, the Bank attempts to cause the deficiency to be cured by
contacting the borrower. The Bank reviews past due loans on a case by case
basis, taking the action it deems appropriate in order to collect the amount
owed. Litigation may be necessary if other procedures are not successful.
Judicial resolution of a past due loan can be delayed if the borrower files a
bankruptcy petition because collection action cannot be continued unless the
Bank first obtains relief from the automatic stay provided by the Bankruptcy
Code.
If a non-mortgage loan becomes delinquent and satisfactory arrangements
for payment cannot be made, the Bank seeks to realize upon any personal property
collateral to the extent feasible and collect any remaining amount owed from the
borrower through legal proceedings, if necessary.
It is the Bank's policy to discontinue accruing interest on a loan when
it is 90 days past due or if management believes that continued interest
accruals are unjustified. The Bank may continue interest accruals if a loan is
more than 90 days past due if the Bank determines that the nature of the
delinquency and the collateral are such that collection of the principal and
interest on the loan in full is reasonably assured. When the accrual of interest
is discontinued, all accrued but unpaid interest is charged against current
period income. Once the accrual of interest is discontinued, the Bank records
interest as and when received until the loan is restored to accruing status. If
the Bank determines that collection of the loan in full is in reasonable doubt,
then amounts received are recorded as a reduction of principal until the loan is
returned to accruing status.
32
The following table sets forth information concerning the Company's
loan portfolio by type of loan at the dates indicated:
DECEMBER 31,
-----------------------------------------------------------------------------------------------------------
2007 2006 2005 2004 2003
------------------ ------------------ ------------------ ------------------ -----------------
% OF % OF % OF % OF % OF
AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL AMOUNT TOTAL
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Commercial and
professional loans $ 76,132 17.4% $ 63,331 17.0% $ 33,370 10.8% $ 16,498 5.7% $ 22,228 7.5%
Secured by real estate
1 - 4 family 142,140 32.6 139,611 37.5 139,931 45.1 155,079 53.9 169,589 57.4
Multi family 3,506 0.8 4,013 1.1 2,874 0.9 4,600 1.6 6,608 2.2
Non-residential
(commercial) 212,850 48.8 160,417 43.1 132,142 42.6 109,597 38.1 94,956 32.2
Consumer 1,691 0.4 4,763 1.3 2,018 0.6 1,989 0.7 2,239 0.7
-------- ----- -------- ----- -------- ----- -------- ----- -------- -----
Total loans 436,319 100.0% 372,135 100.0% 310,335 100.0% 287,763 100.0% 295,620 100.0%
===== ===== ===== ===== =====
Less: Allowance
for loan losses (4,183) (3,771) (3,266) (2,927) (2,593)
Unearned fees (1,534) (1,212) (1,105) (784) (864)
-------- -------- -------- -------- --------
Loans, net $430,602 $367,152 $305,964 $284,052 $292,163
======== ======== ======== ======== ========
33
IMPAIRED LOAN BALANCE, NONACCRUAL LOANS AND LOANS GREATER THAN 90 DAYS STILL
ACCRUING
The following table sets forth certain information regarding nonaccrual
loans, including the ratio of such loans to total assets as of the dates
indicated, and certain other related information. The Bank had no foreclosed
real estate during these periods and loans past due more than 90 days still
accruing were $314,000 and $0 at December 31, 2007 and 2006, respectively.
DECEMBER 31,
---------------------------------------------------
2007 2006 2005 2004 2003
---- ---- ---- ---- ----
(Dollars in Thousands)
Nonaccrual loans:
Commercial and $ -- $ -- $ -- $ -- $ --
professional loans
Consumer -- -- 3 1 --
Secured by real estate 153 201 253 342 109
------- ------- ------- ------- -------
Total nonaccrual loans 153 201 256 343 109
------- ------- ------- ------- -------
Accruing loans delinquent
90 days or more 314 -- 74 50 --
------- ------- ------- ------- -------
Total nonperforming loans $ 467 $ 201 $ 330 $ 393 $ 109
======= ======= ======= ======= =======
Total nonperforming loans
to total assets .04% .02% .03% .04% .01%
======= ======= ======= ======= =======
The following tables present information regarding the Company's total
allowance for loan losses as well as the allocation of such amounts to the
various categories of loans at the dates indicated (dollars in thousands):
DECEMBER 31, 2007
-----------------------------------
ALLOWANCE
FOR LOAN PERCENT OF PERCENT OF
LOSSES ALLOWANCE TOTAL LOANS
---------- ---------- -----------
Commercial and
professional loans $ 929 22.2% 17.4%
Secured by real estate
1 - 4 family 591 14.2 32.6
Multi family 43 1.0 0.8
Non-residential 2,597 62.1 48.8
Consumer and other 21 0.5 0.4
General allowance (1) 3 0.0 --
------- ----- -----
Total allowance
for loan losses $ 4,183 100.0% 100.0%
======= ===== ======
------------------------
(1)The allowance for loan losses is allocated to specific loans as necessary.
DECEMBER 31, 2006
-----------------------------------
ALLOWANCE
FOR LOAN PERCENT OF PERCENT OF
LOSSES ALLOWANCE TOTAL LOANS
---------- ---------- -----------
Commercial and
professional loans $ 852 22.6% 17.0%
Secured by real estate
1 - 4 family 634 16.8 37.5
Multi family 54 1.4 1.1
Non-residential 2,166 57.5 43.1
Consumer and other 64 1.7 1.3
General allowance (1) -- -- --
------- ----- -----
Total allowance
for loan losses $ 3,771 100.0% 100.0%
======= ===== =====
------------------------
(1)The allowance for loan losses is allocated to specific loans as necessary.
34
DECEMBER 31, 2005
-----------------------------------
ALLOWANCE
FOR LOAN PERCENT OF PERCENT OF
LOSSES ALLOWANCE TOTAL LOANS
---------- ---------- -----------
Commercial and
professional loans $ 450 13.8% 10.8%
Secured by real estate
1 - 4 family 937 28.7 45.1
Multi family 39 1.2 0.9
Non-residential 1,784 54.6 42.6
Consumer and other 27 0.8 0.6
General allowance (1) 29 0.9 --
------- ----- -----
Total allowance
for loan losses $ 3,266 100.0% 100.0%
======= ===== =====
------------------------
(1)The allowance for loan losses is allocated to specific loans as necessary.
DECEMBER 31, 2004
-----------------------------------
ALLOWANCE
FOR LOAN PERCENT OF PERCENT OF
LOSSES ALLOWANCE TOTAL LOANS
---------- ---------- -----------
Commercial and
professional loans $ 223 7.6% 5.7%
Secured by real estate
1 - 4 family 775 26.5 53.9
Multi family 62 2.1 1.6
Non-residential 1,398 47.8 38.1
Consumer and other 27 0.9 0.7
General allowance (1) 442 15.1 --
------- ----- -----
Total allowance
for loan losses $ 2,927 100.0% 100.0%
======= ===== =====
------------------------
(1)The allowance for loan losses is allocated to specific loans as necessary.
DECEMBER 31, 2003
-----------------------------------
ALLOWANCE
FOR LOAN PERCENT OF PERCENT OF
LOSSES ALLOWANCE TOTAL LOANS
---------- ---------- -----------
Commercial and
professional loans $ 300 11.6% 7.5%
Secured by real estate
1 - 4 family 424 16.3 57.4
Multi family 89 3.4 2.2
Non-residential 1,198 46.2 32.2
Consumer and other 30 1.2 0.7
General allowance (1) 552 21.3 --
------- ----- -----
Total allowance
for loan losses $ 2,593 100.0% 100.0%
======= ===== =====
------------------------
(1)The allowance for loan losses is allocated to specific loans as necessary.
35
The following table sets forth information regarding the aggregate
maturities of the Company's loans in the specified categories and the amount of
such loans which have fixed and variable rates.
DECEMBER 31, 2007
-----------------------------------------------
WITHIN 1 TO AFTER
1 YEAR 5 YEARS 5 YEARS TOTAL
-------- -------- -------- --------
(In thousands)
FIXED RATE
Commercial and professional $ 7,506 $ 26,662 $ 198 $ 34,366
Non-residential 24,516 21,597 23,871 69,984
-------- -------- -------- --------
Total fixed rate $ 32,022 $ 48,259 $ 24,069 $104,350
-------- -------- -------- --------
ADJUSTABLE RATE
Commercial and professional 23,346 14,989 3,431 41,766
Non-residential 30,098 46,359 68,100 144,557
-------- -------- -------- --------
Total adjustable rate $ 53,444 $ 61,348 $ 71,531 $186,323
-------- -------- -------- --------
Total $ 85,466 $109,607 $ 95,600 $290,673
======== ======== ======== ========
Demand loans, loans with no stated maturity, are included in the table
above in the Within One Year category.
The following table sets forth information with respect to activity in
the Company's allowance for loan losses during the periods indicated (in
thousands, except percentages):
YEARS ENDED DECEMBER 31,
--------------------------------------------------
2007 2006 2005 2004 2003
---- ---- ---- ---- ----
Average loans outstanding $389,520 $327,210 $287,178 $290,774 $291,586
======== ======== ======== ======== ========
Allowance at beginning
of period 3,771 3,266 2,927 2,593 2,315
Charge-offs:
Commercial and other
loans -- 42 26 24 4
Real estate loans -- -- -- -- 13
-------- -------- -------- -------- --------
Total loans charged-off -- 42 26 24 17
-------- -------- -------- -------- --------
Recoveries:
Commercial and other
loans 57 137 185 178 55
Real estate loans -- -- -- -- --
-------- -------- -------- -------- --------
Total loans recovered 57 137 185 178 55
-------- -------- -------- -------- --------
Net recoveries
(charge-offs) 57 95 159 154 38
-------- -------- -------- -------- --------
Provision for loan losses
charged to operating
expenses 355 410 180 180 240
-------- -------- -------- -------- --------
Allowance at end of period $ 4,183 $ 3,771 $ 3,266 $ 2,927 $ 2,593
-------- -------- -------- -------- --------
Ratio of net recoveries
(charge-offs) to average
loans outstanding .01% .03% .06% .05% .01%
======== ======== ======== ======== ========
Allowance as a percent
of total loans 0.96% 1.01% 1.05% 1.02% 0.88%
======== ======== ======== ======== ========
Total loans at end
of period $436,319 $372,135 $310,335 $287,763 $295,620
======== ======== ======== ======== ========
36
DEPOSITS
The Bank concentrates on obtaining deposits from a variety of
businesses, professionals and retail customers. The Bank offers a number of
different deposit programs, including statement savings accounts, NOW accounts,
money market deposits accounts, checking accounts and certificates of deposits
with terms from seven days to five years. Deposit account terms vary according
to the minimum balance required, the time period the funds must remain on
deposit and the interest rate, among other factors. The Bank prices its deposit
offerings competitively within the market it serves. These products are designed
to attract new customers, retain existing customers and create opportunities to
offer other bank products or services. While the market and pricing for deposit
funds are very competitive, the Bank believes that personalized, quality service
is also an important element in retaining core deposit customers.
The following table summarizes the composition of the average balances
of major deposit categories:
DECEMBER 31,
---------------------------------------------------------
2007 2006 2005
---- ---- ----
AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
------ ----- ------ ----- ------ -----
(Dollars in thousands)
Demand deposits $ 50,647 -- $ 47,890 -- $ 44,739 --
NOW and money market 29,984 0.76% 35,141 0.61% 42,756 0.56%
Savings deposits 261,065 3.83 171,604 2.95 221,374 1.99
Time deposits 449,754 4.83 410,729 4.21 338,834 2.82
-------- ---- -------- ---- -------- ----
Total deposits $791,450 4.04% $665,364 3.39% $647,703 2.19%
======== ==== ======== ==== ======== ====
The aggregate amount of jumbo certificates of deposit, each with a
minimum denomination of $100,000, was approximately $247.43 million at December
31, 2007.
The following table summarizes the maturity distribution of time
deposits of $100,000 or more as of December 31, 2007:
(In thousands)
3 months or less $167,994
Over 3 months but within 6 months 61,347
Over 6 months but within 12 months 17,975
Over 12 months 112
--------
Total $247,428
========
37
SHORT-TERM BORROWINGS
Securities sold under agreements to repurchase generally mature within
30 days from the date of the transactions. Short-term borrowings consist of
securities sold under agreements to repurchase and various other borrowings
which generally have maturities of less than one year. The details of these
categories are presented below:
YEARS ENDED DECEMBER 31,
-----------------------------------
2007 2006 2005
---------- ---------- ----------
(Dollars in thousands)
Securities sold under repurchase
agreements and federal funds purchased
Balance at year-end $ 76,842 $ 62,652 $ 73,044
Average during the year $ 40,049 $ 56,236 $108,785
Maximum month-end balance $ 76,842 $ 79,154 $145,489
Weighted average rate during the year 4.93% 3.75% 3.47%
Rate at December 31 4.65% 4.94% 3.59%
CAPITAL RESOURCES AND LIQUIDITY
LIQUIDITY
The management of the Company's liquidity focuses on ensuring that
sufficient funds are available to meet loan funding commitments, withdrawals
from deposit accounts, the repayment of borrowed funds, and ensuring that the
Bank and the Company comply with regulatory liquidity requirements. Liquidity
needs of the Bank have historically been met by deposits, investments in federal
funds sold, principal and interest payments on loans, and maturities of
investment securities.
At December 31, 2007, our portfolio of investment securities included
approximately $185 million of auction rate securities. These investments have
high credit quality ratings of AA or AAA and are fully collateralized by bonds
and other financial instruments. Auction rate securities are generally long-term
debt instruments that provide liquidity through a Dutch auction process that
resets the applicable interest rate at pre-determined calendar intervals,
generally every 28 days.
Recent uncertainties in the credit markets have negatively impacted
our ability to liquidate, if necessary, investments in auction rate securities
because, in recent auctions, the amount of securities submitted for sale has
exceeded the amount of purchase orders. We are not certain as to when the
liquidity issues relating to these available for sale investments will improve;
however, we have the ability to hold these available for sale securities to
maturity, (predominately 20 years after December 31, 2007) thereby recovering
our investment. As a result of the recent auction failures beginning in February
2008, the fair value of these securities, while maintaining their investment
grade rating and interest payments, could be negatively impacted at a later
time. Were this to occur, we may be required to reflect a write-down of certain
of our auction rate securities in future periods as a charge to earnings if any
of our auction rate securities are deemed to be other-than-temporarily impaired.
Such impairment charge would be recorded as other expense and could be material
to our results of operations.
Based on our expected operating cash flows, and our other sources of
cash, we do not expect the potential lack of liquidity in these investments to
affect our capital, liquidity or our ability to execute our current business
plan.
38
For the parent company, Berkshire Bancorp Inc., liquidity means having
cash available to fund operating expenses and to pay stockholder dividends, when
and if declared by the Company's Board of Directors. The Company paid cash
dividends per share of $.18, $.16 and $.15 in fiscal 2007, 2006 and 2005,
respectively. The ability to fund the Company's operations and to pay dividends
is not dependent upon the receipt of dividends from the Bank. At December 31,
2007, the Company had cash of approximately $12.5 million and investment
securities with a fair market value of $12.3 million.
CONTINGENT LIABILITIES AND COMMITMENTS
The Bank maintains financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments include commitments to extend credit and stand-by
letters of credit. The following table presents the Company's commitments at
December 31, 2007.
EXPIRATION BY PERIOD
------------------------------------------------------------------------------
LESS MORE
THAN 1-3 3-5 THAN
TOTAL 1 YEAR YEARS YEARS 5 YEARS
----- ------ ----- ----- -------
(In thousands)
Lines of Credit $ 18,635 $ 8,342 $ 1,379 $ 5,134 $ 3,780
Standby Letters
of Credit 5,374 5,374 -- -- --
Loan Commitments 28,645 13,162 15,483 -- --
-------- -------- -------- ------- -------
Total $ 52,654 $ 26,878 $ 16,862 $ 5,134 $ 3,780
======== ======== ======== ======= =======
CONTRACTUAL OBLIGATIONS
The following table presents the Company's contractual obligations at
December 31, 2007.
PAYMENTS DUE BY PERIODS
------------------------------------------------------------------------------
LESS MORE
THAN 1-3 3-5 THAN
TOTAL 1 YEAR YEARS YEARS 5 YEARS
----- ------ ----- ----- -------
(In thousands)
Long-Term Debt $ 54,288 $ 5,264 $ 22,416 $ 3,927 $ 22,681
Operating Leases 3,019 716 1,121 594 588
Time Deposits 477,502 477,127 375 -- --
-------- -------- -------- ------- --------
Total Contractual
Obligations $534,809 $483,107 $ 23,912 $ 4,521 $ 23,269
======== ======== ======== ======= ========
The Company currently has two unconsolidated subsidiaries and no
special purpose entities.
39
CAPITAL
The capital ratios of the Bank and the Company are presently in excess
of the requirements necessary to meet the "well capitalized" capital category
established by bank regulators. See Note P to the Consolidated Financial
Statements.
INTEREST RATE RISK
Fluctuations in market interest rates can have a material effect on the
Bank's net interest income because the yields earned on loans and investments
may not adjust to market rates of interest with the same frequency, or with the
same speed, as the rates paid by the Bank on its deposits.
Most of the Bank's deposits are either interest-bearing demand deposits
or short term certificates of deposit and other interest-bearing deposits with
interest rates that fluctuate as market rates change. Management of the Bank
seeks to reduce the risk of interest rate fluctuations by concentrating on loans
and securities investments with either short terms to maturity or with
adjustable rates or other features that cause yields to adjust based upon
interest rate fluctuations. In addition, to cushion itself against the potential
adverse effects of a substantial and sustained increase in market interest
rates, the Bank has from time to time purchased off balance sheet interest rate
cap contracts which generally provide that the Bank will be entitled to receive
payments from the other party to the contract if interest rates exceed specified
levels. These contracts, when written, are entered into with major financial
institutions.
The Company seeks to maximize its net interest margin within an
acceptable level of interest rate risk. Interest rate risk can be defined as the
amount of the forecasted net interest income that may be gained or lost due to
favorable or unfavorable movements in interest rates. Interest rate risk, or
sensitivity, arises when the maturity or repricing characteristics of assets
differ significantly from the maturity or repricing characteristics of
liabilities.
40
In the banking industry, a traditional measure of interest rate sensitivity is
known as "gap" analysis, which measures the cumulative differences between the
amounts of assets and liabilities maturing or repricing at various time
intervals. The following table sets forth the Company's interest rate repricing
gaps for selected maturity periods:
BERKSHIRE BANCORP INC.
INTEREST RATE SENSITIVITY GAP AT DECEMBER 31, 2007
(IN THOUSANDS, EXCEPT FOR PERCENTAGES)
--------------------------------------------------------------------------------
3 MONTHS 3 THROUGH 1 THROUGH OVER
OR LESS 12 MONTHS 3 YEARS 3 YEARS TOTAL FAIR VALUE
--------- --------- --------- --------- ---------- ----------
Federal funds sold 31,000 31,000 31,000
(Rate) 4.03%
Interest bearing deposits in banks 7,579 -- -- -- 7,579 7,579
(Rate) 3.49% 3.49%
Loans (1)(2)
Adjustable rate loans 124,428 15,354 25,835 42,391 208,008 209,798
(Rate) 8.10% 7.11% 6.66% 7.33% 7.69%
Fixed rate loans 7,500 25,044 44,311 151,456 228,311 231,591
(Rate) 11.00% 7.66% 7.92% 6.35% 6.95%
--------- --------- --------- --------- ----------
Total loans 131,928 40,398 70,146 193,847 436,319 441,569
Investments (3)(4) 267,476 65,223 141,605 129,181 603,485 599,366
(Rate) 5.81% 4.58% 4.26% 5.46% 5.24%
--------- --------- --------- --------- ----------
Total rate-sensitive assets 437,983 105,621 211,751 323,028 1,078,383
--------- --------- --------- --------- ----------
Deposit accounts (5)
Savings and NOW 288,323 -- -- -- 288,323 288,323
(Rate) 3.64% 3.64%
Money market 33,584 -- -- -- 33,584 33,584
(Rate) 2.98% 2.98%
Time Deposits 319,567 157,560 375 -- 477,502 477,802
(Rate) 4.69% 4.67% 3.48% % 4.68%
--------- --------- --------- --------- ----------
Total deposit accounts 641,474 157,560 375 799,409
Repurchase Agreements 64,842 -- -- 12,000 76,842 77,267
(Rate) 4.53% 4.91% 4.59%
Other borrowings 1,788 3,476 22,416 26,608 54,288 55,160
(Rate) 3.45% 3.21% 5.42% 7.18% 6.08%
--------- --------- --------- --------- ----------
Total rate-sensitive liabilities 708,104 161,036 22,791 38,608 930,539
--------- --------- --------- --------- ----------
Gap (repricing differences) (270,121) ( 55,415) 188,960 284,420 147,844
========= ========= ========= ========= ==========
Cumulative Gap (270,121) (325,536) (136,576) 147,844
========= ========= ========= =========
Cumulative Gap to Total Rate Sensitive
Assets (25.05)% (30.19)% (12.66)% 13.71%
========= ========= ========= =========
---------------------------------------
(1) Adjustable-rate loans are included in the period in which the interest
rates are next scheduled to adjust rather than in the period in which
the loans mature. Fixed-rate loans are scheduled according to their
maturity dates.
(2) Includes nonaccrual loans.
(3) Investments are scheduled according to their respective repricing
(variable rate investments) and maturity (fixed rate securities) dates.
(4) Investments are stated at book value.
(5) NOW accounts and savings accounts are regarded as readily accessible
withdrawal accounts. The balances in such accounts have been allocated
among maturity/repricing periods based upon The Berkshire Bank's
historical experience. All other time accounts are scheduled according
to their respective maturity dates.
41
IMPACT OF INFLATION AND CHANGING PRICES
The Company's financial statements measure financial position and
operating results in terms of historical dollars without considering the changes
in the relative purchasing power of money over time due to inflation. The impact
of inflation is reflected in the increasing cost of the Company's operations.
The assets and liabilities of the Company are largely monetary. As a result,
interest rates have a greater impact on the Company's performance than do the
effects of general levels of inflation. In addition, interest rates do not
necessarily move in the direction, or to the same extent as the price of goods
and services. However, in general, high inflation rates are accompanied by
higher interest rates, and vice versa.
NEW ACCOUNTING PRONOUNCEMENTS
ACCOUNTING FOR FAIR VALUE MEASUREMENT
In September 2006, the Financial Accounting Standards Board (the
"FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 157,
"Fair Value Measurements." The Statement is effective for all financial
statements issued for fiscal years beginning after November 15, 2007, or January
1, 2008 as to the Company. The Statement defines fair value as the price that
would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date, establishes a
framework for measuring fair value, and expands disclosures about fair value
measurements. Adoption of SFAS No. 157 is not expected to have a material impact
on the Company's results of operations or financial condition.
ACCOUNTING FOR DEFINED BENEFIT PENSION AND OTHER POSTRETIREMENT PLANS
In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting
for Defined Benefit Pension and Other Postretirement Plans." The Statement
requires an employer that is a business entity and sponsors one or more
single-employer defined benefit plans to: (1) recognize the funded status of a
benefit plan - measured as the difference between plan assets at fair value and
the benefit obligation - in its statement of financial position, with the
corresponding credit or charge, net of taxes, upon initial adoption to Other
Comprehensive Income; (2) recognize as a component of other comprehensive
income, net of tax, the gains or losses and prior service costs or credits that
arise during the period but are not recognized as components of net periodic
benefit cost pursuant to SFAS No. 87, "Employers' Accounting for Pensions", or
SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than
Pensions"; (3) measure defined benefit plan assets and obligations as of the
date of the employer's fiscal year end; and (4) expand disclosures in the notes
to the financial statements about certain effects on net periodic benefit cost.
The Statement also amends SFAS No. 132 (revised 2003), "Employers' Disclosures
about Pensions and Other Postretirement Benefits", and SFAS No. 88, "Employers'
Accounting for Settlements and Curtailments of Defined Benefit Pension Plans for
Termination Benefits". An employer who has publicly traded equity securities,
such as the Company, is required to initially recognize the funded status of a
defined benefit postretirement plan and to provide the required disclosures as
of the end of its first fiscal year ending after December 15, 2006. For the
Company, this was for the year ended December 31, 2006, and the adoption of
which had no significant effect on Other Comprehensive Income and stockholders'
equity.
The requirement to measure plan assets and benefit obligations as of
the date of the employer's fiscal year end is effective for fiscal years ending
after December 15, 2008, the fiscal year ending December 31, 2008 as to the
Company. Based upon the advice of our consultants, management believes that the
adoption of this statement will have no significant effect on Other
Comprehensive Income and stockholders' equity.
ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES
On July 13, 2006, the FASB issued FASB Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes" ("FIN 48"): an interpretation of
FASB No. 109. FIN 48 clarifies the accounting for uncertainty involved in the
recognition and measurement of a tax position taken or expected to be taken in a
tax return. FIN 48 also provides guidance on derecognition, measurement,
classification, interest
42
and penalties, accounting in interim periods, disclosure, and transition. FIN 48
is effective for fiscal years beginning after December 15, 2006, or January 1,
2007 as to the Company. We adopted FIN 48 on January 1, 2007 which resulted in a
decrease in our tax liability accounts of approximately $965,000 and a
corresponding increase to stockholders' equity as of January 1, 2007.
ACCOUNTING FOR BUSINESS COMBINATIONS
In December 2007, the FASB issued SFAS 141(R), "Accounting for Business
Combinations." This Statement replaces FASB Statement No. 141, "Business
Combinations" and is effective as of the beginning of the fiscal year beginning
on or after December 15, 2008, or January 1, 2009 as to the Company. SFAS 141(R)
establishes principles and requirements for how the acquirer of a business (i)
recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree, (ii) recognizes and measures the goodwill acquired in the business
combination or a gain from a bargain purchase, and (iii) determines the
information to disclose in its financial statements with respect to the nature
and financial effects of the business combination. The adoption of SFAS 141(R)
is not expected to have a material impact on the Company's results of operations
or financial condition.
ACCOUNTING FOR NONCONTROLLING INTERESTS IN CONSOLIDATED FINANCIAL STATEMENTS
In December 2007, the FASB issued SFAS 160, "Accounting For
Noncontrolling Interests In Consolidated Financial Statements." This Statement
amends Accounting Research Bulletin No. 51, "Consolidated Financial Statements"
and is effective as of the beginning of the fiscal year beginning on or after
December 15, 2008, or January 1, 2009 as to the Company. SFAS 160 is designed to
improve the information that a reporting entity provides in its financial
statements with respect to (i) the ownership interests in subsidiaries held by
parties other than the parent, (ii) the amount of consolidated net income
attributable to the parent and to the noncontrolling interest, (iii) changes in
the parent's ownership interest, (iv) the deconsolidation of a subsidiary, and
(v) disclosures identifying and distinguishing between the interests of the
parent and the interests of the noncontrolling owners. The adoption of SFAS 160
is not expected to have a material impact on the Company's results of operations
or financial condition.
FAIR VALUE OPTION FOR FINANCIAL ASSETS AND LIABILITIES
In February 2007, the FASB issued Statement 159, "The Fair Value Option
for Financial Assets and Financial Liabilities" ("SFAS No. 159"). The objective
of SFAS No. 159 is to provide companies with the option to recognize most
financial assets and liabilities and certain other items at fair value.
Statement 159 will allow companies the opportunity to mitigate earnings
volatility caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting. Unrealized gains and losses on
items for which the fair value option has been elected should be reported in
earnings. The fair value option election is applied on an instrument by
instrument basis (with some exceptions), is irrevocable, and is applied to an
entire instrument. The election may be made as of the date of initial adoption
for existing eligible items. Subsequent to initial adoption, the Company may
elect the fair value option at initial recognition of eligible items or on
entering into an eligible firm commitment. The Company can only elect the fair
value option after initial recognition in limited circumstances.
SFAS No. 159 requires similar assets and liabilities for which the
Company has elected the fair value option to be displayed on the face of the
balance sheet either (a) together with financial instruments measured using
other measurement attributes with parenthetical disclosure of the amount
measured at fair value or (b) in separate line items. In addition, SFAS No. 159
requires additional disclosures to allow financial statement users to compare
similar assets and liabilities measured differently either within the financial
statements of the Company or between financial statements of different
companies.
SFAS No. 159 is required to be adopted by the Company on January 1,
2008. Early adoption is permitted; however, the Company did not adopt SFAS No.
159 prior to the required adoption date of January 1, 2008. The Company is
required
43
to adopt SFAS No. 159 concurrent with SFAS No. 157, "Fair Value Measurements."
The remeasurement to fair-value will be reported as a cumulative-effect
adjustment in the opening balance of retained earnings. Additionally, any
changes in fair value due to the concurrent adoption of SFAS No. 157 will be
included in the cumulative-effect adjustment if the fair value option is also
elected for that item.
The Company is currently evaluating, which, if any, items it will elect
to recognize at fair value at the date of adoption. The financial statement
impact will depend on which items the Company elects to recognize at fair value,
fair value at the date of adoption, and the concurrent adoption of SFAS No. 157.
If the Company elects to recognize items at fair value as a result of Statement
159, this could result in increased earnings volatility.
INTERNAL CONTROL OVER FINANCIAL REPORTING
The current objective of the Company's Internal Control Program is to
allow the Bank and management to comply with Part 363 of the FDIC's regulations
("FDICIA") and to allow the Company to comply with Section 302 of the
Sarbanes-Oxley Act of 2002 (the "Act"). In November 2005, the FDIC amended Part
363 of its regulations by raising the asset-size threshold from $500 million to
$1 billion for internal control assessments by management and external auditors.
The final rule was effective December 28, 2005.
Section 302 of the Act requires the CEOs and CFOs of the Company to
(i) certify that the annual and quarterly reports filed with the Securities and
Exchange Commission are accurate and (ii) acknowledge that they are responsible
for establishing, maintaining and periodically evaluating the effectiveness of
the disclosure controls and procedures. Section 404 of the Act requires
management to (i) report on internal control over financial reporting, (ii)
assess the effectiveness of such internal controls, and (iii) obtain an external
auditor's report on management's assessment of its internal control. The Company
is not an accelerated filer as defined in Rule 12b-2 of the Securities Exchange
Act of 1934. Therefore, the Company was not required to comply with Section 404
until the current year ended December 31, 2007.
The Committee of Sponsoring Organizations (COSO) methodology may be
used to document and test the internal controls pertaining to the accuracy of
Company issued financial statements and related disclosures. COSO requires a
review of the control environment (including anti-fraud and audit committee
effectiveness), risk assessment, control activities, information and
communication, and ongoing monitoring.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
44
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
of Berkshire Bancorp Inc.
We have audited the accompanying consolidated balance sheets of Berkshire
Bancorp Inc. and subsidiaries (the "Company") as of December 31, 2007 and 2006,
and the related consolidated statements of income, stockholders' equity and cash
flows for each of the three years in the period ended December 31, 2007. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audits included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Berkshire Bancorp
Inc. and subsidiaries as of December 31, 2007 and 2006, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years in the period ended December 31, 2007, in conformity with accounting
principles generally accepted in the United States of America.
/s/ GRANT THORNTON LLP
New York, New York
March 31, 2008
45
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS)
DECEMBER 31, DECEMBER 31,
2007 2006
----------- -----------
ASSETS
Cash and due from banks $ 8,614 $ 8,061
Interest bearing deposits 7,579 4,950
Federal funds sold 31,000 11,300
----------- -----------
Total cash and cash equivalents 47,193 24,311
Investment Securities:
Available-for-sale 598,961 514,798
Held-to-maturity, fair value of $405
in 2007 and $436 in 2006 395 433
----------- -----------
Total investment securities 599,356 515,231
Loans, net of unearned income 434,785 370,923
Less: allowance for loan losses (4,183) (3,771)
----------- -----------
Net loans 430,602 367,152
Accrued interest receivable 8,602 6,397
Premises and equipment, net 9,362 9,338
Goodwill, net 18,549 18,549
Other assets 6,854 7,678
----------- -----------
Total assets $ 1,120,518 $ 948,656
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 53,805 $ 49,418
Interest bearing 799,410 632,071
----------- -----------
Total deposits 853,215 681,489
Securities sold under agreements to repurchase 76,842 62,652
Long term borrowings 31,607 52,738
Subordinated debt 22,681 22,681
Accrued interest payable 9,089 8,110
Other liabilities 2,826 5,209
----------- -----------
Total liabilities 996,260 832,879
----------- -----------
Stockholders' equity
Preferred stock - $.10 Par value: -- --
2,000,000 shares authorized - none issued
Common stock - $.10 par value
Authorized -- 10,000,000 shares
Issued -- 7,698,285 shares
Outstanding --
December 31, 2007, 7,054,183 shares
December 31, 2006, 6,877,881 shares 770 770
Additional paid-in capital 90,986 90,659
Retained earnings 42,352 37,285
Accumulated other comprehensive loss, net (3,439) (4,772)
Treasury Stock at cost
December 31, 2007, 644,102 shares
December 31, 2006, 820,404 shares (6,411) (8,165)
----------- -----------
Total stockholders' equity 124,258 115,777
----------- -----------
Total liabilities and stockholders' equity $ 1,120,518 $ 948,656
=========== ===========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS
46
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------------
2007 2006 2005
-------- -------- --------
INTEREST INCOME
Federal funds sold and interest bearing deposits $ 1,553 $ 350 $ 302
Investment securities 27,178 24,027 25,355
Loans, including related fees 29,804 23,844 19,399
-------- -------- --------
Total interest income 58,535 48,221 45,056
-------- -------- --------
INTEREST EXPENSE
Deposits 32,083 22,559 14,191
Short-term borrowings 1,976 2,110 3,167
Long-term borrowings 3,734 4,517 5,041
-------- -------- --------
Total interest expense 37,793 29,186 22,399
-------- -------- --------
Net interest income 20,742 19,035 22,657
PROVISION FOR LOAN LOSSES 355 410 180
-------- -------- --------
Net interest income after
provision for loan losses 20,387 18,625 22,477
-------- -------- --------
NON-INTEREST INCOME
Service charges on deposit accounts 658 588 589
Investment securities gains 86 2,336 4
Other income 915 769 613
-------- -------- --------
Total non-interest income 1,659 3,693 1,206
-------- -------- --------
NON-INTEREST EXPENSE
Salaries and employee benefits 8,971 8,481 8,002
Net occupancy expense 2,050 1,961 1,728
Equipment expense 80 108 397
FDIC assessment 86 85 272
Data processing expense 417 366 198
Other 2,714 2,581 2,542
-------- -------- --------
Total non-interest expense 14,318 13,582 13,139
-------- -------- --------
Income before provision for income taxes 7,728 8,736 10,544
Provision for income taxes 2,374 3,856 5,003
-------- -------- --------
Net income $ 5,354 $ 4,880 $ 5,541
======== ======== ========
Net income per share:
Basic $ .77 $ .71 $ .81
======== ======== ========
Diluted $ .76 $ .70 $ .80
======== ======== ========
Number of shares used to compute
net income per share:
Basic 6,987 6,891 6,805
======== ======== ========
Diluted 7,005 6,976 6,939
======== ======== ========
Dividends per share $ .18 $ .16 $ .15
======== ======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS
47
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2007, 2006 AND 2005
(IN THOUSANDS)
ACCUMULATED
STOCK ADDITIONAL OTHER TOTAL
COMMON PAR PAID-IN COMPREHENSIVE RETAINED TREASURY COMPREHENSIVE STOCKHOLDERS'
SHARES VALUE CAPITAL (LOSS) NET EARNINGS STOCK INCOME EQUITY
------ ----- ------- ------------- -------- ----- ------ -------------
BALANCE AT JANUARY 1, 2005 7,698 $770 $89,543 $(2,602) $28,983 $ (9,075) $107,619
Net income 5,541 5,541 5,541
Exercise of stock options 354 1,332 1,686
Tax benefit from exercise
of stock options 697 697
Other comprehensive (loss) net
of reclassification adjustment
and taxes (5,813) (5,813) (5,813)
-------
Comprehensive loss $ (272)
=======
Cash dividends (1,020) (1,020)
------ ---- ------- ------- -------- -------- --------
BALANCE AT DECEMBER 31, 2005 7,698 770 90,594 (8,415) 33,504 (7,743) 108,710
Net income 4,880 4,880 4,880
Acquisition of treasury shares (790) (790)
Exercise of stock options (19) 368 349
Tax benefit from exercise 84 84
of stock options
Other comprehensive income net
of reclassification adjustment
and taxes 3,643 3,643 3,643
-------
Comprehensive income $ 8,523
=======
Cash dividends (1,099) (1,099)
------ ---- ------- ------- -------- -------- --------
BALANCE AT DECEMBER 31, 2006 7,698 770 90,659 (4,772) 37,285 (8,165) 115,777
Adoption of FIN 48 965 965
-------- --------
Adjusted balance at January 1, 2007 38,250 116,742
Net income 5,354 5,354 5,354
Exercise of stock options (32) 1,754 1,722
Tax benefit from exercise
of stock options 359 359
Other comprehensive income net
of reclassification adjustment
and taxes 1,333 1,333 1,333
-------
Comprehensive income $ 6,687
=======
Cash dividends (1,252) (1,252)
------ ---- ------- ------- -------- -------- --------
BALANCE AT DECEMBER 31, 2007 7,698 $770 $90,986 $(3,439) $ 42,352 $ (6,411) $124,258
====== ==== ======= ======= ======== ======== ========
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS
48
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------
2007 2006 2005
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 5,354 $ 4,880 $ 5,541
Adjustments to reconcile net income
to net cash provided by operating
activities:
Realized gains on investment securities (86) (2,336) (4)
Net (accretion) amortization of premiums
of investment securities (1,339) (595) (3)
Depreciation and amortization 739 727 650
Provision for loan losses 355 410 180
CHANGES IN ASSETS AND LIABILITIES:
(Increase) decrease in accrued (2,205) 387 (770)
interest receivable
Decrease (increase) in other assets 1,184 2,021 (3,317)
(Decrease) increase in accrued interest
payable and other liabilities (439) 3,763 3,230
----------- ----------- -----------
Net cash provided by operating activities 3,563 9,257 5,507
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment securities available for sale
Purchases (1,439,103) (489,737) (378,781)
Sales, maturities and calls 1,357,643 580,923 404,533
Investment securities held to maturity
Purchases -- -- --
Maturities 93 129 62
Net (increase) in loans (63,806) (61,598) (22,092)
Acquisition of premises and equipment (763) (1,463) (575)
----------- ----------- -----------
Net cash (used in) provided by
investing activities (145,936) 28,254 3,147
----------- ----------- -----------
49
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------------
2007 2006 2005
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in non interest
bearing deposits 4,387 (851) 8,078
Net increase in interest bearing deposits 167,339 2,080 52,294
Increase (decrease) in securities sold
under agreements to repurchase 14,190 (10,392) (54,703)
Proceeds from long term debt 19,000 2,000 20,000
Repayment of long term debt (40,131) (32,463) (32,404)
Proceeds from issuance of
subordinated debentures, net -- -- 7,217
Acquisition of treasury stock -- (790) --
Proceeds from exercise of common
stock options 1,363 349 1,686
Tax benefits from exercise of 359 84 697
common stock options
Dividends paid (1,252) (1,099) (1,020)
----------- ----------- -----------
Net cash provided by (used in)
financing activities 165,255 (41,082) 1,845
----------- ----------- -----------
Net increase (decrease) in cash and
cash equivalents 22,882 (3,571) 10,499
Cash and cash equivalents at
beginning of year $ 24,311 $ 27,882 $ 17,383
----------- ----------- -----------
Cash and cash equivalents at
end of year $ 47,193 $ 24,311 $ 27,882
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash used to pay interest $ 36,814 $ 26,807 $ 19,184
Cash used to pay income taxes,
net of refunds $ 3,575 $ 4,163 $ 6,716
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE STATEMENTS
50
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2007 AND 2006
NOTE A - ORGANIZATION AND CAPITALIZATION
ORGANIZATION
Berkshire Bancorp Inc. ("Berkshire" or the "Company" or "we" and
similar pronouns), a Delaware corporation, is a bank holding company registered
under the Bank Holding Company Act of 1956. Berkshire's principal activity is
the ownership and management of its indirect wholly-owned subsidiary, The
Berkshire Bank (the "Bank"), a New York State chartered commercial bank. The
Bank is owned through Berkshire's wholly-owned subsidiary Greater American
Finance Group, Inc. ("GAFG").
The Bank was established in 1989 to provide highly personalized
services to high net worth individuals and to small and mid-sized commercial
businesses primarily from the New York City metropolitan area. In March 2001,
the Company expanded its customer base and market area with the acquisition of
GSB Financial Corporation. The Bank's main office and branch is in mid-town
Manhattan. The Bank has one other branch in lower Manhattan, four branches in
Brooklyn, New York, four branches in Orange and Sullivan Counties in New York
State, and one branch in Ridgefield, New Jersey.
The Bank competes with other banking and financial institutions in its
markets. Commercial banks, savings banks, savings and loan associations,
mortgage bankers and brokers, and credit unions actively compete for deposits
and loans. Such institutions, as well as consumer finance, mutual funds,
insurance companies, and brokerage and investment banking firms may be
considered to be competitors of the Bank with respect to one or more of the
services provided by the Bank.
The Company and the Bank are subject to the regulations of certain
state and federal agencies and, accordingly, are periodically examined by those
regulatory authorities. As a consequence of such regulation of banking
activities, the Bank's business may be affected by state and federal
legislation.
TRUST PREFERRED SECURITIES
As of May 18 2004, the Company established Berkshire Capital Trust I, a
Delaware statutory trust, ("BCTI"). The Company owns all the common capital
securities of BCTI. BCTI issued $15.0 million of preferred capital securities to
investors in a private transaction and invested the proceeds, combined with the
proceeds from the sale of BCTI's common capital securities, in the Company
through the purchase of $15.464 million aggregate principal amount of Floating
Rate Junior Subordinated Debentures (the "2004 Debentures") issued by the
Company. The 2004 Debentures, the sole assets of BCTI, mature on July 23, 2034
and bear interest at a floating rate, three month LIBOR plus 2.70%, currently
7.85%.
On April 1, 2005, the Company established Berkshire Capital Trust II, a
Delaware statutory trust, ("BCTII"). The Company owns all the common capital
securities of BCTII. BCTII issued $7.0 million of preferred capital securities
to investors in a private transaction and invested the proceeds, combined with
the proceeds from the sale of BCTII's common capital securities, in the Company
through the purchase of $7.217 million aggregate principal amount of Floating
Rate Junior Subordinated Debentures (the "2005 Debentures") issued by the
Company. The 2005 Debentures, the sole assets of BCTII, mature on May 23, 2035
and bear interest at a floating rate, three month LIBOR plus 1.95%, currently
6.97%.
51
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE A - (CONTINUED)
Based on current interpretations of the banking regulators, the 2004
Debentures and 2005 Debentures (collectively, the "Debentures") qualify under
the risk-based capital guidelines of the Federal Reserve as Tier 1 capital,
subject to certain limitations. The Debentures are callable by the Company,
subject to any required regulatory approvals, at par, in whole or in part, at
any time after five years from the date of issuance. The Company's obligations
under the Debentures and related documents, taken together, constitute a full,
irrevocable and unconditional guarantee on a subordinated basis by the Company
of the obligations of BCTI and BCTII under the preferred capital securities sold
by BCTI and BCTII to investors. FIN46(R) precludes consideration of the call
option embedded in the preferred capital securities when determining if the
Company has the right to a majority of BCTI and BCTII expected residual returns.
Accordingly, BCTI and BCTII are not included in the consolidated balance sheet
of the Company.
The Federal Reserve has issued guidance on the regulatory capital
treatment for the trust-preferred securities issued by BCTI and BCTII. This rule
would retain the current maximum percentage of total capital permitted for Trust
Preferred Securities at 25%, but would enact other changes to the rules
governing Trust Preferred Securities that affect their use as part of the
collection of entities known as "restricted core capital elements." The rule
would take effect March 31, 2009; however, a five year transition period
starting March 31, 2004 and leading up to that date would allow bank holding
companies to continue to count Trust Preferred Securities as Tier 1 Capital
after applying FIN-46(R). Management has evaluated the effects of this rule and
does not anticipate a material impact on its capital ratios when the proposed
rule is finalized.
NOTE B - SUMMARY OF ACCOUNTING POLICIES
1. BASIS OF FINANCIAL STATEMENT PRESENTATION
The consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America
and predominant practice within the banking industry, and include the accounts
of Berkshire Bancorp Inc. and its wholly owned subsidiaries, Greater American
Finance Group, Inc. ("GAFG"), and GAFG's wholly owned subsidiary, the Bank, and
East 39, LLC, (collectively, the "Company"). All significant intercompany
accounts and transactions have been eliminated.
In preparing the financial statements in conformity with accounting
principles generally accepted in the United States of America, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities, the disclosure of contingent assets and liabilities at
the date of the balance sheets, and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The principal estimates that are susceptible to significant change in
the near term relate to the allowance for loan losses, goodwill, and deferred
tax assets and liabilities. The evaluation of the adequacy of the allowance for
loan losses includes an analysis of the individual loans and overall risk
characteristics and size of the different loan portfolios, and takes into
consideration current economic and market conditions, the capability of specific
borrowers to pay specific loan obligations, as well as current loan collateral
values. However, actual losses on specific loans, which also are encompassed in
the analysis, may vary from estimated losses.
Substantially all outstanding goodwill resulted from the acquisition of
The Berkshire Bank and Goshen Savings Bank, depository institutions
concentrating in the New York City and Orange and Sullivan County communities,
respectively. As the result of the market penetration in these New York areas,
the Company had formulated its own strategy to create such a market role.
Accordingly, implicit in the purchase of these franchises was the acquisition of
that role. However, if such benefits, including new business, are not derived or
the Company changes its business plan, an impairment may be recognized.
52
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B - (CONTINUED)
The Company recognizes deferred tax assets and liabilities for the
future tax effects of temporary differences, net operating loss carryforwards
and tax credits. Deferred tax assets are subject to management's judgment based
upon available evidence that future realization is more likely than not. If
management determines that the Company may be unable to realize all or part of
net deferred tax assets in the future, a direct charge to income tax expense may
be required to reduce the recorded value of the net deferred tax asset to the
expected realizable amount.
2. INVESTMENT SECURITIES
The Company accounts for its investment securities in accordance with
Statement of Financial Accounting Standard ("SFAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities". Investments in securities
are classified in one of three categories: held to maturity, trading or
available for sale. Investments for which management has both the ability and
intent to hold to maturity, are carried at cost, adjusted for the amortization
of premiums and accretion of discounts computed by the interest method.
Investments which management believes may be sold prior to maturity due to
changes in interest rates, prepayment risk and equity, liquidity requirements or
other factors, are classified as available for sale. Available-for-sale
securities are carried at fair value, with the unrealized gains and losses, net
of tax, reported as a separate component of stockholders' equity and excluded
from the determination of net income. Gains or losses on disposition are based
on the net proceeds and cost of the securities sold, adjusted for amortization
of premiums and accretion of discounts, using the specific identification
method.
At December 31, 2007, our portfolio of investment securities included
approximately $185 million of auction rate securities. These investments have
high credit quality ratings of AA or AAA and are fully collateralized by bonds
and other financial instruments. Auction rate securities are generally long-term
debt instruments that provide liquidity through a Dutch auction process that
resets the applicable interest rate at pre-determined calendar intervals,
generally every 28 days.
Recent uncertainties in the credit markets have negatively impacted our
ability to liquidate, if necessary, investments in auction rate securities
because, in recent auctions, the amount of securities submitted for sale has
exceeded the amount of purchase orders. We are not certain as to when the
liquidity issues relating to these investments will improve, however, we have
the ability to hold these securities to maturity (predominately 20 years after
December 31, 2007), thereby recovering our investment. As a result of the recent
auction failures beginning in February 2008, the fair value of these securities,
while maintaining their investment grade rating and interest payments, could be
negatively impacted at a later time. Were this to occur, we may be required to
reflect a write-down of certain of our auction rate securities in future periods
as a charge to earnings if any of our auction rate securities are deemed to be
other-than-temporarily impaired. Such impairment charge would be recorded as
other expense and could be material to our results of operations.
Based on our expected operating cash flows, and our other sources of
cash, we do not expect the potential lack of liquidity in these investments to
affect our ability to execute our current business plan.
3. LOANS AND ALLOWANCE FOR LOAN LOSSES
Loans that management has the intent and ability to hold for the
foreseeable future or until maturity or payoff are stated at the amount of
unpaid principal and are net of unearned discount, unearned loan fees and an
allowance for credit losses. The allowance for loan losses is established
through a provision for loan losses charged to expense. Loan principal
considered to be uncollectible by management is charged against the allowance
for credit losses. The allowance is an amount that management believes will be
adequate to absorb
53
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B - (CONTINUED)
specifically identifiable losses and losses on existing loans that may become
uncollectible based upon an evaluation of known and inherent risks in the loan
portfolio. The evaluation takes into consideration such factors as changes in
the nature and size of the loan portfolio, overall portfolio quality, specific
problem or impaired loans, and current economic conditions which may affect the
borrowers' ability to pay. The evaluation details historical losses by loan
category, the resulting loss rates for which are projected at current loan total
amounts.
The Company accounts for its impaired loans in accordance with SFAS No.
114, "Accounting by Creditors for Impairment of a Loan," as amended by SFAS No.
118, "Accounting by Creditors for Impairment of a Loan - Income Recognition and
Disclosures" and SFAS No. 5, "Accounting for Contingencies." Management
considers its investment in one-to-four family real estate loans and consumer
loans to be homogeneous groups of loans. As such, these loans are not
individually evaluated for impairment but rather are collectively evaluated
under SFAS No.5. These standards require that a creditor measure impairment
based on the present value of expected future cash flows discounted at the
loan's effective interest rate, except that as a practical expedient, a creditor
may measure impairment based on a loan's observable market price, or the fair
value of the collateral if the loan is collateral-dependent. Regardless of the
measurement method, a creditor must measure impairment based on the fair value
of the collateral when the creditor determines that foreclosure is probable.
Interest income is accrued as earned on a simple interest basis.
Accrual of interest is discontinued on a loan when management believes, after
considering economic and business conditions and collection efforts, that the
borrower's financial condition is such that collection of interest is doubtful.
When a loan is placed on such non-accrual status, all accumulated accrued
interest receivable applicable to periods prior to the current year is charged
off to the allowance for loan losses. Interest which had accrued in the current
year is reversed out of current period income. Loans 90 days or more past due
and still accruing interest must have both principal and accruing interest
adequately secured and must be in the process of collection.
4. INTEREST RATE SWAP
The Bank, from time to time, has entered into interest rate cap
agreements in order to hedge its exposure to interest rate fluctuations. The
Company adopted the provisions of SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities", as amended, as of January 1, 2001. The
statement requires the Company to recognize all derivative instruments at fair
value as either assets or liabilities. Financial derivatives are reported at
fair value in other assets or other liabilities. For derivatives not designated
as hedges, the gain or loss is recognized in current earnings. Amounts reclassed
into earnings, when the hedged transaction culminates, are included in interest
income. At December 31, 2007 and 2006, the Company had $10.0 million and $20.0
million, respectively, outstanding.
5. BANK PREMISES AND EQUIPMENT
Bank premises and equipment, including leasehold improvements, are
stated at cost less accumulated depreciation. Depreciation expense is computed
on the straight-line method over the estimated useful lives of the assets.
Leasehold improvements are amortized over the shorter of the estimated useful
lives of the improvements or the terms of the related leases. An accelerated
depreciation method is used for tax purposes.
54
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B - (CONTINUED)
6. OTHER REAL ESTATE OWNED
Other real estate owned, representing property acquired through
foreclosure, is recorded at the lower of cost or estimated fair market value,
less costs of disposal. When property is acquired, the excess, if any, of the
loan balance over fair market value is charged to the allowance for loan losses.
Periodically thereafter, the asset is reviewed for subsequent declines in the
estimated fair market value. Subsequent declines, if any, and holding costs, as
well as gains and losses on subsequent sale, are included in the consolidated
statements of operations.
7. GOODWILL
Goodwill resulting from the acquisition of The Berkshire Bank in 1999
and GSB Financial Corporation in 2001 is accounted for under SFAS No. 142,
"Goodwill and Intangible Assets". SFAS No. 142 includes requirements to test
goodwill and indefinite lived intangible assets for impairment rather than
amortize them. The Company performs such tests annually and did not identify any
impairment on its outstanding goodwill and its identifiable intangible assets
from its most recent testing, performed at September 30, 2007.
8. INCOME TAXES
The Company accounts for income taxes under the liability method of
accounting for income taxes. Deferred tax assets and liabilities are determined
based on the difference between the financial statement and tax bases of assets
and liabilities as measured by the enacted tax rates that will be in effect when
these differences reverse. Deferred tax expense is the result of changes in
deferred tax assets and liabilities. The principal types of differences between
assets and liabilities for financial statement and tax return purposes are
allowance for loan losses, deferred loan fees, deferred compensation and
securities available for sale.
As of January 1, 2007, the Company adopted FASB Interpretation No. 48
"Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement
No. 109". The result of adoption was an increase to retained earnings totaling
$965,000 as a previously accrued liability was evaluated and determined to be no
longer necessary as the tax year expired.
9. NET INCOME PER SHARE
The Company follows the provisions of SFAS No. 128, "Earnings Per
Share." Basic earnings per share excludes dilution and is computed by dividing
income available to common shareholders by the weighted-average common shares
outstanding during the period. Diluted earnings per share takes into account the
potential dilution that could occur if securities or other contracts to issue
common stock were exercised and converted into common stock.
10. STOCK BASED COMPENSATION
At December 31, 2007, the Company has one stock-based employee
compensation plan, which is more fully described in Note J. The Company accounts
for the plan in accordance with SFAS Statement No. 123(R), "Share Based Payment"
("SFAS 123R"). Under the fair value recognition provisions of SFAS 123R,
share-based compensation cost is measured at the grant date based on the fair
value of the award and is recognized as expense over the vesting period.
Determining the fair value of share-based awards at the grant date requires
judgement, including estimating the Company's stock price volatility, employee
stock option exercise behaviors and employee option forfeiture rates. Prior to
the adoption of SFAS 123(R), the Company accounted for the plan in accordance
with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," ("APB No. 25") and related interpretations.
The Company did not grant stock options in fiscal 2007, 2006 and 2005,
as a result of which, no stock based compensation expense was recorded in each
of those years.
55
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B - (CONTINUED)
11. CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents are
comprised of cash and due from banks, interest bearing deposits in other
financial institutions with an original maturity of less than ninety days, and
federal funds sold.
12. RESTRICTIONS ON CASH AND DUE FROM BANKS
The Bank is required to maintain reserves against customer demand
deposits by keeping cash on hand or balances with the Federal Reserve Bank in a
non-interest bearing account. The amounts of those reserve and cash balances was
approximately $3,258,000 and $2,617,000 at December 31, 2007 and 2006,
respectively.
13. FEDERAL HOME LOAN BANK STOCK
The Company is required as a condition of membership in the Federal
Home Loan Bank of New York ("FHLBNY") to maintain an investment in FHLBNY common
stock. The stock is redeemable at par, and therefore, its cost is equivalent to
its redemption value.
14. COMPREHENSIVE INCOME
The Company follows the provisions of SFAS No. 130, "Reporting
Comprehensive Income" which includes net income as well as certain other items,
which results in a change to equity during the period. (In thousands.)
YEAR ENDED DECEMBER 31, 2007
-----------------------------------
Tax
Before tax (expense) Net of tax
amount benefit Amount
----------- --------- ----------
Unrealized gains (losses)
on investment securities:
Unrealized holding gains
arising during period $2,278 $ (964) $1,314
Less reclassification adjustment for
gains realized in net income 86 (34) 52
------ ------ ------
Unrealized gain on investment securities 2,192 (930) 1,262
Change in minimum pension liability 71 -- 71
------ ------ ------
Other comprehensive income, net $2,263 $ (930) $1,333
====== ====== ======
YEAR ENDED DECEMBER 31, 2006
-----------------------------------
Tax
Before tax (expense) Net of tax
amount benefit Amount
----------- --------- ----------
Unrealized gains (losses)
on investment securities:
Unrealized holding gains (losses)
arising during period $ 8,673 $(3,511) $ 5,162
Less reclassification adjustment for
gains realized in net income 2,336 (934) 1,402
------- ------- -------
Unrealized gain on investment securities 6,337 (2,577) 3,760
Change in minimum pension liability (117) -- (117)
------- ------- -------
Other comprehensive income, net $ 6,220 $(2,577) $ 3,643
======= ======= =======
56
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE B - (CONTINUED)
YEAR ENDED DECEMBER 31, 2005
--------------------------------------------------
Tax
Before tax (expense) Net of tax
amount benefit Amount
---------------- -------------- --------------
Unrealized gains (losses) on investment securities:
Unrealized holding gains (losses)
arising during period $ (8,834) $ 3,313 $ (5,521)
Less reclassification adjustment for
gains realized in net income 4 (1) 3
-------- ------- --------
Unrealized (loss) on investment securities (8,838) 3,314 (5,524)
Change in minimum pension liability (289) -- (289)
-------- ------- --------
Other comprehensive income (loss), net $ (9,127) $ 3,314 $ (5,813)
======== ======= ========
15. RECLASSIFICATIONS
Certain amounts in the December 31, 2006 and 2005 financial statements
have been reclassified to conform to the current period's presentation.
NOTE C - INVESTMENT SECURITIES
The following is a summary of held to maturity investment securities:
DECEMBER 31, 2007
---------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------------- ---------------- --------------- --------------
(In thousands)
U.S. Government Agencies $ 395 $ 11 $ (1) $ 405
======== ======== ======== ========
DECEMBER 31, 2006
---------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------------- ---------------- --------------- --------------
(In thousands)
U.S. Government Agencies $ 433 $ 4 $ (1) $ 436
======== ======== ======== ========
57
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C - (CONTINUED)
The following is a summary of available-for-sale investment securities:
DECEMBER 31, 2007
----------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------------- --------------- --------------- ---------------
(In thousands)
U.S. Government Agencies $272,789 $ 151 $ (622) 272,318
Mortgage-backed securities 53,886 100 (929) 53,057
Corporate notes 71,147 79 (3,625) 67,601
Municipal securities 1,973 1,031 -- 3,004
Auction rate securities 184,597 -- -- 184,597
Marketable equity
securities and other 18,698 106 (420) 18,384
-------- ------- -------- --------
Totals $603,090 $ 1,467 $ (5,596) $598,961
======== ======= ======== ========
DECEMBER 31, 2006
----------------------------------------------------------------------
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------------- --------------- --------------- ---------------
(In thousands)
U.S. Treasury and Notes $5,002 $ -- $ (12) $ 4,990
U.S. Government Agencies 322,986 -- (5,822) 317,164
Mortgage-backed securities 67,472 92 (1,711) 65,853
Corporate notes 44,366 334 (662) 44,038
Municipal securities 5,698 1,489 -- 7,187
Auction rate securities 71,500 -- -- 71,500
Marketable equity
securities and other 3,919 216 (69) 4,066
-------- ------- -------- --------
Totals $520,943 $ 2,131 $ (8,276) $514,798
======== ======= ======== ========
The Company has investments in certain debt and equity securities that
have unrealized losses or may be otherwise impaired, but an other-than-temporary
impairment has not been recognized in the financial statements as management
believes the decline is due to the credit markets coupled with the interest rate
environment. The following table indicates the length of time individual
securities have been in a continuous unrealized loss position at December 31,
2007 (in thousands):
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
----------------------------- ----------------------------- -----------------------------
FAIR VALUE UNREALIZED FAIR VALUE UNREALIZED FAIR VALUE UNREALIZED
LOSSES LOSSES LOSSES
DESCRIPTION OF SECURITIES
U.S. Government Agencies $ -- $ -- $204,397 $ 623 $204,397 $ 623
Mortgage-backed securities 3,058 7 41,427 922 44,485 929
Corporate notes 27,468 2,428 17,885 1,197 45,353 3,625
-------- ------- -------- ------- -------- -------
Subtotal, debt securities 30,526 2,435 263,709 2,742 294,235 5,177
Marketable equity securities
and other 1,406 324 213 96 1,619 420
-------- ------- -------- ------- -------- -------
Total temporarily
impaired securities $ 31,932 $ 2,759 $263,922 $ 2,838 $295,854 $ 5,597
======== ======= ======== ======= ======== =======
58
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C - (CONTINUED)
The Company had a total of 90 debt securities with a fair market value
of $294.24 million which were temporarily impaired at December 31, 2007. The
total unrealized loss on these securities was $5.18 million, of which $1.55
million is attributable to changes in interest rates which have decreased the
market value of these securities. The remaining unrealized loss of $3.63 million
is on 4 corporate notes which are currently reorganizing in U.S. bankruptcy
court. We have the ability to hold these securities to maturity, all but 4 of
which are US Government Agency securities and mortgage-backed securities,
therefore, the unrealized losses associated with these securities are not
considered to be other than temporary.
The Company also had 8 equity securities with an aggregated fair market
value of $1.62 million which were temporarily impaired at December 31, 2007. The
total unrealized loss on these securities was $420,000. Based upon our review of
the available information, such unrealized losses are not considered to be other
than temporary.
The following table indicates the length of time individual securities
have been in a continuous unrealized loss position at December 31, 2006 (in
thousands):
LESS THAN 12 MONTHS 12 MONTHS OR LONGER TOTAL
----------------------------- ----------------------------- -----------------------------
FAIR VALUE UNREALIZED FAIR VALUE UNREALIZED FAIR VALUE UNREALIZED
LOSSES LOSSES LOSSES
DESCRIPTION OF SECURITIES
U.S. Treasury and Notes $ -- $ -- $ 4,990 $ 12 $ 4,990 $ 12
U.S. Government Agencies 12,061 9 305,104 5,814 317,165 5,823
Mortgage-backed securities 1,732 52 49,454 1,659 51,186 1,711
Corporate notes -- -- 10,939 662 10,939 662
Municipal securities -- -- -- -- -- --
-------- -------- -------- -------- -------- --------
Subtotal, debt securities 13,793 61 370,487 8,147 384,280 8,208
Marketable equity securities
and other -- -- 13 69 13 69
-------- -------- -------- -------- -------- --------
Total temporarily $ 13,793 $ 61 $370,500 $ 8,216 $384,293 $ 8,277
impaired securities ======== ======== ======== ======== ======== ========
The Company had a total of 86 debt securities with a fair market value
of $384.28 million which were temporarily impaired at December 31, 2006. The
total unrealized loss on these securities was $8.28 million, of which $8.11
million is attributable to increases in interest rates which have decreased the
market value of these securities. The remaining unrealized loss of $153,000 is
on 2 corporate notes which are currently reorganizing in U.S. bankruptcy court.
We have the ability to hold these securities to maturity, all but 7 of which are
US Government and US Government Agency securities, therefore, the unrealized
losses associated with these securities are not considered to be other than
temporary.
The Company also had 2 equity securities with an aggregated fair market
value of $13,000 which were temporarily impaired at December 31, 2006. The total
unrealized loss on these securities was $69,000. Based upon our review of the
available information, such unrealized losses are not considered to be other
than temporary.
59
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE C - (CONTINUED)
The amortized cost and fair value of investment securities available
for sale and held to maturity, by contractual maturity, at December 31, 2007 are
shown below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
DECEMBER 31, 2007
------------------------------------------
AVAILABLE FOR SALE HELD TO MATURITY
-------------------- -------------------
AMORTIZED FAIR AMORTIZED FAIR
COST VALUE COST VALUE
-------- -------- -------- --------
(In thousands)
Due in one year or less $ 76,692 $ 76,303 $ -- $ --
Due after one through
five years 173,831 173,404 -- --
Due after five through
ten years 85,810 82,697 16 16
Due after ten years 63,462 63,576 379 389
Auction rate securities 184,597 184,597 -- --
Marketable equity securities
and other 18,698 18,384 -- --
-------- -------- -------- --------
Totals $603,090 $598,961 $ 395 $ 405
======== ======== ======== ========
Gross gains realized on the sales of investment securities for the
years ended December 31, 2007, 2006 and 2005 were approximately $125,000,
$2,342,000, and $10,000, respectively. Gross losses were approximately $39,000,
$5,000, and $6,000 for the years ended December 31, 2007, 2006 and 2005,
respectively.
As of December 31, 2007 and 2006, securities sold under agreements to
repurchase with a book value of approximately $76.84 million and $62.65 million,
respectively, were outstanding. The book value of the securities pledged for
these repurchase agreements was $78.95 million and $71.30 million, respectively.
As of December 31, 2007 and 2006, the Company did not have any investment
securities of any one issuer where the carrying value exceeded 10% of
shareholders' equity.
60
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE D - LOANS
Major classifications of loans are as follows:
DECEMBER 31, DECEMBER 31,
2007 2006
------------ ------------
(In thousands)
Commercial and professional loans $ 76,132 $ 63,331
Secured by real estate
1 - 4 family 142,140 139,611
Multi family 3,506 4,013
Non-residential 212,850 160,417
Consumer 1,691 4,763
--------- ---------
436,319 372,135
Deferred loan fees (1,534) (1,212)
Allowance for loan losses (4,183) (3,771)
--------- ---------
$ 430,602 $ 367,152
========= =========
Changes in the allowance for loan losses are as follows:
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------
2007 2006 2005
------------- ----------- -----------
(In thousands)
Balance at beginning $ 3,771 $ 3,266 $ 2,927
of year
Provision charged to 355 410 180
operations
Loans charged off -- (42) (26)
Recoveries 57 137 185
------- ------- -------
Balance at end of year $ 4,183 $ 3,771 $ 3,266
======= ======= =======
The Bank had $153,000, $201,000 and $256,000 of non accrual loans as of
December 31, 2007, 2006 and 2005, respectively, and $314,000, $0 and $74,000 of
loans delinquent more than ninety days and still accruing interest at December
31, 2007, 2006 and 2005, respectively. The Bank classified the non-accrual loans
of $153,000 as impaired loans at December 31, 2007. However, no specific
allocation from the allowance for loan losses was made because the collateral
underlying each loan was deemed to be sufficient to cover any loss in the event
of a default. Therefore, all of the allowance for loan loss is includable in
regulatory capital.
In accordance with banking regulations, the Bank, from time to time,
enters into lending transactions in the ordinary course of business with
directors, executive officers, principal stockholders and affiliates of such
persons on the same terms as those prevailing for comparable transactions with
other borrowers. The following table summarizes the activity in loans to related
parties.
Balance at 12/31/06 $ 9,701,822
New Loans 3,600,000
Repayments 183,276
-----------
Balance at 12/31/07 $13,118,546
===========
61
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE E - PREMISES AND EQUIPMENT
Major classifications of premises and equipment are summarized as
follows:
ESTIMATED DECEMBER 31, DECEMBER 31,
USEFUL LIVES 2007 2006
------------------ ------------- ------------
(In thousands)
Land Indefinite $ 3,572 $ 3,572
Buildings 39 years 5,190 5,190
Furniture and equipment 3 to 10 years 3,262 3,052
Leasehold improvements 2 to 10 years 2,207 1,653
------- -------
14,231 13,467
Accumulated depreciation and (4,869) (4,129)
amortization ------- -------
Total $ 9,362 $ 9,338
======= =======
Depreciation and amortization expense was approximately $739,000,
$727,000 and $650,000 for the years ended December 31, 2007, 2006 and 2005,
respectively.
NOTE F - DEPOSITS
The aggregate amount of jumbo certificates of deposits greater than
$100,000 were approximately $247.53 million and $203.59 million as of December
31, 2007 and 2006, respectively.
The scheduled maturities of all certificates of deposit are as follows:
DECEMBER 31, 2007
-----------------
(In thousands)
2008 $ 477,127
2009 373
2010 2
---------
$ 477,502
=========
NOTE G - BORROWINGS
SHORT-TERM BORROWINGS Securities sold under agreements to repurchase
generally mature within 30 days from the date of the transactions. Short-term
borrowings consist of various borrowings which generally have maturities of less
than one year. The details of these categories are presented below:
YEAR ENDED DECEMBER 31,
-----------------------------------
2007 2006 2005
--------- --------- ----------
(Dollars in Thousands)
Securities sold under repurchase
agreements and federal funds purchased
Balance at year-end $ 76,842 $ 62,652 $ 73,044
Average during the year $ 40,049 $ 56,236 $108,785
Maximum month-end balance $ 76,842 $ 79,154 $145,489
Weighted average rate during the year 4.93% 3.75% 3.47%
Rate at December 31 4.65% 4.94% 3.59%
62
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE G - (CONTINUED)
LONG-TERM BORROWINGS At December 31, 2007, advances from the Federal
Home Loan Bank ("FHLB") totaling $31.61 million will mature within one to five
years and are reported as long-term borrowings. The advances are collateralized
by FHLB stock and certain first mortgage loans totaling $31.61 million. The
advances had a weighted average rate of 5.00%. Unused lines of credit at the
FHLB were $69.8 million at December 31, 2007.
Outstanding long-term borrowings mature as follows (in thousands):
YEAR AMOUNT
------ ---------
2008 $ 5,264
2009 8,416
2010 14,000
2011 --
2012 3,927
---------
Total $ 31,607
=========
NOTE H - EARNINGS PER SHARE
The Company's calculation of earnings per share in accordance with SFAS
No. 128 is as follows:
YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS, EXCEPT PER SHARE DATA)
-------------------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
---------------- ------------------- --------------
Basic earnings per share
Net income available to
common stockholders $5,354 6,987 $ .77
Effect of dilutive securities
Options -- 18 (.01)
------ ------- -------
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $5,354 7,005 $ .76
====== ======= =======
YEAR ENDED DECEMBER 31, 2006
(IN THOUSANDS, EXCEPT PER SHARE DATA)
-------------------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
---------------- ------------------- --------------
Basic earnings per share
Net income available to
common stockholders $4,880 6,891 $ .71
Effect of dilutive securities
Options -- 85 (.01)
------ ------- -------
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $4,880 6,976 $ .70
====== ======= =======
63
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE H - (CONTINUED)
YEAR ENDED DECEMBER 31, 2005
(IN THOUSANDS, EXCEPT PER SHARE DATA)
-------------------------------------------------------
Income Shares Per share
(numerator) (denominator) amount
---------------- ------------------- --------------
Basic earnings per share
Net income available to
common stockholders $5,541 6,805 $ .81
Effect of dilutive securities
Options -- 134 (.01)
------ ------- -------
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $5,541 6,939 $ .80
====== ======= =======
NOTE I - INCOME TAXES
The components of income tax expense are as follows:
YEARS ENDED DECEMBER 31,
----------------------------------------------------
2007 2006 2005
---- ---- ----
Current $ 2,723,000 $ 4,282,000 $ 4,985,000
Deferred Taxes (Benefit) (349,000) (426,000) 18,000
----------- ----------- -----------
$ 2,374,000 $ 3,856,000 $ 5,003,000
=========== =========== ===========
A reconciliation of the provision for income taxes for the years ended
December 31, 2007, 2006 and 2005 and the amount computed by applying the
statutory Federal income tax rate to income from continuing operations follows:
YEARS ENDED DECEMBER 31,
------------------------------------------------
2007 2006 2005
---- ---- ----
Effective Tax Reconciliation
Tax at statutory rate $ 2,627,000 $ 2,970,000 $ 3,584,960
State and City, net of federal
income tax benefit 1,195,000 1,123,109 1,311,420
Permanent items (1,430,000) (337,670) (4,352)
Other (18,000) 100,561 110,972
----------- ----------- -----------
Actual provision for
income taxes $ 2,374,000 $ 3,856,000 $ 5,003,000
=========== =========== ===========
64
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE I - (CONTINUED)
The tax effect of the principal temporary differences at December 31,
2007 and 2006 are as follows:
DECEMBER 31,
-------------------------
2007 2006
---- ----
Net deferred tax assets
Loan loss provision $1,950,000 $1,721,000
Depreciation 230,000 123,000
Other 315,000 301,000
Unrealized loss on
investment securities 2,015,000 2,979,000
---------- ----------
Net deferred tax asset
included in other assets $4,510,000 $5,124,000
========== ==========
NOTE J - STOCK PLANS
In March 1999, the stockholders of the Company approved the 1999 Stock
Incentive Plan (the "1999 Stock Incentive Plan"). The 1999 Stock Incentive Plan
permits the granting of awards in the form of nonqualified stock options,
incentive stock options, restricted stock, deferred stock, and other stock-based
incentives. Up to 600,000 shares of common stock of the Company may be issued
pursuant to the 1999 Stock Incentive Plan. Officers, directors and other key
employees of the Company or any subsidiary are eligible to receive awards under
the 1999 Stock Incentive Plan. Options outstanding under the 1999 Stock
Incentive Plan were 2,076 and 185,878 as of December 31, 2007 and 2006,
respectively. The Company did not grant options in 2007, 2006 and 2005.
A summary of activity with respect to the Stock Option Plan follows:
DECEMBER 31,
----------------------------------------------------------------------
2007 2006 2005
------------------- -------------------- ---------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------ ----- ------ ----- ------ -----
Outstanding at
beginning of year 185,878 $ 9.76 223,203 $ 9.70 365,084 $10.65
Granted -- $ -- -- $ -- -- $ --
Cancelled (7,500) $10.00 -- $ -- (3,000) $12.67
Exercised (176,302) $ 9.77 (37,325) $ 9.34 (138,881) $12.20
-------- ------- --------
Outstanding at
end of year 2,076 $ 8.29 185,878 $ 9.76 223,203 $ 9.70
======== ======= ========
Exercisable at
end of year 2,076 $ 8.29 185,878 $ 9.76 223,203 $ 9.70
======== ======= ========
Weighted average fair
value of options
granted during the
year $ -- $ -- $ --
====== ====== ======
65
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE J - (CONTINUED)
The following table summarizes information about options outstanding
and exercisable at December 31, 2007:
OPTIONS OUTSTANDING AND EXERCISABLE
---------------------------------------------------------------------------
NUMBER WEIGHTED
OUTSTANDING AVERAGE WEIGHTED
AT REMAINING AVERAGE
RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE
EXERCISE PRICES 2007 LIFE (YEARS) PRICE
--------------- ------------ ------------ --------
$ 5.98 - $8.64 2,076 2.45 $ 8.29
========
NOTE K - EMPLOYEE BENEFIT PLANS
1. RETIREMENT INCOME PLAN
The Company's Retirement Income Plan (the "Plan") covers substantially
all full-time employees. Benefits are based upon a combination of employee
compensation and years of service. The Company pays the entire cost of the Plan
and funds such costs as they accrue. The Company's funding policy is to make
annual contributions within minimum and maximum levels required by applicable
regulations. The Company's customary contributions are designed to fund normal
cost on a current basis and to fund over 30 years the estimated prior service
cost of benefit improvements (15 years of annual gains and losses). The
projected unit cost method was used to determine the annual cost.
The following table summarizes the major categories of Plan assets as
of the dates indicated:
DECEMBER 31,
-----------------------------------------------------------------
2007 2006
------------------------------- -------------------------------
FAIR VALUE % OF TOTAL FAIR VALUE % OF TOTAL
-------------- -------------- -------------- -------------
(In thousands, except percentages
Mutual Funds
International Equity Fund $ 266 10.86% $ 198 9.54%
Large Cap Equity Growth Fund 608 24.82 504 24.28
International Investment
Grade Bond Fund 844 34.45 637 30.68
Small Cap Equity Growth Fund 58 2.36 99 4.77
Large Cap Equity Value Fund 528 21.55 487 23.46
Corporate Common Stocks(1) 138 5.63 151 7.27
Cash and cash equivalents 8 0.33 -- --
------- ------ ------- ------
Total Plan Assets $ 2,450 100.00% $ 2,076 100.00%
======= ====== ======= ======
---------------
(1) Includes 4,500 shares of the Company's Common Stock with a market value
of $72,045 and $73,350 at December 31, 2007 and 2006, respectively.
66
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE K - (CONTINUED)
The assets of the Plan are primarily invested in well diversified
common stock and fixed income funds designed to minimize risk while maximizing
expected portfolio returns. To achieve the long term rate of return, Plan assets
are invested in a mixture of instruments, including but not limited to,
corporate common stock, investment grade bond funds, small and large cap equity
funds and international equity funds. The allocation of assets is determined by
the Investment Manager, and typically include 50% to 70% equities, with the
remainder invested in fixed income and a minimal amount of cash. Presently, this
diversified portfolio is expected to return approximately 8.50% in the long run.
The expected rate of return on Plan assets was determined based upon a
review of historical returns, both for our Plan and for medium to large-sized
defined benefit pension funds with similar asset allocations. This review
generated separate expected future long-term returns for each asset class listed
in the above table. These expected future returns were then blended based upon
our Plan's target asset allocation.
ASSUMPTIONS
Weighted-average assumptions used to determine benefit obligations were
as follows at the dates indicated:
DECEMBER 31,
-----------------------------
2007 2006
------------- -------------
Discount rate 6.30% 5.75%
Rate of compensation increase 5.00% 5.00%
Weighted-average assumptions used to determine net periodic benefit
cost for the years ended December 31, 2007 and 2006 were as follows:
DECEMBER 31,
-----------------------------------
2007 2006
---------------- ----------------
Discount rate 5.75% 5.50%
Rate of compensation increase 5.00% 5.00%
Expected return on plan assets 8.50% 8.50%
Measurement date 12/31/2007 12/31/2006
67
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE K - (CONTINUED)
The following table sets forth the Plan's benefit obligations, fair
value of the Plan assets and the funded status of the Plan in accordance with
FAS 158 for the years ended December 31, 2007 and 2006:
DECEMBER 31,
-----------------------------------
2007 2006
----------------- ----------------
CHANGE IN BENEFIT OBLIGATION
Benefit obligation at beginning of year $ 3,103,843 $ 2,735,177
Service cost 407,623 353,071
Interest cost 177,221 149,594
Actuarial (gain) loss 63,668 (3,660)
Benefits paid (191,949) (130,339)
----------- -----------
Benefits obligation at end of year $ 3,560,406 $ 3,103,843
=========== ===========
CHANGE IN PLAN ASSETS
Fair value of plan assets at beginning of year $ 2,075,998 $ 1,719,290
Actual return on plan assets 177,141 154,347
Employer contribution 389,400 332,700
Benefits paid (191,949) (130,339)
----------- -----------
Fair value of plan assets at end of year $ 2,450,590 $ 2,075,998
=========== ===========
AMOUNTS RECOGNIZED IN THE STATEMENT OF FINANCIAL
POSITION CONSIST OF:
Liabilities $(1,109,816) $(1,027,845)
Prepaid benefit cost N/A N/A
Accrued benefit cost N/A N/A
Intangible asset N/A N/A
Accumulated other comprehensive charge N/A N/A
----------- -----------
Net amount recognized at year end $ 1,109,816 $ 1,027,845
=========== ===========
ADDITIONAL YEAR-END INFORMATION FOR PENSION PLANS WITH ACCUMULATED
BENEFIT OBLIGATIONS IN EXCESS OF PLAN ASSETS
Projected benefit obligation $ 3,560,406 $ 3,103,843
Accumulated benefit obligation 3,560,406 3,103,843
Fair value of plan assets 2,450,590 2,075,998
68
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE K - (CONTINUED)
A summary of the components of net periodic benefit cost and other amounts
recognized in other comprehensive income in accordance with FAS 158 for the
years ended December 31, 2007, 2006 and 2005 is as follows:
DECEMBER 31,
------------------------------------------
2007 2006 2005
--------- --------- ---------
Service cost $ 407,623 $ 353,071 $ 304,144
Interest cost 177,221 149,594 134,275
Expected return on assets (182,142) (151,131) (150,819)
Amortization
Prior service cost 18,370 18,370 18,370
(Gain) loss 52,649 60,286 40,091
--------- --------- ---------
Net periodic pension cost $ 473,721 $ 430,190 $ 346,061
========= ========= =========
The following table sets forth other changes in plan assets and benefit
obligations recognized in other comprehensive income in accordance with FAS 158
at December 31, 2007 and 2006:
DECEMBER 31,
-------------------
2007 2006
-------- --------
Net loss (gain) $ 68,669 $ N/A
Prior service cost N/A N/A
Increase (decrease) in minimum liability included in other
comprehensive income prior to FAS 158 application N/A (67,162)
Initial OCI charge upon FAS 158 application N/A 102,504
Amortization of prior service cost (18,370) N/A
Amortization of transition obligation (52,649) N/A
-------- --------
Total recognized in other comprehensive income (2,350) 35,342
Total recognized in net periodic benefit cost and other
comprehensive income $471,371 $465,532
The estimated net loss (gain), prior service cost and net transition obligation
that will be amortized from the accumulated other comprehensive income into net
periodic benefit cost over the next fiscal year are $43,000, $18,000 and zero,
respectively.
ESTIMATED FUTURE BENEFIT PAYMENTS
We estimate future benefit payments to be as follows:
BENEFIT
YEARS PAYMENTS
----- --------
2008 $ 265,958
2009 199,872
2010 193,469
2011 240,195
Years 2012-2016 2,719,826
69
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE K - (CONTINUED)
COMPANY CONTRIBUTIONS
The Company contributed $389,400 to its Retirement Plan in the fiscal
year ended December 31, 2007. During the fiscal year ending December 31, 2008,
we expects to contribute approximately $750,000 to the Plan.
2. POSTRETIREMENT WELFARE PLAN
The Bank, as successor to Goshen Bank provides certain health care and
life insurance benefits for retired employees and their spouses. The
postretirement health care and life insurance benefits plan was terminated for
persons retiring after December 31, 1998. Eligible employees retired on or
before that date will have benefits paid through the plan under the agreed upon
terms existing at the employee's retirement date.
DECEMBER 31,
---------------------------------
2007 2006
---------------- ---------------
(In thousands)
Change in benefit obligation
Benefit obligation at beginning of year $ 698 $ 735
Service cost -- --
Interest cost 41 42
Actual (gain) loss (6) (27)
Benefits paid (55) (52)
--------- ---------
Benefits obligation at end of year 678 698
--------- ---------
Change in plan assets
Fair value of plan assets
at beginning of year -- --
Actual return on plan assets -- --
Employer contribution 55 49
Benefits paid (55) (49)
--------- ---------
Fair value of plan assets
at end of year -- --
--------- ---------
Funded status (698) (678)
Unrecognized net actuarial loss N/A N/A
--------- ---------
Accrued benefit cost (included in
other liabilities) $ 678 $ 698
========= =========
70
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE K - (CONTINUED)
Net benefit cost included the following components:
YEAR ENDED DECEMBER 31,
----------------------------------------
2007 2006
------------------- ------------------
(In thousands)
Service cost $ -- $ --
Interest cost on projected
benefit obligation 41 42
Actual return on plan assets -- --
-------- --------
Net periodic benefit cost $ 41 $ 42
======== ========
The assumed discount rate used in determining the actuarial present
value of the projected benefit obligation was 6.50% and 6.125% in 2007 and 2006,
respectively.
3. 401(k) PLANS
The Bank has a 401(k) plan in which employees can contribute up to 15%
of their salary. The Bank also matches 50% of the employee contribution up to a
maximum of 3% of the employee's salary. The matching expense was $124,000,
$124,000 and $107,000 for the years ended December 31, 2007, 2006 and 2005,
respectively.
4. DEFERRED COMPENSATION ARRANGEMENTS
GSB Financial and Goshen Bank established deferred compensation
arrangements for certain directors and executives. These deferred compensation
arrangements were terminated as a result of the acquisition. At December 31,
2007 and 2006, the balance accumulated under these arrangements was
approximately $228,000 and $245,000, respectively, and will be paid out when the
individual (i) ceases to be a director and/or executive of the Company; (ii)
attains the age of 75; or (iii) specifies a particular date.
In July 2006, the Bank established the Deferred Compensation Plan of
The Berkshire Bank (the "Plan") to provide for a systematic method by which key
employees of the Bank may defer payment of all or part of the compensation that
may be earned by them. The Plan is intended to be a nonqualified and unfunded
plan maintained primarily for the purpose of providing deferred compensation for
a select group of management or highly compensated employees pursuant to
Sections 201(2), 301(a)(3) and 401(a)(1) of the Employee Retirement Income
Security Act of 1974, as amended. At December 31, 2007 and 2006, the balances
accumulated under the Plan were approximately $95,000 and $30,000, respectively.
71
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE L - COMMITMENTS AND CONTINGENCIES
1. LEASES AND OTHER COMMITMENTS
The Company leases certain of its operating facilities under
non-cancelable operating leases expiring in 2008 through 2016. The leases
require payment by the Company of the real estate taxes and insurance on the
leased properties. Approximate future minimum annual rental payments are as
follows:
Year Ending (In thousands)
December 31,
---------------
2008 $ 716
2009 648
2010 473
2011 292
2012 303
Thereafter 558
--------
$ 2,990
========
Rental expense was approximately $1,329,000, $1,286,000 and $1,208,000
for the fiscal years ended December 31, 2007, 2006 and 2005, respectively.
Included in rental expense was approximately $368,000, 328,000 and $359,000 for
the fiscal years ended December 31, 2007, 2006 and 2005, respectively, which was
paid to a company affiliated with a director of the Company.
NOTE M - FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107 requires disclosure of the estimated fair value of an
entity's assets and liabilities considered to be financial instruments. For the
Company, as for most financial institutions, the majority of its assets and
liabilities are considered financial instruments as defined in SFAS No. 107.
However, many such instruments lack an available trading market, as
characterized by a willing buyer and seller engaging in an exchange transaction.
Also, it is the Company's general practice and intent to hold its financial
instruments to maturity and not to engage in trading or sales activities, except
for certain loans. Therefore, the Company had to use significant estimations and
present value calculations to prepare this disclosure.
Changes in the assumptions or methodologies used to estimate fair
values may materially affect the estimated amounts. Also, management is
concerned that there may not be reasonable comparability between institutions
due to the wide range of permitted assumptions and methodologies in the absence
of active markets. This lack of uniformity gives rise to a high degree of
subjectivity in estimating financial instrument fair values.
Estimated fair values have been determined by the Company using the
best available data and an estimation methodology suitable for each category of
financial instruments. The estimation methodologies used, the estimated fair
values, and recorded book balances at December 31, 2007 and 2006 are outlined
below.
For cash and cash equivalents, the recorded book values of $47.19
million and $24.31 million at December 31, 2007 and 2006, respectively,
approximate fair values.
The estimated fair values of investment securities are based on quoted
market prices, if available. Estimated fair values are based on quoted market
prices of comparable instruments if quoted market prices are not available.
72
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE M - (CONTINUED)
DECEMBER 31,
------------------------------------------------------------------------
2007 2006
--------------------------------- -------------------------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
--------------- ---------------- ------------------ -----------------
(In thousands)
Investment securities $599,356 $599,366 $515,231 $515,234
Loans, net of unearned income 434,785 441,569 370,923 375,052
Time Deposits 477,502 477,802 423,712 423,161
Repurchase Agreements 76,842 77,267 62,652 62,606
Long-term Debt 54,288 55,160 75,419 75,569
The net loan portfolio at December 31, 2007 and 2006 has been valued
using a present value discounted cash flow where market prices were not
available. The discount rate used in these calculations is the estimated current
market rate adjusted for credit risk. The carrying value of accrued interest
approximates fair value.
The estimated fair values of demand deposits (i.e. interest (checking)
and non-interest bearing demand accounts, savings and certain types of money
market accounts) are, by definition, equal to the amount payable on demand at
the reporting date (i.e. their carrying amounts). The carrying amount of accrued
interest payable approximates its fair value.
The fair value of commitments to extend credit is estimated based upon
the amount of unamortized deferred loan commitment fees. The fair value of
letters of credit is based upon the amount of unearned fees plus the estimated
cost to terminate letters of credit. Fair values of unrecognized financial
instruments, including commitments to extend credit, and the fair value of
letters of credit are considered immaterial.
The fair value of interest rate caps, included in long-term debt, are
based upon the estimated amount the Company would receive or pay to terminate
the contracts or agreements, taking into account current interest rates and,
when appropriate, the current creditworthiness of the counterparties. The
aggregate fair value for the interest rate caps were approximately $0 and
$20,000 at December 31, 2007 and 2006, respectively.
The fair value of the long term debt approximates the carrying value
due to the re-pricing of the debt.
73
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE N - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK AND CONCENTRATIONS
OF CREDIT RISK
The Bank is party to financial instruments with off-balance-sheet risk
in the normal course of business to meet the financing needs of their customers.
These financial instruments include commitments to extend credit and standby
letters of credit. Such financial instruments are recorded in the financial
statements when they become payable. Those instruments involve, to varying
degrees, elements of credit and interest rate risk in excess of the amount
recognized in the consolidated balance sheets. The contract or notional amounts
of those instruments reflect the extent of involvement the Banks have in
particular classes of financial instruments.
The Bank's exposure to credit loss in the event of non-performance by
the other party to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual or notional amount
of those instruments. The Bank uses the same credit policies in making
commitments and conditional obligations as they do for on-balance-sheet
instruments.
Unless noted otherwise, the Bank does not require collateral or other
security to support financial instruments with credit risk. The approximate
contract amounts are as follows:
DECEMBER 31,
---------------------------------------
2007 2006
------------------- ------------------
(In thousands)
Unused lines of credit $ 18,635 $ 19,601
Commitments to extend credit 28,645 18,687
Standby letters of credit and financial
guarantees written 5,374 3,423
-------- --------
$ 52,654 $ 41,711
======== ========
Interest rate caps-notional amount $ 10,000 $ 20,000
======== ========
Commitments to extend credit are agreements to lend to a customer as
long as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Bank upon extension of credit, is based on management's
credit evaluation.
Standby letters of credit are conditional commitments issued by the
Bank to guarantee the performance of a customer to a third party. Those
guarantees are primarily issued to support public and private borrowing
arrangements, including commercial paper, bond financing and similar
transactions. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
The Bank holds residential or commercial real estate, accounts receivable,
inventory and equipment as collateral supporting those commitments for which
collateral is deemed necessary. The extent of collateral held for those
commitments at December 31, 2007 varies up to 100%.
74
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE N - (CONTINUED)
The Company defines the initial fair value of these letters of credit
as the fee received from the customer. The maximum potential undiscounted amount
of future payments of these letters of credit as of December 31, 2007 are
$5,374,000 and they expire through 2008. Amounts due under these letters of
credit would be reduced by any proceeds the Company would be able to obtain in
liquidating the collateral for the loans, which varies depending on the
customer.
The Bank grants loans primarily to customers in New York and its
immediately adjacent suburban communities. Although the Bank has a diversified
loan portfolio, a large portion of their loans are secured by commercial or
residential real property. The Bank does not generally engage in non-recourse
lending and typically will require the principals of any commercial borrower to
obligate themselves personally on the loan. Although the Bank has diversified
loan portfolios, a substantial portion of their debtors' ability to honor their
contracts is dependent upon the economic sector. Commercial and standby letters
of credit were granted primarily to commercial borrowers.
The Bank has entered into interest rate cap agreements in order to
hedge its exposure to interest rate fluctuations. The Company adopted the
provisions of SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities", as amended, as of January 1, 2001. The statement requires the
Company to recognize all derivative instruments at fair value as either assets
or liabilities. Financial derivatives are reported at fair value in other assets
or other liabilities. For derivatives not designated as hedges, the gain or loss
is recognized in current earnings. Amounts reclassed into earnings, when the
hedged transaction culminates, are included in interest income.
NOTE O - REGULATORY MATTERS
The Bank is subject to various regulatory capital requirements
administered by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory - and possible additional
discretionary - actions by regulators that, if undertaken, could have a direct
material effect on the Bank's consolidated financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Company must meet specific capital guidelines that involve quantitative
measures of the Bank's assets, liabilities and certain off-balance-sheet items
as calculated under regulatory accounting practices. The Bank's capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
Quantitative measures established by regulations to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set forth in
the table below) of total and Tier 1 capital (as defined in the regulations) to
risk-weighted assets, and of Tier 1 capital to average assets. Management
believes that, as of December 31, 2007, the Bank meets all capital adequacy
requirements to which it is subject.
As of December 31, 2007, the Bank met all regulatory requirements for
classification as well capitalized under the regulatory framework for prompt
corrective action. To be categorized as well capitalized, the Bank must maintain
minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set
forth in the following table. There are no conditions or events since that date
that management believes have changed the institution's category.
75
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE O - (CONTINUED)
The following table sets forth the actual and required regulatory
capital amounts and ratios of, the Company and the Bank as of December 31, 2007
and 2006 (dollars in thousands):
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------ ----------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
DECEMBER 31, 2007
Total Capital (to Risk-Weighted Assets)
Company 136,012 18.3% 59,461 >8.0% -- N/A
-
Bank 104,500 14.5% 57,753 >8.0% 72,191 >10.0%
- -
Tier I Capital (to Risk-Weighted Assets)
Company 131,829 17.7% 29,731 >4.0% -- N/A
-
Bank 100,317 13.9% 28,876 >4.0% 43,314 >6.0%
- -
Tier I Capital (to Average Assets)
Company 131,829 12.9% 41,040 >4.0% -- N/A
-
Bank 100,317 9.7% 41,288 >4.0% 51,610 >5.0%
- -
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS
------ ----------------- -----------------
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
DECEMBER 31, 2006
Total Capital (to Risk-Weighted Assets)
Company 128,452 23.9% 43,031 >8.0% -- N/A
-
Bank 99,170 19.3% 41,120 >8.0% 51,400 >10.0%
- -
Tier I Capital (to Risk-Weighted Assets)
Company 124,681 23.2% 21,516 >4.0% -- N/A
-
Bank 95,400 18.6% 20,560 >4.0% 30,840 >6.0%
- -
Tier I Capital (to Average Assets)
Company 124,681 13.4% 37,322 >4.0% -- N/A
-
Bank 95,400 10.9% 35,022 >4.0% 43,778 >5.0%
- -
76
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE P - CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY
The condensed financial information for Berkshire Bancorp Inc. (parent
company only) is as follows:
CONDENSED BALANCE SHEETS
(IN THOUSANDS)
DECEMBER 31,
-------------------------------
2007 2006
--------------- -------------
ASSETS
Cash $ 12,478 $ 11,515
Equity investment in subsidiaries 121,896 113,972
Investment in securities available for sale 12,297 15,874
Accrued interest receivable 215 189
Other assets 1,455 1,023
--------- ---------
Total assets $ 148,341 $ 142,573
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Subordinated debt $ 22,681 $ 22,681
Other liabilities 1,402 4,115
--------- ---------
Total liabilities 24,083 26,796
--------- ---------
Stockholders' equity
Common stock 770 770
Additional paid-in capital 90,986 90,659
Retained earnings 42,352 37,285
Accumulated other comprehensive
loss, net (3,439) (4,772)
Common stock in treasury, at cost (6,411) (8,165)
--------- ---------
Total stockholders' equity 124,258 115,777
--------- ---------
$ 148,341 $ 142,573
========= =========
77
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE P - (CONTINUED)
CONDENSED STATEMENTS OF INCOME
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
2007 2006 2005
-------- -------- -------
INCOME
Interest income from the Bank $ 51 $ 65 $ 53
Interest income 1,271 1,115 1,622
Gain on sales of 125 1,600 10
investment securities
Other income 235 235 217
-------- -------- --------
Total income 1,682 3,015 1,902
EXPENSES
Salaries and employee benefits 771 697 605
Interest expense 1,840 1,780 1,268
Other expenses 746 602 580
-------- -------- --------
Total expenses 3,357 3,079 2,453
-------- -------- --------
Income (loss) before income taxes
and equity in undistributed net
income of the Bank (1,675) (64) (551)
Equity in undistributed
net income of the Bank 6,727 5,203 6,229
-------- -------- --------
Income before taxes 5,052 5,139 5,678
(Benefit) provision for
income taxes (302) 259 137
-------- -------- --------
Net income $ 5,354 $ 4,880 $ 5,541
======== ======== ========
78
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE P - (CONTINUED)
CONDENSED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------------
2007 2006 2005
-------- -------- --------
Operating activities:
Net income $ 5,354 $ 4,880 $ 5,541
Adjustments to reconcile net
income to net cash provided by
(used in) operating activities:
Gain on sales of investment securities (125) (1,600) (10)
Equity in undistributed net income of the Bank (6,727) (5,203) (6,229)
Dividends received from the Bank 1,810 1,730 1,291
(Decrease) increase in other liabilities (1,748) 23 1,025
(Increase) decrease in other assets (99) 816 (851)
-------- -------- --------
Net cash (used in) provided by operating activities (1,535) 646 767
-------- -------- --------
Investing activities:
Investment securities available for sale
Purchases (1,635) (3,725) (4,548)
Sales 6,670 4,854 140
Net (increase) decrease in loans (3,007) -- 6,059
Contributions to the Bank -- -- (7,217)
-------- -------- --------
Net cash provided by (used in) investing activities 2,028 1,129 (5,566)
-------- -------- --------
Financing activities:
Proceeds from exercise of common stock options 1,363 349 1,686
Tax benefits from exercise of common stock options 359 84 697
Acquisition of treasury stock -- (790) --
Issuance of subordinated debentures -- -- 7,217
Dividends paid (1,252) (1,099) (1,020)
-------- -------- --------
Net cash provided by (used in) financing activities 470 (1,456) 8,580
-------- -------- --------
Net increase in cash and cash equivalents 963 319 3,781
Cash and cash equivalents at beginning of year 11,515 11,196 7,415
-------- -------- --------
Cash and cash equivalents at end of year $ 12,478 $ 11,515 $ 11,196
======== ======== ========
79
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE Q - SUBSEQUENT EVENT
At December 31, 2007, our portfolio of investment securities included
approximately $185 million of auction rate securities. These investments have
high credit quality ratings of AA or AAA and are fully collateralized by bonds
and other financial instruments. Auction rate securities are generally long-term
debt instruments that provide liquidity through a Dutch auction process that
resets the applicable interest rate at pre-determined calendar intervals,
generally every 28 days.
Recent uncertainties in the credit markets have negatively impacted our
ability to liquidate, if necessary, investments in auction rate securities
because, in recent auctions, the amount of securities submitted for sale has
exceeded the amount of purchase orders. We are not certain as to when the
liquidity issues relating to these investments will improve. As a result of the
timing of the recent auction failures beginning in February 2008, we are
uncertain as to the current fair market value of the auction rate securities we
hold. Based on the fair market value of the auction rate securities and an
analysis of other-than-temporary impairment factors, including, but not limited
to, whether the credit ratings of the issuers or the insurers deteriorate, or
the collateral of the securities deteriorates, we may be required to reflect a
write-down of certain of our auction rate securities in the first quarter of
2008 as a charge to earnings if any of our auction rate securities are deemed to
be other-than-temporarily impaired. Such impairment charge would be recorded as
other expense and could be material to our results of operations. At December
31, 2007, management evaluated the market value of these securities, concluding
that the values stated herein are appropriate.
Based on our expected operating cash flows, and our other sources of
cash, we do not expect the potential lack of liquidity in these investments to
affect our ability to execute our current business plan.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE.
Not Applicable.
ITEM 9A(T). CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES.
As of the end of the period covered by this Annual Report on Form 10-K, the
Company evaluated the effectiveness of the design and operation of its
"disclosure controls and procedures" as defined in Rule 13a-15(e) of the
Securities Exchange Act of 1934 ("Disclosure Controls"). This evaluation
("Controls Evaluation") was done under the supervision and with the
participation of the Company's management, including the Chief Executive Officer
("CEO"), who is also the Chief Financial Officer ("CFO"). Based upon the
Controls Evaluation, the CEO/CFO has concluded that the Disclosure Controls are
effective in reaching a reasonable level of assurance that information required
to be disclosed by the Company is recorded, processed, summarized and reported
within the time period specified in the Securities and Exchange Commission's
rules and forms and that any material information relating to the Company is
accumulated and communicated with management, including its principal
executive/financial officer to allow timely decisions regarding required
disclosure.
MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING.
Management of the Company is responsible for establishing and maintaining
adequate "internal control over financial reporting" for the Company as defined
in Rule 13a-15(f) under the Securities Exchange Act of 1934 ("Internal
Control"). The Company's Internal Control is designed to provide reasonable
assurance to the Company's management and Board of Directors regarding the
preparation and fair presentation of published financial statements and the
reliability of financial reporting.
80
Management of the Company, including the CEO/CFO, assessed the effectiveness of
the Company's Internal Control as of December 31, 2007. In making this
assessment, management used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission ("COSO") in Internal
Control-Integrated Framework. Based on its assessment, management believes that,
as of December 31, 2007, the Company's Internal Control is effective based on
those criteria.
This Annual Report on Form 10-K does not include an attestation report of the
Company's registered public accounting firm regarding Internal Control.
Management's report was not subject to attestation by the Company's registered
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit the Company to provide only management's report
in this annual report.
LIMITATIONS ON THE EFFECTIVENESS OF CONTROLS.
The Company's management, including the CEO/CFO, does not expect that its
Disclosure Controls and/or its Internal Control will prevent all error and all
fraud. A control system, no matter how well conceived and operated, can provide
only reasonable, not absolute, assurance that the objectives of the control
system are met. Further, the design of a control system must reflect the fact
that there are resource constraints, and the benefits of controls must be
considered relative to their costs.
Because of the inherent limitations in all control systems, no evaluation of
controls can provide absolute assurance that all control issues and instances of
fraud, if any, within the Company have been detected. These inherent limitations
include the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the control. The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions;
over time, control may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING.
In accordance with SEC requirements, the CEO/CFO notes that during the fiscal
quarter ended December 31, 2007, no changes in the Company's Internal Control
have occurred that have materially affected or are reasonably likely to
materially affect the Company's Internal Control.
ITEM 9B. OTHER INFORMATION
On December 18, 2007, the Board of Directors of the Company, upon the
recommendation of the independent directors of the Company, approved bonuses for
fiscal year 2007 to Messrs. Steven Rosenberg, Moses Krausz and David Lukens of
$30,000, $275,000 and $30,000, respectively, and fixed salaries for Messrs.
Steven Rosenberg and David Lukens for fiscal year 2008 at $230,000 and $192,000,
respectively, effective January 1, 2008.
The Bank's Deferred Compensation Plan (the "Plan") was established in
July 2006 to provide for a systematic method by which key employees of the Bank
may defer payment of not less than 3% and not more than 50% of his or her
compensation that would otherwise be payable during the year. The Deferred
Compensation Plan is intended to be a nonqualified and unfunded plan maintained
primarily for the purpose of providing deferred compensation for a select group
of management or highly compensated employees pursuant to Sections 201(2),
301(a)(3) and 401(a)(1) of the Employee Retirement Income Security Act of 1974,
as amended. On November 29, 2007, the Plan was amended with respect to the
selection of the employees eligible to participate in the Plan, and for
additional amounts to be credited to a participant's account.
81
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following are the current directors and executive officers of the Company:
NAME AGE POSITION(S)
---- --- --------------------------------------------------
Steven Rosenberg 59 President, Chief Executive Officer,
Chief Financial Officer and Director
William L. Cohen 66 Director
Martin A. Fischer 70 Director
Moses Marx 72 Director
Randolph B. Stockwell 61 Director
Moses Krausz 67 President of The Berkshire Bank
David Lukens 58 Executive Vice President, Chief Financial Officer
of The Berkshire Bank
Mr. Rosenberg has served as President and Chief Executive Officer of
the Company since March 1999 and as Vice President and Chief Financial Officer
of the Company from April 1990 to March 1999. He continues to serve as Chief
Financial Officer. Mr. Rosenberg was elected a director in May 1995. From
September 1987 through April 1990, he served as President and Director of Scomel
Industries, Inc., a company engaged in international marketing and consulting.
Mr. Rosenberg is a director of The Cooper Companies, Inc. (a developer and
manufacturer of healthcare products).
Mr. Cohen was elected a director in July 1993. He has served as the
Chief Executive Officer of Andover Properties, LLC, a real estate development
company specializing in self storage facilities since November 2003, and has
been a private investor for over six years. Mr. Cohen served as President, Chief
Executive Officer and Chairman of the Board of The Andover Apparel Group, Inc.,
an apparel manufacturing company, from 1980 to 2000.
Mr. Fischer was elected a director on December 6, 2006. He has been the
President and Chief Executive of Mount Carmel Cemetery Association, a New York
State not-for-profit corporation since April 2001. Mr. Fischer was counsel to
Warshaw, Burstein, Cohen, Schlesinger and Kuh, a New York City law firm, from
1987 until 2001 and served as President, Chief Operating Officer and a director
of Kinney System, Inc. and The Katz Parking System, Inc. from 1981 to 1986. Mr.
Fischer was appointed Commissioner of the New York State Insurance Fund in 1977
and served as its Chairman until January 1995.
Mr. Marx was elected a director in May 1995. Mr. Marx has been the
General Partner in United Equities Company since 1954 and General Partner in
United Equities Commodities Company since 1972. He is also President of Momar
Corp. All of these are investment companies. Mr. Marx is a director of The
Cooper Companies, Inc.
Mr. Stockwell was elected a director in July 1988. He has been a
private investor for over ten years. Since April 1999, Mr. Stockwell has served
as President of Yachting Systems of America, LLC. In addition, he served in
various capacities with the Community Bank, a commercial bank, from September
1972 to January 1987.
Mr. Krausz has held the position of President of the Bank since March
1992 and Chief Executive Officer since November 1993. He was elected a director
in May 2007. Prior to joining the Bank, Mr. Krausz was Managing Director of SFS
Management Co., L.P., a mortgage banker, from 1987 to 1992 and was President of
UMB Bank and Trust Company, a New York State chartered bank, from 1978 to 1987.
Mr. Lukens has held the position of Senior Vice President and Chief
Financial Officer of the Bank since December 1999 and Executive Vice President
since December 2003. Prior to joining the Bank, Mr. Lukens was Senior Vice
President and Chief Financial officer of First Washington State Bank, a New
Jersey commercial bank, from 1994 to 1999 and was Vice President and Controller
at the Philadelphia, PA branch of Bank Leumi Le-Israel B.M., an international
commercial bank, from 1978 to 1994.
There are no family relationships (whether by blood, marriage or
adoption) among any of the Company's current directors or executive officers.
82
At each annual meeting of stockholders, the successors to the directors
then serving are elected to serve from the time of their election and
qualification until the next annual meeting following their election or until
their successors have been duly elected and qualified, or until their earlier
death, resignation or removal. All of our current directors have been elected to
serve until the annual meeting of stockholders to be held in 2008. The Company's
officers, except for Messrs. Krausz and Lukens who have employment agreements,
serve at the discretion of the Board of Directors.
AUDIT COMMITTEE MEMBERS, FINANCIAL EXPERT AND INDEPENDENCE
Our Board of Directors has established an Audit Committee comprised of
three independent directors, Messrs. William L. Cohen, Martin A. Fischer and
Randolph B. Stockwell. All of the members of the Audit Committee meet the
independence requirements under current NASDAQ corporate governance standards
for companies whose securities are listed on NASDAQ. Based upon their education
and relevant experience, our Board has determined that Messrs. Cohen and
Stockwell each qualify as financial experts as defined by the Sarbanes-Oxley Act
of 2002 and the rules of the Securities and Exchange Commission.
CORPORATE CODE OF ETHICS
We have adopted a Corporate Code of Ethics that applies to the
directors, officers and employees, including the senior management: the chief
executive officer, chief financial officer, controller and persons performing
similar functions, of Berkshire Bancorp Inc. and its subsidiaries. Copies of our
Corporate Code of Ethics are available without charge upon written request to
the Company, Attention President, at its principal executive office.
ITEM 11. EXECUTIVE COMPENSATION
Our Board of Directors has delegated primary authority for executive
compensation to the three independent members of the Board, or Independent
Directors, who, though not a formal compensation committee of the Board, act in
such capacity.
EXECUTIVE COMPENSATION
The following table shows the compensation paid in or with respect to
the last fiscal year to the individual who served as our Chief Executive Officer
and Chief Financial Officer for the fiscal years ended December 31, 2007 and
2006, and to each of the other executive officers of the Bank whose total
compensation was more than $100,000 during the fiscal years ended December 31,
2007 and 2006 (our "named executive officers").
SUMMARY COMPENSATION TABLE
CHANGE IN
PENSION VALUE
AND
NONQUALIFIED
DEFERRED
COMPENSATION ALL OTHER
NAME AND PRINCIPAL SALARY BONUS EARNINGS COMPENSATION TOTAL
POSITION YEAR $ $ $ $ $
Steven Rosenberg 2006 200,000 25,000 232,267 -- 457,267
President, Chief Executive Officer 2007 220,000 30,000 301,822 -- 551,822
and Chief Financial Officer
Moses Krausz 2006 422,130 250,000 -- 11,424 683,554
President and Chief Executive Officer 2007 436,201 275,000 818 11,575 723,594
of The Berkshire Bank
David Lukens 2006 174,000 25,000 11,996 7,658 218,654
Executive Vice President 2007 183,000 30,000 13,822 8,736 235,558
and Chief Financial Officer
of The Berkshire Bank
83
NARRATIVE TO SUMMARY COMPENSATION TABLE
Mr. Rosenberg does not have an employment agreement with us. The amounts
reported for Change in Pension Value and Nonqualified Deferred Compensation
Earnings includes only the change in the value of his benefit payable under our
Retirement Income Plan. Mr. Rosenberg does not participate in the Bank's 401(k)
Plan or its Deferred Compensation Plan.
Mr. Krausz has an employment agreement with us. The agreement expires on April
30, 2010 unless automatically renewed for up to three additional years as
provided for in the agreement. The agreement provides for the payment to Mr.
Krausz of a specified base salary with fixed annual increases, the payment of a
discretionary bonus and participation in our employee benefit plans. There are
no change in control provisions in Mr. Krausz's employment agreement. Mr. Krausz
is a participant in the Bank's 401(k) Plan and its Deferred Compensation Plan.
The amounts reported in All Other Compensation consists of contributions we made
to Mr. Krausz's 401(k) account of $6,750 and $6,600 in 2007 and 2006,
respectively, and income associated with life insurance coverage.
Mr. Lukens has an employment agreement with us. The agreement will expire on
June 30, 2008 unless automatically renewed for up to three additional years as
provided for in the agreement. The agreement provides for the payment to Mr.
Lukens of a base salary and annual bonus, and participation in our employee
benefit plans. There are no change in control provisions Mr. Lukens' employment
agreement. Mr. Lukens is a participant in the Bank's 401(k) Plan and its
Deferred Compensation Plan. The amounts reported in All Other Compensation
consists of contributions we made to Mr. Lukens' 401(k) account of $6,161 and
$5,970, in 2007 and 2006, respectively, and income associated with life
insurance coverage.
GRANTS OF PLAN-BASED AWARDS IN FISCAL YEAR ENDED DECEMBER 31, 2007
There were no grants of awards made to any of our named executive
officers in 2007 and 2006 under any non-equity or equity incentive plan.
1999 STOCK INCENTIVE PLAN
Our 1999 Stock Incentive Plan permits the granting of awards in the
form of nonqualified stock options, incentive stock options, restricted stock,
deferred stock, and other stock-based incentives. Up to 600,000 shares of our
common stock may be issued pursuant to the 1999 Stock Incentive Plan (subject to
appropriate adjustment in the event of changes in our corporate structure).
Officers, directors and other key employees of us or any of our subsidiaries are
eligible to receive awards under the 1999 Stock Incentive Plan. The option
exercise price of all options which are granted under the 1999 Stock Incentive
Plan must be at least equal to 100% of the fair market value of a share of
common stock of the Company on the date of grant. At December 31, 2007, options
to acquire 550,257 shares of our common stock have been granted under this plan,
2,076 options are outstanding and exercisable, and 49,743 options are available
for future grants.
POST-EMPLOYMENT COMPENSATION
RETIREMENT INCOME PLAN. Our Retirement Income Plan is a noncontributory defined
benefit plan covering substantially all of our full-time, non-union United
States employees. Under the Retirement Income Plan, our benefits were based upon
a combination of employee compensation and years of service. We paid the entire
cost of the plan for our employees and funded such costs as they accrued. Our
funding policy was to make annual contributions within minimum and maximum
levels required by applicable regulations. Our customary contributions were
designed to fund normal cost on a current basis and fund over 30 years the
estimated prior service cost of benefit improvements (15 years of annual gains
and losses). The projected unit cost method was used to determine the annual
cost. Plan assets consist principally of equity and fixed income mutual funds.
84
Benefit accruals were frozen as of September 15, 1988, resulting in a
plan curtailment. As a result of such curtailment, we did not accrue benefits
for future services; however, we did continue to contribute as necessary for any
unfunded liabilities. In 2000, we reinstated the Retirement Income Plan to cover
substantially all of our full-time, non-union United States employees.
Except for Mr. Rosenberg whose benefit is subject to the laws governing
the Retirement Income Plan, a participant in the Retirement Income Plan
accumulates a balance in his or her retirement account by receiving: (i) an
annual retirement credit of 5% of gross wages paid during the year, but not in
excess of the applicable annual maximum compensation permitted to be taken into
account under Internal Revenue Service guidelines for each year of service; and
(ii) an annual interest credit based upon the 30-year U. S. Treasury securities
rate. We pay the entire cost of the Retirement Income Plan for our employees and
fund such costs as they accrue.
Our plan provides for a normal retirement age of 65. However, the
estimated annual unreduced benefits payable under the Retirement Income Plan
upon earlier retirement at age 62 for Messrs. Rosenberg and Lukens are
approximately $160,000 and $16,000, respectively. In accordance with the laws
currently governing the Retirement Income Plan, the estimated annual benefit
payable to Mr. Rosenberg is not expected to increase. Mr. Krausz is not a
participant in the Retirement Income Plan. (See Note K of Notes to Consolidated
Financial Statements for more information concerning the Retirement Income
Plan).
DEFERRED COMPENSATION PLAN. The Bank's deferred compensation plan was
established in July 2006 to provide for a systematic method by which key
employees of the Bank may defer payment of not less than 3% and not more than
50% of his or her compensation that would otherwise be payable during the year.
The Deferred Compensation Plan is intended to be a nonqualified and unfunded
plan maintained primarily for the purpose of providing deferred compensation for
a select group of management or highly compensated employees pursuant to
Sections 201(2), 301(a)(3) and 401(a)(1) of the Employee Retirement Income
Security Act of 1974, as amended.
On June 30 and December 31 of each year, account balances are credited
with the applicable earnings rate, the highest deposit rate paid by the Bank on
its generally available interest bearing deposit accounts (excluding time
deposits), in effect at that time. Distributions from the Deferred Compensation
Plan may be made upon (i) termination of employment, (ii) an unforeseeable
emergency, (iii) death, (iv) disability, as defined under Section 409A of the
Internal Revenue Code of 1986, as amended, (the "Code") and (v) a Change in
Control Event, to the extent such Change in Control Event constitutes
permissible payment under Section 409A of the Code.
COMPENSATION OF DIRECTORS
DIRECTOR COMPENSATION FOR THE FISCAL YEAR ENDED DECEMBER 31, 2007.
FEES EARNED
OR PAID IN ALL OTHER
CASH COMPENSATION TOTAL
NAME $ $ $
William L. Cohen 32,500 -- 32,500
Moses Marx 27,500 -- 27,500
Martin A. Fischer 29,333 -- 29,333
Randolph B. Stockwell 32,500 -- 32,500
Each director who is not also an employee receives a stipend of $25,000
per annum and $1,500 for each day during which he participates in a meeting of
the Board or a Committee of the Board. Each of these directors also receives a
fee of $1,000 for telephonic meetings of the Board or a Board Committee. In
addition, see "1999 Stock Incentive Plan" above.
85
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND RELATED
STOCKHOLDER MATTERS.
The following table sets forth certain information as of March 26, 2008
with respect to the beneficial ownership of our Common Stock by (i) each person
who is known by us to own beneficially more than 5% of our Common Stock, (ii)
each of our directors and persons named in the Summary Compensation Table, and
(iii) all executive officers and directors as a group.
AMOUNT AND NATURE
NAME AND ADDRESS OF OF BENEFICIAL PERCENT
TITLE OF CLASS BENEFICIAL OWNER OWNERSHIP OF CLASS
--------------------- ------------------------------------------- --------------------- -----------
Common Stock William L. Cohen 7,500 *
Common Stock Martin A. Fischer 9,800 *
Common Stock Moses Krausz 90,464 (1) 1.3%
Common Stock David Lukens 600 *
Common Stock Moses Marx 3,822,702 (2) 54.2%
160 Broadway
New York, NY 10038
Common Stock Steven Rosenberg 62,580 *
Common Stock Randolph B. Stockwell 21,000 *
Common Stock All executive officers and directors as a
group (7 persons) 4,014,646 56.9%
---------------------------------------------------------
* Less than 1%
(1) Includes 2,100 shares owned by Mr. Krausz's spouse.
(2) Includes 285,000 shares owned by Momar Corporation and 386,163 shares
owned by Terumah Foundation. Does not include 37,302.32 shares
representing 23.0% of the shares owned by Eva and Esther, L.P., of
which Mr. Marx has a 23.0% limited partnership interest. Mr. Marx's
daughters and their husbands are the general partners of Eva and
Esther, L.P.
EQUITY COMPENSATION PLANS
The following table details information regarding our existing equity
compensation plans as of December 31, 2007.
(c)
NUMBER OF SECURITIES
(a) (b) REMAINING AVAILABLE FOR
NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE FUTURE ISSUANCE UNDER
ISSUED UPON EXERCISE OF EXERCISE PRICE OF EQUITY COMPENSATION PLANS
OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, (EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN (a)
------------- ------------------- ------------------- -----------------------
Equity compensation 2,076 $ 9.76 49,743
plans approved by
security holders
Equity compensation -- -- --
plans not approved by
security holders
Total 2,076 $ 9.76 49,743
86
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
AND DIRECTOR INDEPENDENCE.
The Bank has made loans to certain of its directors and their
affiliates and, assuming continued compliance with generally applicable credit
standards, it expects to continue to make such loans. All of these loans (i)
were made in the ordinary course of business, (ii) were made on the same terms,
including interest rates, as those available to other persons not related to the
Company, and (iii) did not involve more than the normal risk of collectibility
or present other unfavorable features.
In January 2000, the Bank entered into a lease agreement with Bowling
Green Associates, LP, the principal owner of which is Mr. Marx, for commercial
space to open a bank branch. We obtained an appraisal of the market rental value
of the space from an independent appraisal firm and management believes that the
terms of the lease, including the annual rent paid, $368,000 and $328,000 in
fiscal 2007 and 2006, is comparable to the terms and annual rent that would be
paid to non-affiliated parties in a similar commercial transaction for similar
commercial space.
See Item 1. Business - Transactions With Related Parties and Item 2.
Properties for additional information.
INDEPENDENCE OF DIRECTORS
Our board has determined that Messrs. William L. Cohen, Martin A. Fischer
and Randolph B. Stockwell are independent under the independence standards of
the NASDAQ Stock Market LLC.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The Company's principal accountant is Grant Thornton LLP ("Grant
Thornton"). The total fees paid to Grant Thornton for the last two fiscal years
are as follows:
FISCAL YEAR ENDED FISCAL YEAR ENDED
DECEMBER 31, 2007 DECEMBER 31, 2006
----------------------- -----------------------
AUDIT FEES $316,380 $281,540
AUDIT RELATED FEES: Professional services -- --
rendered for employee benefit plan audits,
accounting assistance in connection with
acquisitions and consultations related to
financial accounting and reporting standards
TAX FEES: Tax consulting, preparation of 68,910 68,200
returns
ALL OTHER FEES: Professional services -- --
rendered for corporate support
The Audit Committee has established its pre-approval policies and
procedures, pursuant to which the Audit Committee approved the foregoing audit
and permissible non-audit services provided by Grant Thornton LLP in 2007 and
2006. Consistent with the Audit Committee's responsibility for engaging our
independent auditors, all audit and permitted non-audit services require
pre-approval by the Audit Committee. The full Audit Committee approves proposed
services and fee estimates for these services. The Audit Committee chairperson
has been designated by the Audit Committee to approve any services arising
during the year that were not pre-approved by the Audit Committee and services
that were pre-approved. Service approved by the Audit Committee chairperson are
communicated to the full Audit Committee at its next regular quarterly meeting
and the Audit Committee reviews services and fees for the fiscal year at each
such meeting. Pursuant to these procedures, the Audit Committee approved the
foregoing audit and permissible non-audit services provided by Grant Thornton
LLP.
87
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(a) DOCUMENTS FILED AS PART OF THIS REPORT:
(1) Financial Statements
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2007 and 2006
Consolidated Statements of Income for the Years Ended December 31,
2007, 2006 and 2005
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 2007, 2006 and 2005
Consolidated Statements of Cash Flows for the Years Ended December 31,
2007, 2006 and 2005
Notes to Consolidated Financial Statements
Schedule
Number Description
-------- -----------
None
All schedules for which provision is made in the applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are not applicable and, therefore, have been omitted.
(3) Exhibits
EXHIBIT
NUMBER DESCRIPTION
------ -----------
2.1 Agreement and Plan of Reorganization, dated as of August 16, 2000, by
and between Berkshire Bancorp Inc., Greater American Finance Group,
Inc., The Berkshire Bank, GSB Financial Corporation and Goshen Savings
Bank (incorporated by reference to the Companies Registration Statement
on Form S-4 dated October 13, 2000.
3.1 Amended and Restated Certificate of Incorporation of the Company
(incorporated by reference to Exhibit 3.1 to the Company's Current
Report on Form 8-K dated March 30, 1999, and the Company's Quarterly
Report on Form 10-Q for the Quarterly Period Ended June 30, 2004).
3.2 Amended and Restated By-laws of the Company (incorporated by reference
to Exhibit 3.2 to the Company's Current Report on Form 8-K dated March
30, 1999).
10.1 1999 Stock Incentive Plan of the Company (incorporated by reference to
Exhibit 10.8 to the Company's Current Report on Form 8-K dated March
30, 1999).+
10.2 Employment Agreement, dated May 1, 1999, between The Berkshire Bank and
Moses Krausz (incorporated by reference to Exhibit 10.3 to the
Company's Annual Report on Form 10-K for the Fiscal Year Ended December
31, 2000).+
10.3 Employment Agreement, dated January 1, 2001, between The Berkshire Bank
and David Lukens (incorporated by reference to Exhibit 10.4 to the
Company's Annual Report on Form 10-K for the Fiscal Year Ended December
31, 2000).+
10.4 Lease Agreement, dated October 26, 1999, between Braun Management, Inc.
as agent for Bowling Green Associates, L.P., and The Berkshire Bank
(incorporated by reference to Exhibit 10.5 to the Company's Quarterly
Report on Form 10-Q for the Quarterly Period Ended March 31, 2001).
10.5 Amendment No. 2 to Employment Agreement, dated January 1, 2001, by and
between The Berkshire Bank and David Lukens (incorporated by reference
to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
Quarterly Period Ended June 30, 2006).+
88
10.6 Deferred Compensation Plan of The Berkshire Bank, dated June 27, 2005,
(incorporated by reference to Exhibit 10.2 to the Company's Quarterly
Report on Form 10-Q for the Quarterly Period Ended June 30, 2006).+
10.7 Amendment No. 1 to Deferred Compensation of The Berkshire Bank, dated
August 17, 2006 (incorporated by reference to Exhibit 10.1 to the
Company's Quarterly Report on Form 10-Q for the Quarterly Period Ended
September 30, 2006).+
10.8 Amendment No. 3 to Employment Agreement, dated July 23, 2007, by and
between The Berkshire Bank and Moses Krausz (incorporated by reference
to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
Quarterly Period Ended June 30, 2007).+
10.9 Amendment No. 2 to Deferred Compensation of The Berkshire Bank, dated
August 17, 2006.+
21. Subsidiaries of the Company.
23. Consent of Independent Registered Public Accounting Firm
31. Certification of Principal Executive and Financial Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32. Certification of Principal Executive and Financial Officer pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
--------------------------
+ Denotes a management compensation plan or arrangement.
89
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON
ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
BERKSHIRE BANCORP INC.
BY: /s/ Steven Rosenberg
--------------------------------------
STEVEN ROSENBERG
President, (Chief Executive Officer)
DATE: March 26, 2008
--------------------------------------
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934,
THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.
Signature Title Date
--------- ----- ----
President, (Chief
Executive Officer,
Principal Financial
Officer and Principal
Accounting Officer);
/s/ Steven Rosenberg Director March 26, 2008
-------------------------
STEVEN ROSENBERG
/s/ William L. Cohen Director March 26, 2008
-------------------------
WILLIAM L. COHEN
/s/ Martin A. Fischer Director March 26, 2008
-------------------------
MARTIN A. FISCHER
/s/ Moses Krausz Director March 26, 2008
-------------------------
MOSES KRAUSZ
/s/ Moses Marx Director March 26, 2008
-------------------------
MOSES MARX
/s/ Randolph B. Stockwell Director March 26, 2008
--------------------------
RANDOLPH B. STOCKWELL
90