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BERK > SEC Filings for BERK > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for BERKSHIRE BANCORP INC /DE/ | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for BERKSHIRE BANCORP INC /DE/


14-Nov-2012

Quarterly Report


ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Executive Summary

We are a Delaware corporation organized in March 1979, and a bank holding company registered under the Bank Holding Company Act of 1956. We acquired The Berkshire Bank (the "Bank"), our indirect wholly-owned subsidiary in March 1999. The Bank was organized in 1987 as a New York State chartered commercial bank. Our principal activity is the ownership and management of the Bank. Our activities are primarily funded by cash on hand, rental income, income from our portfolio of investment securities and dividends, if any, received from the Bank. Our common stock is traded on the NASDAQ Stock Market under the symbol "BERK."

The Bank's principal business consists of gathering deposits from the general public and investing those deposits together with funds generated from ongoing operations and borrowings, primarily in residential and commercial loans, debt obligations issued by the U.S. Government and its agencies, debt obligations of business corporations, and mortgage-backed securities. The Bank 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 Teaneck, New Jersey. The Bank's revenues are derived principally from interest on loans, and interest and dividends on investments in the securities portfolio. The Bank's primary regulator at the state level is 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"). Deposits are insured to the maximum allowable amount by the FDIC. The Bank is a member of the Federal Home Loan Bank system. The Company, as a bank holding company, is regulated by the Federal Reserve Board of New York.

Our results of operations depend primarily on net interest income, which is the difference between the income earned on our interest-earning assets and the cost of our interest-bearing liabilities. Net interest income is the result of our interest rate margin, which is the difference between the average yield earned on interest-earning assets and the average cost of interest-bearing liabilities, adjusted for the difference in the average balance of interest-earning assets as compared to the average balance of interest-bearing liabilities. We also generate non-interest income from loan fees, service charges on deposit accounts, mortgage servicing fees, and other fees, dividends on Federal Home Loan Bank of New York ("FHLB-NY") stock and net gains and losses on sales of securities and loans. Our operating expenses consist principally of employee compensation and benefits, occupancy and equipment costs, other general and administrative expenses and income tax expense. Our results of operations also can be significantly affected by our periodic provision for loan losses and specific provision for losses on loans.

On July 21, 2010 the Dodd-Frank Act was signed into law by President Obama. The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States, establishes the Consumer Financial Protection Bureau (the "Bureau"), and will require the Bureau and other federal agencies to implement many new and significant rules and regulations. At this time it is difficult to predict the extent to which the Dodd-Frank Act or the resulting rules and regulations will impact our business. Compliance with these new laws and regulations will likely result in additional costs, and may adversely impact our results of operations, financial condition or liquidity.

Our investment policy, approved by the Board of Directors, is designed primarily to manage the interest rate sensitivity of our overall assets and liabilities, to generate a favorable return without incurring undue interest rate and credit risk, to complement our lending activities and to provide and maintain liquidity. In establishing our investment strategies, we consider our business and growth strategies, the economic environment, our interest rate risk exposure, our interest rate sensitivity "gap" position, the types of securities to be held, and other factors. We classify our investment securities as available for sale.

We decreased our provision for loan losses by $4.2 million during the nine months ended September 30, 2012 compared to an increase in the provision for loan losses of $1.6 million during the nine months ended September 30, 2011. The decrease in the provision for loan losses was deemed appropriate as a result of the regular quarterly analysis of the allowance for loan losses. The regular quarterly analysis is based on management's evaluation of the risk inherent in the various components of the loan portfolio and other factors, including historical loan loss experience (which is updated at least annually), changes in the composition and volume of the portfolio, collection policies and experience, trends in the volume of non-accrual loans and regional and national economic conditions. See "Provision for Loan Losses" below in this Item 2 for further discussion of the allowance for loan losses.

Net income, before the provision or benefit for income taxes, for the three and nine months ended September 30, 2012 was $6.4 million and $9.8 million, respectively, compared to net income, before dividends on our Series A Preferred Stock and before the provision for income taxes, for the three and nine months ended September 30, 2011 of $3.3 million and $49.6 million, respectively. Net income for the nine months ended September 30, 2012 includes the gain of $4.2 million due to the decrease in the provision for loan losses. No Series A Preferred Stock was outstanding during 2012. Net income for the three and nine months ended September 30, 2011 includes a one time gain of $42.5 million due to the settlement agreement discussed below.

Net income allocated to common stockholders, after the provision for income taxes, was $3.2 million and $8.7 million for the three and nine months ended September 30, 2012, respectively. Net income allocated to common stockholders, after dividends on our Series A Preferred Stock and provision for income taxes, was $1.8 million and $43.6 million for the three and nine months ended September 30, 2011, respectively.

In April 2012, we received a notice from the Federal Reserve Bank of New York stating that they do not object to the Company's request to redeem $15.5 million of Floating Rate Junior Subordinated Debt Securities Due 2034. On July 23, 2012, we redeemed said security, including accrued interest.

On May 16, 2011, we entered into a settlement agreement with the selling financial institution of the auction rate securities in the Bank's investment portfolio. Pursuant to the agreement, in settlement of all claims made by the Bank, the institution paid to the Bank the sum of $42.5 million, which is recorded in other income on the Statement of Operations.

Recent Developments

In late October 2012, Hurricane Sandy caused damage and business interruption to the Company's cable systems, with the most significant impact in the New York metropolitan area. The Company is in the early stages of assessing the financial, operational and customer impacts of the storm, including impact on properties held by the Bank as collateral, and is, therefore, unable to estimate its full financial and operational impact. However, it is not expected to be significant to the Company's overall fourth-quarter 2012 financial results.

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. All references to earnings per share, unless stated otherwise, refer to earnings per diluted share. References to Notes herein are references to the "Notes to Consolidated Financial Statements" of the Company located in Item 1 herein.

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 ("GAAP") and general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and 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. See "Provision for Loan Losses" below in this Item 2 for further discussion of the allowance for loan losses.

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.

The Company conducts a periodic review and evaluation of its securities portfolio, taking into account the severity and duration of each unrealized loss, as well as management's intent and ability to hold the security until the unrealized loss is substantially eliminated, in order to determine if a decline in market value of any security below its carrying value is either temporary or other than temporary. Unrealized losses on held-to-maturity securities that are deemed temporary are disclosed but not recognized. Unrealized losses on debt or equity securities available-for-sale that are deemed temporary are excluded from net income and reported net of deferred taxes as other comprehensive income or loss. All unrealized losses that are deemed other than temporary on either available-for-sale or held-to-maturity securities are recognized immediately as a reduction of the carrying amount of the security, with a charge recorded in the Company's consolidated statements of operations.

The following table presents the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed in both dollars and rates.

                                                        For The Three Months Ended September 30,
                                                   2012                                           2011
                                               Interest                                        Interest
                                 Average          and            Average         Average          and           Average
                                 Balance       Dividends       Yield/Rate        Balance       Dividends      Yield/Rate
                                                                (Dollars in Thousands)
INTEREST-EARNING ASSETS:
Loans (1)                       $ 312,192     $     4,658              5.97 %   $ 332,246     $     5,229            6.30 %
Investment securities             405,846           2,406              2.37       418,746           3,240            3.09
Other (2)(5)                      121,233              59              0.19       108,682              65            0.24
Total interest-earning assets     839,271           7,123              3.39       859,674           8,534            3.97
Noninterest-earning assets         28,505                                          29,937
Total Assets                    $ 867,776                                       $ 889,611

INTEREST-BEARING LIABILITIES:
Interest bearing deposits         238,740             118              0.20 %     219,882             236            0.43 %
Time deposits                     358,442           1,026              1.14       377,837           1,267            1.34
Other borrowings                   60,358             515              3.41        80,437             721            3.59
Total interest-bearing
liabilities                       657,540           1,659              1.01       678,156           2,224            1.31

Demand deposits                    75,733                                          78,270
Noninterest-bearing
liabilities                         4,302                                          11,751
Stockholders' equity (5)          130,201                                         121,434

Total liabilities and
stockholders' equity            $ 867,776                                       $ 889,611

Net interest income                           $     5,464                                     $     6,310

Interest-rate spread (3)                                               2.38 %                                        2.66 %

Net interest margin (4)                                                2.60 %                                        2.94 %

Ratio of average
interest-earning assets to
average interest bearing
liabilities                          1.28                                            1.27

(1) Includes nonaccrual loans.

(2) Includes interest-bearing deposits, federal funds sold and securities purchased under agreements to resell.

(3) Interest-rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest bearing liabilities.

(4) Net interest margin is net interest income as a percentage of average interest-earning assets.

(5) Average balances are daily average balances except for the parent company which have been calculated on a monthly basis.

                                                     For The Nine Months Ended September 30,
                                               2012                                            2011
                                           Interest                                         Interest
                            Average           and            Average         Average           and           Average
                            Balance        Dividends       Yield/Rate        Balance        Dividends      Yield/Rate
                                                             (Dollars in Thousands)

INTEREST-EARNING ASSETS:
Loans (1)                  $  317,757     $    14,445              6.06 %   $  343,668     $    16,406            6.37 %
Investment securities         412,310           7,143              2.31        390,962           9,901            3.38
Other (2)(5)                  109,651             243              0.30         93,964             199            0.28
Total interest-earning
assets                        839,718          21,831              3.47        828,594          26,506            4.27
Noninterest-earning
assets                         28,432                                           30,799
Total Assets               $  868,150                                       $  859,393

INTEREST-BEARING
LIABILITIES:
Interest bearing
deposits                      229,318             325              0.19 %      213,552             754            0.47 %
Time deposits                 363,464           3,219              1.18        383,221           3,858            1.34
Other borrowings               71,820           1,747              3.24         81,567           2,227            3.64
Total interest-bearing
liabilities                   664,602           5,291              1.06        678,340           6,839            1.34

Demand deposits                73,373                                           78,306
Noninterest-bearing
liabilities                     4,714                                            7,970
Stockholders' equity (5)      125,461                                           94,777

Total liabilities and
stockholders' equity       $  868,150                                       $  859,393

Net interest income                       $    16,540                                      $    19,667

Interest-rate spread (3)                                           2.41 %                                         2.93 %

Net interest margin (4)                                            2.63 %                                         3.16 %

Ratio of average
interest-earning assets
to average interest
bearing liabilities              1.26                                             1.22

(1) Includes nonaccrual loans.

(2) Includes interest-bearing deposits, federal funds sold and securities purchased under agreements to resell.

(3) Interest-rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest bearing liabilities.

(4) Net interest margin is net interest income as a percentage of average interest-earning assets.

(5) Average balances are daily average balances except for the parent company which have been calculated on a monthly basis.

Results of Operations

Results of Operations for the Three and Nine Months Ended September 30, 2012 Compared to the Three and Nine Months Ended September 30, 2011.

Net Income Allocated to Common Stockholders.Net income allocated to common stockholders for the three and nine-month periods ended September 30, 2012 was $3.2 million and $8.7 million, respectively, or $.22 and $.60 per common share, respectively. Net income allocated to common stockholders for the three and nine-month periods ended September 30, 2011 was $1.8 million and $43.6 million, respectively, or $.25 and $6.18 per common share, respectively.

The net income allocated to common stockholders reported for the three months ended September 30, 2012 includes a provision for income taxes of $3.3 million, or $.23 per common share. The net income allocated to common stockholders reported for the nine months ended September 30, 2012 includes a provision for income taxes of $1.2 million, or $.08 per common share. The net income allocated to common stockholders reported for the three months ended September 30, 2011 includes (i) dividends accrued on our Series A Preferred Stock of $1.2 million, or $.17 per common share and (ii) provision for income taxes of $281,000, or $.04 per common share. The net income allocated to common stockholders reported for the nine months ended September 30, 2011 includes (i) dividends accrued on our Series A Preferred Stock of $3.6 million, or $.51 per common share, (ii) a provision for income taxes of $2.4 million, or $.34 per common share, and (iii) a one-time settlement payment of $42.5 million, or $6.02 per common share.

The Company's net income is largely dependent on interest rate levels, the demand for the Company's loan and deposit products and the strategies employed to manage the interest rate and other risks inherent in the banking business.

Net Interest Income. The Company's primary source of revenue is net interest income, or the difference between interest income earned on interest-earning assets, such as loans and investment securities, and interest expense on interest-bearing liabilities such as deposits and borrowings. The amount of interest income is dependent upon many factors including: (i) the amount of interest-earning assets that the Company can maintain based upon its funding sources; (ii) the relative amounts of interest-earning assets versus interest-bearing liabilities; and (iii) the difference between the yields earned on those assets and the rates paid on those liabilities. Non-performing loans adversely affect net interest income because they must still be funded by interest-bearing liabilities, but they do not provide interest income. Furthermore, when we designate an asset as non-performing, all interest which has been accrued but not actually received is deducted from current period income, further reducing net interest income.

For the three and nine-month periods ended September 30, 2012, net interest income was $5.5 million and $16.5 million, respectively, compared to net interest income of $6.3 million and $19.7 million for the three and nine-month periods ended September 30, 2011. The decrease in net interest income during the 2012 periods compared to the 2011 periods was primarily due to the decrease in the average yields earned on the average amount of interest-earning assets, partially offset by the decrease in the average amount of interest-bearing liabilities and the decrease in the average rates paid on interest-bearing liabilities.

The average yields earned on interest-earning assets declined to 3.39% and 3.47% during the three and nine months ended September 30, 2012, respectively, from 3.97% and 4.27% during the three and nine months ended September 30, 2011, respectively. The average rates paid on interest-bearing liabilities declined to 1.01% and 1.06% during the three and nine months ended September 30, 2012, respectively, from 1.31% and 1.34% during the three and nine months ended September 30, 2011, respectively. The Company's interest-rate spread, the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, declined to 2.38% and 2.41% during the three and nine months September 30, 2012, respectively, from 2.66% and 2.93% during the three and nine months ended September 30, 2011, respectively.

Net Interest Margin. Net interest margin, or annualized net interest income as a percentage of average interest-earning assets, was 2.60% and 2.63% for the three and nine months ended September 30, 2012, respectively, compared to 2.94% and 3.16% during the three and nine months ended September 30, 2011. We seek to secure and retain customer deposits with competitive products and rates, while making strategic use of the prevailing interest rate environment to borrow funds at what we believe to be attractive rates. We invest such deposits and borrowed funds in a prudent mix of fixed and adjustable rate loans, investment securities and short-term interest-earning assets. The decrease in net interest margin is primarily due to the decrease in the average amounts of higher yielding loans as a percentage of the total mix of interest-earning assets.

Interest Income. Total interest income for the quarter ended September 30, 2012 decreased by $1.4 million to $7.1 million from $8.5 million for the quarter ended September 30, 2011. The decrease in total interest income was primarily due to the decrease in the average yield earned on the average amount of interest-earning assets to 3.39% during the 2012 quarter from 3.97% during the 2011 quarter, and the decrease in the average amount of higher yielding loans to $312.2 million during the 2012 quarter from $332.2 million during the 2011 quarter.

Total interest income for the nine-month period ended September 30, 2012 decreased by $4.7 million to $21.8 million from $26.5 million for the nine-month period ended September 30, 2011. The decrease in total interest income was due to the decrease in the average yield earned on the average amount of interest-earning assets to 3.47% during the nine-month period of 2012 from 4.27% during the nine-month period of 2011 and the decrease in the average amount of higher yielding loans to $317.8 million during the nine-month period of 2012 from $343.7 million during the nine-month period of 2011.

The following tables present the composition of interest income for the indicated periods:

                                 Three Months Ended September 30,
                                 2012                        2011
                         Interest        % of        Interest        % of
                          Income        Total         Income        Total
                                (In thousands, except percentages)
Loans                   $    4,658        65.39 %   $    5,229        61.27 %
Investment Securities        2,406        33.78          3,240        37.97
Other                           59         0.83             65         0.76
Total Interest Income   $    7,123       100.00 %   $    8,534       100.00 %




                                 Nine Months Ended September 30,
                                 2012                       2011
                        Interest        % of       Interest        % of
                         Income        Total        Income        Total
                               (In thousands, except percentages)
Loans                   $  14,445        66.17 %   $  16,406        61.90 %
Investment Securities       7,143        32.72         9,901        37.35
Other                         243         1.11           199         0.75
Total Interest Income   $  21,831       100.00 %   $  26,506       100.00 %

Loans, which are inherently risky and therefore command a higher return than our portfolio of investment securities and other interest-earning assets, decreased to 37.2% and 37.8% of total average interest-earning assets during the three and nine months ended September 30, 2012, respectively, from 38.6% and 41.5% of total interest-earning assets during the three and nine months ended September 30, 2011, respectively. The average amounts of investment securities was 48.4% and 49.1% of total average interest-earning assets during the three and nine months ended September 30, 2012, respectively, compared to 48.7% and 47.2% of total interest-earning assets during the three and nine months ended September 30, 2011, respectively. While we actively seek to originate new loans with qualified borrowers who meet the Bank's underwriting standards, our strategy has been to maintain those standards, sacrificing some current income to avoid possible large future losses in the loan portfolio.

At September 30, 2012 and 2011, total non-performing loan assets were $511,000 and $6.3 million, respectively, all of which were non-accrual loans. Depending upon the contractual interest rate of a loan, significant additions to non-performing loans, were such additions to occur, could have a material adverse effect on our results of operations. The effect of the decrease in non-accrual loans in 2012 from 2011 was negligible.

Federal Home Loan Bank Stock. The Bank owns stock of the Federal Home Loan Bank New York ("FHLB-NY") which is necessary for it to be a member of the FHLB-NY. Membership requires the purchase of stock equal to 1% of the Bank's residential mortgage loans or 5% of the outstanding borrowings, whichever is greater. The stock is redeemable at par. Therefore, its cost is equivalent to its redemption value. The Bank's ability to redeem FHLB-NY shares is dependent upon the redemption practices of the FHLB-NY. At September 30, 2012, the FHLB-NY neither placed restrictions on redemption of shares in excess of a member's required investment in stock, nor stated that it will cease paying dividends. The Bank did not consider this asset impaired at either September 30, 2012 or December 31, 2011.

Interest Expense. Total interest expense for the quarter ended September 30, 2012 decreased by $500,000 to $1.7 million from $2.2 million for the quarter ended September 30, 2011. The decrease in interest expense was due to the decrease in the average amounts of interest-bearing liabilities to $657.5 million from $678.2 million during the three months ended September 30, 2012 and . . .

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