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BERK > SEC Filings for BERK > Form 10-Q on 13-Nov-2013All 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/


13-Nov-2013

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 State Department of Financial Services (the "NYSDFS"), 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 Bank of New York.

The May 14, 2009 Memorandum of Understanding (MOU) entered into between the board of directors of the Bank, the FDIC and the NYSDFS was replaced on January 31, 2013 with a revised MOU between the board of directors of the Bank, the FDIC and the NYSDFS and covers supervisory concerns and Bank Secrecy Act weakness.

The MOU requires that a committee of the board of directors of the Bank of at least three directors ("Compliance Committee") be established to ensure compliance with the MOU. The Compliance Committee meets monthly and presents a monthly written status report to the board of the Bank on actions taken by the Bank to comply with the MOU.

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.

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 primarily classify our investment securities as available for sale.

We decreased our provision for loan losses by $865,000 thousand during the nine months ended September 30, 2013 compared to a decrease in the provision for loan losses of $4.2 million during the nine months ended September 30, 2012. 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, 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. No net provisions were made during any of the quarters ended September 30, 2013.

Net income, before the provision for income taxes, for the three and nine months ended September 30, 2013 was $1.6 million and $4.5 million, respectively, compared to net income, before the benefit for income taxes, for the three and nine months ended September 30, 2012 of $6.4 million and $9.8 million, respectively.

Net income was $1.0 million and $2.9 million for the three and nine months ended September 30, 2013, respectively, compared to $3.2 million and $8.7 million for the three and nine months ended September 30, 2012, respectively.

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,
                                            2013                                 2012
                                           Interest    Average                  Interest    Average
                               Average       and       Yield/       Average       and       Yield/
                               Balance    Dividends     Rate        Balance    Dividends     Rate
                                                     (Dollars in Thousands)
INTEREST - EARNING ASSETS:
Loans (1)                     $ 306,955   $    4,265      5.56 %   $ 312,192   $    4,658      5.97 %
Investment securities           353,623        2,174      2.46 %     405,846        2,406      2.37 %
Other (2)(5)                     86,666           72      0.33 %     121,233           59      0.19 %
Total interest - earning
assets                          747,244        6,511      3.49 %     839,271        7,123      3.39 %
Noninterest - earning
assets                           26,160                               28,505
Total Assets                    773,404                              867,776

INTEREST - BEARING
LIABILITIES:
Interest bearing deposits       201,497          132      0.26 %     238,740          118      0.20 %
Time deposits                   316,923          733      0.93 %     358,442        1,026      1.14 %
Other borrowings                 32,772          263      3.21 %      60,358          515      3.41 %
Total interest - bearing
liabilites                      551,192        1,128      0.82 %     657,540        1,659      1.01 %

Demand deposits                  85,124                               75,733
Noninterest - bearing
liabilities                       5,852                                4,302
Stockholders' equity (5)        131,236                              130,201

Total liabilities and
stockholders' equity          $ 773,404                            $ 867,776

Net interest income                       $    5,383                           $    5,464

Interest - rate spread (3)                                2.67 %                               2.38 %

Net interest margin (4)                                   2.88 %                               2.60 %

Ratio of average interest -
earning assets to average
interest bearing
liabilities                        1.36                                 1.28

(1)Includes nonaccrual loans.
(2)Includes interest-bearing deposits, federal funds sold, and dividends on FHLBNY stock.
(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,
                                             2013                              2012
                                           Interest    Average               Interest    Average
                                 Average      and      Yield/      Average      and      Yield/
                                 Balance   Dividends    Rate       Balance   Dividends    Rate
                                                     (Dollars in thousands)
INTEREST - EARNING ASSETS:
Loans (1)                        299,274      12,741      5.68 %   317,757      14,445      6.06 %
Investment securities            355,516       6,452      2.42 %   412,310       7,143      2.31 %
Other (2)(5)                     116,393         275      0.32 %   109,651         243      0.30 %
Total interest - earning
assets                           771,183      19,468      3.37 %   839,718      21,831      3.47 %
Noninterest - earning assets      24,545                            28,432
Total Assets                     795,728                           868,150

INTEREST - BEARING
LIABILITIES:
Interest bearing deposits        205,214         387      0.25 %   229,318         325      0.19 %
Time deposits                    326,112       2,385      0.98 %   363,464       3,219      1.18 %
Other borrowings                  41,241       1,037      3.35 %    71,820       1,747      3.24 %
Total interest - bearing         572,567       3,809      0.89 %   664,602       5,291      1.06 %

Liabilities

Demand deposits                   82,406                            73,373
Noninterest - bearing
liabilities                        5,930                             4,714
Stockholders' equity (5)         134,825                           125,461

Total liabilities and
stockholders' equity             795,728                           868,150

Net interest income                           15,659                            16,540

Interest - rate spread (3)                                2.48 %                            2.41 %

Net interest margin (4)                                   2.71 %                            2.63 %
Ratio of average interest -
earning assets to average
interest bearing liabilities        1.35                              1.26

(1)Includes nonaccrual loans.
(2)Includes interest-bearing deposits, federal funds sold, dividends on FHLBNY stock.
(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, 2013 Compared to the Three and Nine Months Ended September 30, 2012.

Net Income. Net income for the three and nine months ended September 30, 2013 was $1.0 million and $2.9 million, respectively, or $0.07 per share and $0.20 per share, respectively, compared to net income of $3.2 million and $8.7 million, respectively, or $0.22 per share and $0.60 per share, for the three and nine months ended September 30, 2012, respectively.

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, 2013, net interest income was $5.4 million and $15.7 million, respectively, compared to net interest income of $5.5 million and $16.5 million, respectively, for the three and nine-month periods ended September 30, 2012. The decrease in net interest income during the 2013 period compared to the 2012 period was primarily due to the decrease in the average interest earning asset balances for both the three month and the nine month periods ending September 30, 2013.

The average yields earned on interest-earning assets increased to 3.49% and declined to 3.37% during the three and nine-month periods ended September 30, 2013, respectively, from 3.39% and 3.47% during the three and nine-month periods ended September 30, 2012, respectively. The average rates paid on interest-bearing liabilities declined to 0.82% and 0.89% during the three and nine-month periods ended September 30, 2013, respectively, from 1.01% and 1.06% during the three and nine-month periods ended September 30, 2012, 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, increased to 2.67% and 2.48% during the three and nine-month periods ended September 30, 2013, respectively, from 2.38% and 2.41% during the three and nine-month periods ended September 30, 2012, respectively.

Net Interest Margin. Net interest margin, or annualized net interest income as a percentage of average interest-earning assets, was 2.88% and 2.71% for the three and nine-month periods ended September 30, 2013, respectively, compared to 2.60% and 2.63% for the three and nine-month periods ended September 30, 2012, respectively. We seek to secure and retain customer deposits with competitive products and rates, while making strategic use of the prevailing interest rate environment to borrow funds at what we believe to be attractive rates. We invest such deposits and borrowed funds in a prudent mix of fixed and adjustable rate loans, investment securities, and short-term interest-earning assets. The increase in net interest margin is primarily due to the increase in the average amounts of higher yielding investment securities as a percentage of the total mix of interest-earning assets.

Interest Income. Total interest income for the quarter ended September 30, 2013 decreased by $0.6 million to $6.5 million from $7.1 million for the quarter ended September 30, 2012. The decrease in total interest income was primarily due to the decrease in the average outstanding balances of interest earning assets to $747.2 million from $839.3 million, offset by a decrease in the average balances of interest bearing liabilities to $551.2 from $ 657.5 at September 30, 2013 and September 30, 2012, respectively.

Total interest income for the nine months ended September 30, 2013 decreased by $2.3 million to $19.5 million from $21.8 million for the nine months ended September 30, 2012. 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 3.37% during the 2013 nine-month period from 3.47% during the 2012 nine-month period, and the decrease in the average amount of higher yielding investment securities during the 2013 period from the 2012 period.

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

                               Three Months Ended September 30,
                                2013                     2012
                        Interest      % of        Interest      % of
                         Income      Total         Income      Total
                                    (Dollars in thousands)
Loans                       4,265      65.51 %        4,658      65.40 %
Investment Securities       2,174      33.39 %        2,395      33.62 %
Other                          72       1.10 %           70       0.98 %
Total Interest Income       6,511     100.00 %        7,123     100.00 %



                               Nine Months Ended September 30,
                                2013                     2012
                        Interest      % of       Interest      % of
                         Income      Total        Income      Total
                                   (Dollars in thousands)
Loans                      12,741      65.45 %      14,445      66.17 %
Investment Securities       6,452      33.14 %       7,106      32.55 %
Other                         275       1.41 %         280       1.28 %
Total Interest Income      19,468     100.00 %      21,831     100.00 %

Loans, which are inherently risky and therefore command a higher return than our portfolio of investment securities and other interest-earning assets, increased to 41.1% and 38.8% of our total average interest-earning assets during the three and nine-month periods ended September 30, 2013, respectively, from 37.2% and 37.8% of total interest-earning assets during the three and nine-month periods ended September 30, 2012, respectively. The average amounts of investment securities was 47.3% and 46.1% of total average interest-earning assets during the three and nine-month periods ended September 30, 2013, respectively, compared to 48.4% and 49.1% of total interest-earning assets during the three and nine-month periods ended September 30, 2012, 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, 2013 and 2012, total non-performing loan assets were $890,000 and $511,000, 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 2013 from 2012 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, 2013, 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, 2013 or December 31, 2012.

Interest Expense. Total interest expense for the quarter ended September 30, 2013 decreased by $0.6 million to $1.1 million from $1.7 million for the quarter ended September 30, 2012. The decrease in interest expense was due to the decrease in the average amounts of interest-bearing liabilities to $551.2 million for the quarter ended September 30, 2013 from $657.5 million during the quarter ended September 30, 2012, and the decrease in the average rates paid on interest-bearing liabilities to 0.82% during the 2013 quarter from 1.01% during the 2012 quarter.

Total interest expense for the nine-month period ended September 30, 2013 decreased by $1.5 million to $3.8 million from $5.3 million for the nine-month period ended September 30, 2012. The decrease in interest expense was due to the decrease in the average amounts of interest-bearing liabilities to $572.6 million during the nine-month period ended September 30, 2013 from $664.6 million during the nine-month period ended September 30, 2012, respectively, and the decrease in the average rates paid on interest-bearing liabilities to 0.89% during the 2013 nine-month period from 1.06% during the 2012 nine-month period.

The following tables present the components of interest expense as of the dates indicated:

                               Three Months Ended September 30,
                                  2013                 2012
                            Interest    % of      Interest    % of
                            Expense    Total      Expense    Total
                                     (Dollars in thousands)
Interest-Bearing Deposits        132    11.70 %        118     7.11 %
Time Deposits                    733    64.98 %      1,026    61.85 %
Other Borrowings                 263    23.32 %        515    31.04 %
Total Interest Expense         1,128   100.00 %      1,659   100.00 %



                                Nine Months Ended September 30,
                                  2013                  2012
                            Interest    % of      Interest    % of
                            Expense    Total      Expense    Total
                                    (Dollars in thousands)
Interest-Bearing Deposits        387    10.16 %        325     6.14 %
Time Deposits                  2,385    62.62 %      3,219    60.84 %
Other Borrowings               1,037    27.22 %      1,747    33.02 %
Total Interest Expense         3,809   100.00 %      5,291   100.00 %

Non-Interest Income. Non-interest income consists primarily of realized gains on sales of marketable securities and service fee income. Total non-interest income for the three and nine months ended September 30, 2013 was $249,000 and $1.2 million respectively, compared to $766,000 and $1.4 million for the three and nine months ended September 30, 2012, respectively. The increase in non-interest income was primarily due to a tax refund.

Non-Interest Expense. Non-interest expense includes salaries and employee benefits, occupancy and equipment expenses, legal and professional fees, and other operating expenses associated with the day-to-day operations of the Company. Total non-interest expense for the three and nine months ended September 30, 2013 was $4.3 million and $13.2 million, respectively, compared to $4.0 million and $12.3 million for the three and nine months ended September 30, 2012, respectively.

The following tables present the components of non-interest expense as of the dates indicated:

                                        Three Months Ended September 30,
                                         2013                      2012
                                 Non-Interest    % of      Non-Interest    % of
                                   Expense      Total        Expense      Total
. . .
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