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, 2003
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: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.10 per share
(Title of Class)
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 an accelerated filer (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, 2003: $39,576,260.
Number of shares of Common Stock outstanding as of March 25, 2004: 2,207,080.
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 Company's actual results and experiences 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, 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. As used in this
Annual Report on Form 10-K, the term "Berkshire", the "Company" or "we" and
similar pronouns shall mean Berkshire Bancorp Inc. and its consolidated
subsidiaries unless the context otherwise requires. Berkshire's principal
activity is the ownership and management of our wholly-owned banking subsidiary,
The Berkshire Bank (the "Bank"), a New York State chartered commercial bank.
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
New York, NY 10038
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, its
agencies, and business corporations, and mortgage-backed securities. The Bank
currently operates from five deposit-taking offices in New York City and four
deposit-taking offices in Orange and Sullivan Counties, New York. In July 1995,
the Bank
2
opened a branch in Brooklyn, in January 2001, the Bank opened a branch in
downtown Manhattan and in March 2001, as a result of the merger with Goshen
Bank, the Bank acquired two branches in Goshen, NY, a branch in Harriman, NY and
a branch in Bloomingburg, NY. These branches provide the Bank with customary
retail banking offices. On March 22, 2001, the Company purchased a parcel of
land and building located in mid-town Manhattan for a total purchase price of
$3.49 million in cash. In January 2003, the Bank relocated its main office to
and opened a branch at this mid-town Manhattan location. The Bank opened two
additional branches in Brooklyn, New York during 2003.
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 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
and mortgage-backed securities.
Market Area. The Bank draws its customers principally from the New York
City metropolitan area and, since the merger with Goshen Bank in 2001, 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. 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.
In March, 2001, pursuant to the terms of an Agreement and Plan of
Reorganization dated August 16, 2000 (the "Agreement"), we completed the merger
with GSB Financial Corporation, a Delaware corporation, a savings and loan
holding company ("GSB Financial"), and its wholly-owned subsidiary, Goshen
Savings Bank, a federal savings bank, chartered and existing under the laws of
the United States ("Goshen Bank"). GSB Financial was merged with and into
Berkshire and Goshen Bank was merged with and into The Berkshire Bank. Holders
of the common stock of GSB Financial received $20.75 in cash for each share of
common stock of GSB Financial held by them, or, in the alternative, at their
election, 0.6027 shares of Berkshire's common stock. As a result of this
transaction, 978,032 shares of GSB Financial common stock were converted into
589,460 shares of Berkshire common stock, and 974,338 shares of GSB Financial
common stock were purchased for $20.75 per share, totaling approximately $20.2
million.
3
This transaction was accounted for under the purchase method of accounting.
Goodwill of $7.5 million was recorded in the transaction. Effective January 1,
2002, we adopted Statement of Financial Accounting Standard No. 142, Goodwill
and Intangible Assets which eliminates the amortization of goodwill and requires
an annual impairment test. As of December 31, 2003, we have completed the
transitional testing of our intangible assets, including goodwill. We did not
identify any impairment on our outstanding goodwill.
On November 7, 2002, we sold our 24.9% interest in a merchant credit card
processing company for $285,000, which represents our initial purchase price in
December 1999. We accounted for our interest in this company under the equity
method of accounting and have recorded approximately $200,000 in net losses
since December 1999. The initial purchase price to Berkshire was received in
full during 2003.
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 one subsidiary, Berkshire Agency, Inc., a company engaged in the
title insurance business.
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 FDIC.
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 now 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. However, pursuant to
Section 103 of the Gramm-Leach-Bliley Act, the Company may elect, provided it
meets certain conditions, to engage in a significantly broader range of
activities or own shares of companies that engage in such broader activities,
those that are determined to be financial in nature or incidental to such
financial activity or complementary in certain situations, to a financial
activity. The Company has not so elected.
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.
4
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 types.
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, 2003 and 2002, the Company satisfied all applicable Federal
Reserve minimum capital requirements.
Source of Strength Doctrine. It is the Federal Reserve policy that bank
holding companies must serve as a source of financial strength to its subsidiary
depository institutions and must commit all available resources to support such
institutions even if it might not otherwise do so. Although this "source of
strength" policy has been challenged in litigation, the Federal Reserve
continues to take the position that it has authority to enforce it. The Federal
Reserve also has the authority to terminate any activity of the Company that
constitutes a serious risk to the financial soundness or stability of the Bank
or, in extreme cases, to terminate its control of any bank or nonbank
subsidiaries.
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
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.
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.
5
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
ration of 4.0% to 5.0% or more. As of December 31, 2003 and 2002, the Bank's
Tier I leverage capital ratio was 7.0% and 7.8%, 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,
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, 2003 and 2002, the Bank maintained a 18.3%
and 18.5% Tier I risk-based capital ratio and a 19.1% and 19.4% 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, 2003 and 2002, the Bank was well capitalized under all three of these
standards.
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
6
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
2002 and 2003 calendar years totaled approximately $12.12 million. However, the
ability of Berkshire to pay future dividends and meet its other financial
obligations is not presently dependent upon the receipt of dividends from the
Bank.
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 shareholders 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.
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 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 (see Item. 2 - Properties for additional
information).
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.
7
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 2003 was equal to 0.0168% of its insured deposits and which is recorded
as a deposit insurance premium expense for financial statement purposes.
Beginning in 2004, the assessment was revised to 0.0154% 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 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.
8
Personal Holding Company Status. For the fiscal years ended December 31,
2003, 2002 and 2001, 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. Accordingly, on December 4, 2001, the Board of
Directors of the Company declared a cash dividend in the amounts of $.04 per
common share. No such dividend was required to be paid in fiscal 2003 and 2002.
(See Dividends in Item 5).
Employees. On March 25, 2004, Berkshire had one full time employee and the
Bank employed approximately 90 full time and 8 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 2. Properties.
The following are Berkshire's and the Bank's principal facilities as of
March 25, 2004:
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 9,700 Owned Feb 2008 (4)
Brooklyn, NY Bank Branch 4,500 $131,000 March 2008
Brooklyn, NY Bank Branch 1,433 $ 34,800 March 2008
Brooklyn, NY Bank Branch 2,592 $102,000 December 2012
New York, NY Bank Branch 5,500 $237,000 June 2005 (2) (3)
Goshen, NY Bank Branch 10,680 Owned
Harriman, NY Bank Branch 1,623 Owned
Bloomingburg, NY Bank Branch 1,530 $ 25,000 August 2005
----------
(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.
(4) Leased by the Bank from the Company at an annual rent of $375,000 which
management believes is comparable to the annual rent that would be paid by
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 the Bank or
its assets is 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 operations of the Bank.
ITEM 4. Submission of Matters to a Vote of Security Holders.
Not Applicable.
9
PART II
ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.
The Company's Common Stock trades on the Nasdaq National Market System
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 the National
Association of Securities Dealers, Inc.
High Low
----- -----
Fiscal Year Ended December 31, 2003
January 1, 2003 to March 31, 2003 34.45 31.85
April 1, 2003 to June 30, 2003 39.50 32.50
July 1, 2003 to September 30, 2003 44.50 35.00
October 1, 2003 to December 31, 2003 51.00 41.50
High Low
------ -----
Fiscal Year Ended December 31, 2002
January 1, 2002 to March 31, 2002 28.74 27.66
April 1, 2002 to June 30, 2002 32.00 27.81
July 1, 2002 to September 30, 2002 32.476 29.62
October 1, 2002 to December 31, 2002 34.31 31.00
As of the close of business on March 25, 2004, there were approximately
2,043 holders of record of the Company's Common Stock.
Dividends
For the fiscal years ended December 31, 2003, 2002 and 2001, 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. Accordingly, on December 4, 2001, the
Board of Directors of the Company declared a cash dividend in the amounts of
$.04 per common share. No such dividend was required to be paid in fiscal 2003
and 2002.
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 8, 2001 April 16, 2001 April 30, 2001 $.10
October 5, 2001 October 19, 2001 October 29, 2001 $.10
April 8, 2002 April 23, 2002 April 30, 2002 $.10
October 4, 2002 October 21, 2002 October 29, 2002 $.12
April 8, 2003 April 23, 2003 April 30, 2003 $.12
October 3, 2003 October 21, 2003 October 29, 2003 $.15
The declaration, payment and amount of such dividends in the future is
within the discretion of the Board of Directors and will depend upon our
earnings, capital requirements, financial condition and other relevant factors.
Equity Compensation Plans
See Part III, Item 12 for information concerning the Company's equity
compensation plans.
10
ITEM 6. Selected Financial Data.
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Five Year Financial Highlights (a)
The following is a summary of certain financial information with respect to
the Company at and for the fiscal years ended December 31, 2003, 2002, 2001 and
2000, and at and for the proforma twelve months ended December 31, 1999. This
information is derived from and should be read in conjunction with the Company's
financial statements and notes thereto included elsewhere in this Form 10-K.
December 31,
----------------------------------------------------
2003 2002 2001 2000 1999(b)
-------- -------- -------- -------- --------
(Dollars in thousands,except per share data)
Balance Sheet Data:
Total Assets $905,669 $683,738 $536,365 $244,023 $192,130
Loans, net 292,163 273,182 250,010 74,515 64,668
Investment securities 569,848 371,458 242,579 117,060 89,497
Goodwill, net 18,549 18,549 18,438 11,543 12,073
Deposits 604,255 473,818 338,776 137,647 104,087
Stockholders' equity 103,490 98,525 95,992 79,107 78,070
Interest income 34,426 32,242 24,941 14,019 9,852
Interest expense 13,647 13,416 11,877 5,184 3,101
-------- -------- -------- -------- --------
Net interest income before
provision for loan losses 20,779 18,826 13,064 8,835 6,751
Provision for loan losses 240 387 287 55 55
-------- -------- -------- -------- --------
Net interest income 20,539 18,439 12,777 8,780 6,696
Investment securities gains 2,746 1,539 637 13,288 10,731
Other income 1,237 748 786 1,330 578
Other expenses 11,463 10,780 7,838 3,829 3,489
Amortization of goodwill -- -- 935 635 730
-------- -------- -------- -------- --------
Income before income taxes 13,059 9,946 5,427 18,934 13,786
Provision for income taxes 5,644 4,349 2,128 6,868 5,527
-------- -------- -------- -------- --------
Net income $ 7,415 $ 5,597 $ 3,299 $ 12,066 $ 8,259
======== ======== ======== ======== ========
Net income per share:
Basic $ 3.35 $ 2.44 $ 1.41 $ 5.76 $ 3.88
======== ======== ======== ======== ========
Diluted $ 3.30 $ 2.43 $ 1.41 $ 5.76 $ 3.65
======== ======== ======== ======== ========
Cash dividends per
common share $ .27 $ .22 $ .24 $ .64 $ .32
======== ======== ======== ======== ========
Selected Operating Ratios
Return on average assets (c) 0.9% 0.9% 0.8% 5.8% 7.0%
Return on average equity (c) 7.2% 5.9% 3.5% 14.9% 14.6%
Net interest margin (c) 2.7% 3.3% 3.6% 4.7% 4.9%
Average equity/average assets 12.7% 15.6% 23.8% 39.1% 47.9%
Allowance for loan
losses/total loans 0.9% 0.8% 0.8% 1.5% 1.4%
(a) The prior years' amounts have been reclassified to conform to the current
years' presentation.
(b) On December 10, 1999, the Company changed its fiscal year end from October
31 to December 31st of each year. This change was effective December 31,
1999. For presentation purposes, proforma operations data is shown for the
twelve months ended December 31, 1999.
(c) Selected amounts for the two months ended December 31, 1999 were annualized
to calculate ratios.
11
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 ("Berkshire", the "Company" or "we"
and similar pronouns) for the fiscal years ended December 31, 2003, 2002 and
2001. 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
On March 30, 2001, the Company acquired GSB Financial Corporation and its
wholly owned subsidiary, Goshen Savings Bank ("Goshen Bank"). Goshen Bank was
simultaneously merged with and into our wholly owned subsidiary, The Berkshire
Bank (the "Bank"). The Company's historic financial statements included in this
Form 10-K for the twelve months ended December 31, 2001 do not include the
operations of Goshen Bank from January 1, 2001 through March 31, 2001.
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 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 each defined reporting unit. 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, 2003, the Company completed its annual testing,
which determined that no impairment write-offs were necessary.
12
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.
Discussion of Financial Condition and Results of Operations
Overview
Fiscal Year Ended December 31, 2003 Compared to Fiscal Year Ended December
31, 2002. Net income was $7.42 million, or $3.30 per share, for the fiscal year
ended December 31, 2003, compared to $5.60 million, or $2.43 per share, for the
fiscal year ended December 31, 2002, an increase of 32.48%. Investment
securities, loans and total assets increased by 53.41%, 6.95% and 32.46%,
respectively. Two new branches were opened in Brooklyn, New York during 2003
making a total of nine bank branches in operation at years' end.
Fiscal Year Ended December 31, 2002 Compared to Fiscal Year Ended December
31, 2001. Net income was $5.60 million, or $2.43 per share, for the fiscal year
ended December 31, 2002, compared to $3.30 million, or $1.41 per share, for the
fiscal year ended December 31, 2001, an increase of 69.66%. Investment
securities, loans and total assets increased by 53.13%, 9.31% and 27.48%,
respectively, due in part to the acquisition of GSB Financial on March 30, 2001.
Fiscal Year Ended December 31,
------------------------------------
2003 2002 % Inc.
(In millions, except per share data)
Total Assets $905.7 $683.7 32%
Loans, net 292.2 273.2 7%
Investment Securities 569.8 371.5 53%
Total Liabilities 802.2 585.2 37%
Deposits 604.3 473.8 28%
Borrowings 192.1 104.4 84%
Stockholders' Equity 103.5 98.5 5%
Total Income 38.4 34.5 11%
Interest Income 34.4 32.2 7%
Total Expense 25.4 24.6 3%
Interest Expense 13.6 13.4 1%
Net Interest Income 20.8 18.8 11%
Net Income 7.4 5.6 32%
Diluted Income Per Share 3.30 2.43 36%
Bank Branches 9 7 --
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.
13
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, 2003 December 31, 2002
--------------------------------- ---------------------------------
Interest Interest
Average and Average Average and Average
Balance Dividends Yield/Rate Balance Dividends Yield/Rate
-------- --------- ---------- -------- --------- ----------
INTEREST-EARNING ASSETS:
Loans (1) $291,586 $19,061 6.54% $265,961 $18,723 7.04%
Investment securities 470,412 15,321 3.26 298,008 13,383 4.49
Other (2)(5) 3,946 44 1.12 8,479 136 1.60
-------- ------- ---- -------- ------- ----
Total interest-earning assets 765,944 34,426 4.49 572,448 32,242 5.63
---- ----
Noninterest-earning assets 37,844 36,541
-------- --------
Total Assets $803,788 $608,989
======== ========
INTEREST-BEARING LIABILITIES:
Interest bearing deposits 201,817 2,593 1.28 116,331 1,644 1.41
Time deposits 333,112 7,537 2.26 273,452 8,766 3.21
Other borrowings 125,609 3,517 2.80 86,210 3,006 3.49
-------- ------- ---- -------- ------- ----
Total interest-bearing
liabilities 660,538 13,647 2.07 475,993 13,416 2.82
------- ---- ------- ----
Demand deposits 32,592 30,102
Noninterest-bearing liabilities 8,318 7,586
Stockholders' equity (5) 102,340 95,308
-------- --------
Total liabilities and
stockholders' equity $803,788 $608,989
======== ========
Net interest income $20,779 $18,826
======= =======
Interest-rate spread (3) 2.42% 2.81%
==== ====
Net interest margin (4) 2.71% 3.29%
==== ====
Ratio of average interest-
earning assets to average
interest bearing liabilities 1.16 1.20
======== ========
Twelve Months Ended
December 31, 2001
---------------------------------
Interest
Average and Average
Balance Dividends Yield/Rate
-------- --------- ----------
INTEREST-EARNING ASSETS:
Loans (1) $195,296 $15,143 7.75%
Investment securities 154,787 9,156 5.92
Other (2)(5) 15,215 642 4.22
-------- ------- ----
Total interest-earning assets 365,298 24,941 6.83
----
Noninterest-earning assets 32,993
--------
Total Assets $398,291
========
INTEREST-BEARING LIABILITIES:
Interest bearing deposits 85,194 2,291 2.69
Time deposits 155,079 7,867 5.07
Other borrowings 36,510 1,719 4.71
-------- ------- ----
Total interest-bearing
liabilities 276,783 11,877 4.29
------- ----
Demand deposits 21,857
Noninterest-bearing liabilities 4,802
Stockholders' equity (5) 94,849
--------
Total liabilities and
stockholders' equity $398,291
========
Net interest income $13,064
=======
Interest-rate spread (3) 2.54%
====
Net interest margin (4) 3.58%
====
Ratio of average interest-
earning assets to average
interest bearing liabilities 1.32
========
----------
(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.
14
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, 2003
Versus
Twelve Months Ended December 31, 2002
Increase (Decrease) Due To
-------------------------------------
Rate Volume Total
------- ------ -------
Interest-earning assets:
Loans $(1,330) $1,668 $ 338
Investment securities (3,278) 5,216 1,938
Other (41) (51) (92)
------- ------ -------
Total (4,649) 6,833 2,184
------- ------ -------
Interest-bearing
liabilities:
Deposit accounts:
Interest bearing deposits (151) 1,100 949
Time deposits (2,598) 1,369 (1,229)
Other borrowings (595) 1,106 511
------- ------ -------
Total (3,344) 3,575 231
------- ------ -------
Net interest income $(1,305) $3,891 $ 1,953
======= ====== =======
Twelve Months Ended December 31, 2002
Versus
Twelve Months Ended December 31, 2001
Increase (Decrease) Due To
-------------------------------------
Rate Volume Total
------- ------- ------
Interest-earning assets:
Loans $(1,395) $ 4,975 $3,580
Investment securities (2,204) 6,431 4,227
Other (399) (107) (506)
------- ------- ------
Total (3,998) 11,299 7,301
------- ------- ------
Interest-bearing
liabilities:
Deposit accounts:
Interest bearing deposits (1,090) 443 (647)
Time deposits (2,884) 3,783 899
Other borrowings (449) 1,736 1,287
------- ------- ------
Total (4,423) 5,962 1,539
------- ------- ------
Net interest income $ 425 $ 5,337 $5,762
======= ======= ======
15
Interest Rate Risk
Fluctuations in market interest rates can have a material effect on the
Company'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 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 are entered into with major financial institutions.
We seek to maximize our 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.
Provision for Loan Losses
The Company maintains an allowance for loan losses at a level deemed
sufficient to absorb losses, which are inherent in the loan portfolio at each
balance sheet date. Management reviews the adequacy of the allowance on at least
a quarterly basis to ensure that the provision for loan losses has been charged
against earnings in an amount necessary to maintain the allowance at a level
that is appropriate based on management's assessment of estimated losses. The
Company's methodology for assessing the appropriateness of the allowance for
loan losses consists of several key elements. These elements include a specific
allowance for loan watch list classified loans, an allowance based on historical
trends, an additional allowance for special circumstances, and an unallocated
portion. The Company consistently applies the following comprehensive
methodology.
The allowance for loan watch list classified loans addresses those loans
maintained on the Company's loan watch list, which are assigned a rating of
substandard, doubtful, or loss. Substandard loans are those with a well-defined
weakness or a weakness, which jeopardizes the repayment of the debt. A loan may
be classified as substandard as a result of impairment of the borrower's
financial condition and repayment capacity. Loans for which repayment plans have
not been met or collateral equity margins do not protect the Company may also be
classified as substandard. Doubtful loans have the characteristics of
substandard loans with the added characteristic that collection or liquidation
in full, on the basis of presently existing facts and conditions, is highly
improbable. Although the possibility of loss is extremely high for doubtful
loans, the classification of loss is deferred until pending factors, which might
improve the loan, have been determined. Loans rated as doubtful in whole or in
part are placed in nonaccrual status. Loans, which are classified as loss, are
considered uncollectible and are charged to the allowance for loan losses. There
were $109,000 and $59,000 of classified loans at December 31, 2003 and 2002,
respectively, and no loans classified as of December 31, 2001.
Loans on the loan watch list may also be impaired loans, which are defined
as nonaccrual loans or troubled debt restructurings, which are not in compliance
with their restructured terms. Each of the classified loans on the loan watch
list is individually analyzed to determine the level of the potential loss in
the loan under the current circumstances. The specific reserve established for
these criticized and impaired loans is based on careful analysis of the loan's
performance, the related collateral value, cash flow considerations and the
financial capability of any guarantor. The allowance for loan watch list
classified loans is equal to the total amount of potential unconfirmed losses
for
16
the individual classified loans on the watch list. Loan watch list loans are
managed and monitored by assigned Senior Management.
The allowance based on historical trends uses charge-off experience of the
Company to estimate potential unconfirmed losses in the balances of the loan and
lease portfolios. The historical loss experience percentage is based on the
charge-off history. Historical loss experience percentages are applied to all
non-classified loans to obtain the portion of the allowance for loan losses
which is based on historical trends. Before applying the historical loss
experience percentages, loan balances are reduced by the portion of the loan
balances, which are subject to guarantee, by a government agency. Loan balances
are also adjusted for unearned discount on installment loans.
The Company also maintains an unallocated allowance. The unallocated
allowance is used to cover any factors or conditions, which may cause a
potential loan loss but are not specifically identifiable. It is prudent to
maintain an unallocated portion of the allowance because no matter how detailed
an analysis of potential loan losses is performed these estimates by definition
lack precision. Management must make estimates using assumptions and
information, which is often subjective and changing rapidly.
Since all identified losses are immediately charged off, no portion of the
allowance for loan losses is restricted to any individual loan or groups of
loans, and the entire allowance is available to absorb any and all loan losses.
A loan is placed in a nonaccrual status at the time when ultimate
collectibility of principal or interest, wholly or partially, is in doubt. Past
due loans are those loans which were contractually past due 90 days or more as
to interest or principal payments but are well secured and in the process of
collection. Renegotiated loans are those loans which terms have been
renegotiated to provide a reduction or deferral of principal or interest as a
result of the deteriorating financial position of the borrower.
Results of Operations Fiscal Year Ended December 31, 2003 Compared to Fiscal
Year Ended December 31, 2002.
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, 2003 was $7.42
million, or $3.30 per share, as compared to $5.60 million, or $2.43 per share,
for the fiscal year ended December 31, 2003.
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.
Interest rates, as measured by the prime rate, began the year at 4.25%, declined
by 25 basis points in late June to 4.00% and remained at that level through
December 31, 2003. We have operated in a consistently declining interest rate
environment since May 2000 when the prime rate peaked at 9.50% which has also
been a period of low inflation, stock market uncertainties, recession and the
aftermath of September 11, 2001.
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, 2003, net interest income increased
by $1.95 million, or 10.37%, to $20.78 million from $18.83 million for the
fiscal year ended December 31, 2002. The increase in net interest income was the
result of a 33.80% growth in the average amount of interest-earning assets to
$765.94 million at the end of 2003 from $572.45 million at the end of 2002,
partially offset by the 38.77% growth in the average amount of interest-bearing
liabilities to $660.54 million from $475.99 million at December 31, 2003 and
2002,
17
respectively, as well as the difference between the yield on assets compared to
the cost of liabilities.
During fiscal 2003, the average yield on interest-earning assets fell to
4.49% from 5.63% in fiscal 2002, a decline of 20.25%, while the average cost of
interest-bearing liabilities fell to 2.07% from 2.82%, a decline of 26.60% The
interest-rate spread, the difference between the average yield on
interest-earning assets and the average cost of interest bearing liabilities,
eased by 39 basis points to 2.42% during fiscal 2003 from 2.81% during fiscal
2002.
If interest rates remain stable, we expect to see only moderate pressure on
the Company's interest-rate spread and net interest income. Investment
securities in our portfolio that have been sold, matured or called by the issuer
during fiscal 2003 have been replaced with securities carrying somewhat lower
yields and, by design, shorter maturities to protect against a rising interest
rate environment. Rates paid on deposit accounts may continue to decline as
well, albeit at a slower pace due to competition for deposits in the market
place.
Net Interest Margin. Net interest margin, or annualized net interest income as a
percentage of average interest-earning assets, declined to 2.71% in fiscal 2003
from 3.29% in fiscal 2002. 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, and to invest such funds in a prudent mix of loans and investment
securities. The average amounts of loans and investment securities increased by
$25.63 million and $172.40 million, respectively, to $291.59 million and $470.41
million, respectively, in the year ended December 31, 2003, from $265.96 million
and $298.01 million, respectively, in the year ended December 31, 2002.
The average yield on loans declined to 6.54% in 2003 from 7.04% in 2002 as
older loans with higher rates, commercial and residential mortgage loans, were
paid off, matured, and/or refinanced at lower rates. During periods of low and
stable interest rates, as was the case during 2003, borrowers gravitate towards
fixed-rate loans to lock in a low interest rate, whereas adjustable rate loans
are generally preferred when interest rates are high. One-to-four family
mortgage loans, approximately 57% of our loan portfolio at December 31, 2003,
are particularly sensitive to changes in interest rates.
The average amounts of interest-bearing deposits and time deposits
increased by $85.49 million and $59.66 million, respectively, to $201.82 million
and $333.11 million, respectively, in fiscal year 2003, from $116.33 million and
$273.45 million, respectively, in fiscal year 2002. Borrowed funds increased by
$39.40 million to $125.61 million in 2003 from $86.21 million in the 2002.
During fiscal year 2003, the average rates paid on interest-bearing deposits,
time deposits and borrowed funds declined to 1.28%, 2.26% and 2.80%,
respectively, from 1.41%, 3.21% and 3.49%, respectively in fiscal year 2002.
Interest Income. Total interest income for the fiscal year ended December 31,
2003 increased by $2.18 million, or 6.77%, to $34.43 million from $32.24 million
for the fiscal year ended December 31, 2002. The increase was the result of the
33.80% increase in the average amount of total interest-earning assets to
$765.94 million in fiscal year 2003 from $572.45 million in fiscal 2002.
Interest income on loans and investment securities increased to $19.06 million
and $15.32 million, respectively, in fiscal year 2003, from $18.72 million and
$13.38 million, respectively in fiscal year 2003.
Interest Expense. Total interest expense for the fiscal year ended December 31,
2003 increased by $231,000, or 1.72%, to $13.65 million from $13.42 million for
the fiscal year ended December 31, 2002. The increase in interest expense was
due primarily to the 38.77% increase in the average amount of total
interest-bearing liabilities, all but offset by the 26.60% decline in the
average rate paid on such balances. Interest expense increased to $2.59 million
on interest-bearing deposits and decreased to $7.54 million on time deposits
during fiscal year 2003, from $1.64 million and $8.77 million, respectively,
during fiscal year 2002. Interest expense on borrowings, which are generally
invested in earning assets of similar maturities, increased to $3.52 million
in fiscal year 2003 from $3.01 million in fiscal year 2002.
18
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, 2003, total non-interest income increase by $1.70 million, or
74.16%, to $3.98 million from $2.29 million for the fiscal year ended December
31, 2002. Investment securities gains increased to $2.75 million in fiscal year
2003 from $1.54 million in fiscal 2002, as we sold securities during 2003,
realizing gains, and purchased new securities with shorter maturities. Service
charges on deposit accounts increased by $92,000 to $640,000 in fiscal year
2003 from $548,000 in fiscal year 2002.
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, 2003
increased by $683,000, or 6.34%, to $11.46 million from $10.78 million for the
year ended December 31, 2002. The increase was largely due to the $690,000
increase in salaries and employee benefits resulting from the additional
personnel required to operate our expanding business.
Provision for Income Tax. During the years ended December 31, 2003 and 2002, we
recorded income tax expense of $5.64 million and $4.35 million, respectively.
The tax provisions for federal, state and local taxes recorded for 2003 and 2002
represent effective tax rates of 43.22% and 43.73%, respectively.
Results of Operations Fiscal Year Ended December 31, 2002 Compared to Fiscal
Year Ended December 31, 2001.
General. On March 30, 2001, Berkshire, through its wholly-owned subsidiaries,
the Bank and Greater American Finance Group, Inc., completed its merger with GSB
Financial (see Note A of Notes to Consolidated Financial Statements). This
transaction was accounted for under the purchase method of accounting and,
accordingly, the results of operation for the Company include only the results
of operation of GSB Financial for the nine month period from April 1 through
December 31, 2001. The Company acquired total loans, assets and deposits of
$134.06 million, $190.04 million and $127.86 million, respectively.
Net Income. Net income for the fiscal year ended December 31, 2002 was $5.60
million, or $2.43 per share, as compared to $3.30 million, or $1.41 per share,
for the fiscal year ended December 31, 2001. The increase was due in part to the
acquisition of GSB Financial referenced above.
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, thereby eliminating annual goodwill amortization
expense of approximately $1.0 million. Had SFAS No. 142 been in effect on
January 1, 2001, net income in fiscal 2001 would have been $4.23 million, or
$1.81 per share.
Interest rates, as measured by the prime rate, stabilized at 4.75%
throughout the first ten months of 2002. During 2001, in contrast, the prime
rate declined from 9.00% at the beginning of the year to 4.75% at years' end.
Net Interest Income. The Company's primary source of revenue is net interest
income, or the difference between interest income on earning assets and interest
expense on interest-bearing liabilities.
For the fiscal year ended December 31, 2002, net interest income increased
by approximately $5.76 million, or 44.11%, to $18.83 million from $13.06 million
for the fiscal year ended December 31, 2001. The year over year increase in net
interest income was the result of two factors. Firstly, the $207.15 million, or
56.71%, increase in average interest-earning assets to $572.45 million from
$365.30 million in fiscal 2001, partially offset by the $199.21 million, or
71.97%, increase in average interest-bearing liabilities to $475.99 million from
$276.78 million in fiscal 2001. The second factor contributing to the increase
in net interest income was the difference between the yield on assets compared
to the cost of liabilities. The average yield on interest-earning assets in 2002
declined to 5.63% from 6.83% in 2001, a decline of 120 basis points, or 17.57%,
however, the average cost of interest-bearing liabilities in 2002 declined to
2.82% from 4.29%, a steeper decline of 147 basis points, or 34.27% The
interest-
19
rate spread, the difference between the average yield on interest-earning assets
and the average cost of interest bearing liabilities, which has a direct bearing
on net interest income, improved to 2.81% in fiscal 2002 from 2.54% in fiscal
2001.
Net Interest Margin. Net interest margin, or annualized net interest income as a
percentage of average interest-earning assets, declined to 3.29% in fiscal 2002
from 3.58% in fiscal 2001.
During fiscal 2002, the Company made use of the prevailing interest rate
environment to secure deposits and to borrow funds at what we believe to be
attractive rates, and to invest such funds in loans and investment securities.
The average amounts of loans and investment securities increased by $70.67
million and $143.22 million, respectively, to $265.96 million and $298.01
million, respectively, in fiscal 2002 from $195.30 million and $154.79 million,
respectively, in fiscal 2001. Time deposits and borrowings increased by $118.37
million and $49.70 million, respectively, during 2002 to $273.45 million and
$86.21 million, respectively, from $155.08 million and $36.51 million,
respectively, during 2001.
Interest Income. Total interest income for the fiscal year ended December 31,
2002 increased by $7.30 million, or 29.27%, to $32.24 million from $24.94
million for the fiscal year ended December 31, 2001. The increase was the result
of the higher levels of average interest-earning assets during fiscal 2002 over
fiscal 2001. The average amount of loans and investment securities increased by
36.18% and 92.53%, respectively, contributing $18.72 million and $13.38 million
of interest income, respectively, compared to $15.14 million and $9.16 million
of interest income, respectively, in fiscal 2001.
As may be expected during a period of falling interest rates, the average
yield on interest-earning assets declined to 5.63% during fiscal 2002 from 6.83%
in fiscal 2001. The average yield on loans declined to 7.04% from 7.75% and we
expect this trend may continue as homeowners refinance their existing mortgage
loans, commercial loans at higher rates are paid off and/or renewed, and new
mortgage loans and commercial loans are made, all at today's lower rates. The
average yield on investment securities has declined as well, to 4.49% in 2002
from 5.92% in 2001, as securities in our portfolio with above market rates have
either matured or have been called by the issuer, and have been replaced by
securities that meet our investment policy criteria, albeit with lower yields.
Interest Expense. Total interest expense for the fiscal year ended December 31,
2002 increased by $1.54 million, to $13.42 million from $11.88 million for the
fiscal year ended December 30, 2001. The increase is due to the overall increase
of $199.21 million in the average amount of interest-bearing liabilities to
$475.99 million in fiscal 2002 from $276.78 million in fiscal 2001. Interest
bearing deposits and time deposits increased by 62.23% to $389.78 million in
2002 from $240.27 million in 2001. Borrowings increased by 136.13% to $86.21
million in 2002 from $36.51 million in 2001 as a result of our strategy of
employing excess capital to fund the growth of our business. The increase in
total interest expense was partially offset by the decline in the average rates
paid on interest-bearing liabilities to 2.82% during the 2002 period from 4.29%
during the 2001 period.
Non-Interest Income. Non-interest income consists primarily of realized gains on
sales of investment securities and service fee income. For the fiscal year ended
December 31, 2002, total non-interest income was $2.29 million, compared to
$1.42 million for the fiscal year ended December 31, 2001. Service fee income
increased to $548,000 in fiscal 2002 from $395,000 in fiscal 2001 as a result of
the growth in deposits at the Bank. Investment securities gains increased to
$1.54 million in 2002 from $637,000 in 2001, and other non-interest income
declined to $200,000 in 2002 from $391,000 in 2001.
Non-Interest Expense. Non-interest expense includes salaries and employee
benefits, occupancy and equipment expenses, professional fees and other
operating expenses associated with the day-to-day operations of the Company.
Total non-interest expense for the fiscal year ended December 31, 2002 was
$10.78 million as compared to $8.77 million for the fiscal year ended December
31, 2001. The year to year increases are due primarily to increases in salaries
and employee benefits and net occupancy expenses resulting from the expansion of
the business.
20
Provision for Income Tax. During the fiscal year ended December 31, 2002, the
Company recorded income tax expense of $4.35 million, compared to income tax
expense of $2.13 million for the fiscal year ended December 31, 2001. The tax
provisions for federal, state and local taxes recorded for fiscal 2002 and 2001
represent effective tax rates of 43.73% and 39.21%, respectively. The increase
in the effective rate is primarily due to the elimination of the non-deductible
amortization expense of goodwill.
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 the Federal Home Loan Mortgage Corporation (Freddie Mac),
the Federal National Mortgage Association (Fannie Mae) or the Government
National Mortgage Association (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.
As required by the Statement of Financial Accounting Standard No. 115
("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.
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,
---------------------------------------------------------------
2003 2002 2001
------------------- ------------------- -------------------
Fair Fair Fair
Cost Value Cost Value Cost Value
-------- -------- -------- -------- -------- --------
(In thousands)
Available-For-Sale
U.S. Treasury Notes $ 39,941 $ 39,847 $ 20,110 $ 20,213 $ 30,012 $ 30,038
U.S. Government Agencies 419,175 416,753 301,224 303,597 170,610 170,156
Mortgage-backed securities 93,875 97,448 6,256 6,262 2,493 2,499
Corporate notes 1,570 1,662 3,878 4,076 751 639
Municipal securities 991 1,061
Marketable equity
securities and other 12,305 12,366 36,383 36,477 37,547 37,634
-------- -------- -------- -------- -------- --------
Total $567,857 $569,137 $367,851 $370,625 $241,413 $240,966
======== ======== ======== ======== ======== ========
Held-To-Maturity
U.S. Government Agencies $ 711 $ 715 $ 833 $ 835 $ 1,613 $ 1,598
-------- -------- -------- -------- -------- --------
Total $ 711 $ 715 $ 833 $ 835 $ 1,613 $ 1,598
======== ======== ======== ======== ======== ========
21
The following tables summarize the Company's available-for-sale and held-
to-maturity securities at December 31, 2003:
December 31, 2003
--------------------------------
Weighted
Average
Yield Cost Fair Value
-------- -------- ----------
(Dollars in thousands)
Available-For-Sale
U.S. Treasury Notes
Due after one year through five years 1.28% $ 39,941 $ 39,847
-------- --------
39,941 39,847
-------- --------
U.S. Government Agencies Obligations
Due within one year -- --
Due after one year through five years 2.90 61,115 61,145
Due after five years through ten years 4.56 196,934 195,168
Due after ten years 3.92 161,126 160,440
-------- --------
419,175 416,753
-------- --------
Municipal Obligations
Due after ten years 5.44 991 1,061
-------- --------
991 1,061
-------- --------
Mortgage-backed securities
Due after ten years 4.55 93,875 97,448
-------- --------
93,875 97,448
-------- --------
Corporate Notes
Due within one year -- --
Due after one year through five years 9.68 1,570 1,662
-------- --------
1,570 1,662
-------- --------
Common Stocks -- 90 90
Preferred Stocks 11.84 1,178 1,239
Money market funds 1.02 7,150 7,150
Federal Home Loan Bank Stock 0.00 3,887 3,887
-------- --------
12,305 12,366
-------- --------
$567,857 $569,137
======== ========
Held-To-Maturity
U.S. Government Agencies Obligations
Due after one year through five years 3.13 74 74
Due after five years through ten years 2.50 70 70
Due after ten years 6.13 567 571
-------- --------
$ 711 $ 715
======== ========
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, 2003, 2002 and 2001 , the Company had total loans, net of
unearned income of $294.76 million, $275.50 million and $252.23 million,
respectively, and an allowance for loan losses of $2.59 million, $2.32 million
and $2.03 million, respectively. From time to time, the Bank may originate
22
residential mortgage loans and then 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.
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.
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, 2003 and 2002,
approximately $169.59 million and $180.73 million, respectively, or 57.4% and
65.4%, respectively, of the Company's total loan portfolio consisted of such
23
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, 2003 and 2002,
approximately 12% and 11%, respectively, of the Bank's residential one-to-four
family owner-occupied first mortgage portfolio were ARMs and approximately 88%
and 89%, 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%.
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.
Origination of Loans. Loan originations can be attributed to depositors,
retail customers, telephone inquiries, advertising, the efforts of the Bank's
loan officers, and referrals from other borrowers and real estate brokers and
builders. The Bank originates loans primarily through its own efforts.
Occasionally, the Bank may obtain loan opportunities as a result of referrals
from loan brokers.
At December 31, 2003, the Bank's total capital, net of goodwill and loan
loss reserves, was approximately $60.7 million and thus it was generally not
permitted to make loans to one borrower in excess of approximately $9.1 million,
with an additional amount of approximately $6.1 million being permitted if
secured by readily marketable collateral. The Bank was also not permitted to
make any single mortgage loan in an amount in excess of approximately $9.1
million. At December 31, 2003, the Bank was in compliance with these standards.
24
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.
The following tables set forth information concerning the Company's loan
portfolio by type of loan at the dates indicated:
December 31,
------------------------------------------------------
2003 2002 2001
---------------- ---------------- ----------------
% of % of % of
Amount Total Amount Total Amount Total
-------- ----- -------- ----- -------- -----
(Dollars in thousands)
Commercial and
professional loans $ 22,228 7.5% $ 16,704 6.0% $ 19,130 7.6%
Secured by real estate
1 - 4 family 169,589 57.4 180,730 65.4 165,195 65.5
Multi family 6,608 2.2 8,958 3.2 11,186 4.4
Non-residential
(commercial) 94,956 32.2 65,809 23.8 51,893 20.6
Consumer 2,239 0.7 4,051 1.6 4,689 1.8
Other -- -- -- -- 140 0.1
-------- ----- -------- ----- -------- -----
Total loans 295,620 100.0% 276,252 100.0% 252,233 100.0%
===== ===== =====
Less:
Allowance for
loan losses (2,593) (2,315) (2,030)
Unearned fees (864) (755) (193)
-------- -------- --------
Loans, net $292,163 $273,182 $250,010
======== ======== ========
25
December 31, October 31,
2000 1999 (1)
--------------- ---------------
% of % of
Amount Total Amount Total
------- ----- ------- -----
(Dollars in thousands)
Commercial and
professional loans $ 9,419 12.5% $ 6,824 11.3%
Secured by real estate 51,300 84.7
1 - 4 family 25,677 34.0
Multi family 4,765 6.3
Non-residential (commercial) 34,968 46.2
Consumer 229 0.3 1,932 3.2
Other 565 0.7 501 0.8
------- ----- -------
Total loans 75,623 100.0% 60,557 100.0%
===== =====
Less:
Allowance for loan losses (1,108) (905)
Unearned fees (275) --
------- -------
Loans, net $74,240 $59,652
======= =======
(1) Information is prepared on a proforma basis for comparability purposes.
Balances stated are not reflected in the historical financial statements of
the Company.
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 no loans past due more than 90 days still
accruing at December 31, 2003 and 2002, respectively.
December 31, October 31,
------------------------- -----------
2003 2002 2001 2000 1999(1)
---- ---- ---- ---- -------
(Dollars in Thousands)
Nonaccrual loans:
Commercial and $ -- $-- $ 9 $-- $ --
professional loans
Secured by real estate 109 59 -- -- 121
---- --- --- --- ----
Total nonaccrual loans 109 59 9 -- 121
---- --- --- --- ----
Total nonperforming loans $109 $59 $ 9 $-- $121
==== === === === ====
Total nonperforming loans
to total assets .01% -- -- -- .07%
==== === === === ====
(1) Information is prepared on a proforma basis for comparability purposes.
Balances stated are not reflected in the historical financial statements of
the Company.
26
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, 2003
------------------------------------
Allowance
for Loan Percent of Percent of
Losses Allowance Total Loans
--------- ---------- -----------
Commercial and
professional loans $ 300 11.6% 0.10%
Secured by real estate
1 - 4 family 424 16.3 0.14
Multi family 89 3.4 0.03
Non-residential 1,198 46.2 0.41
Consumer and other 30 1.2 0.01
General allowance (1) 552 21.3 0.19
------ ----- ----
Total allowance
for loan losses $2,593 100.0% 0.88%
====== ===== ====
----------
(1) The allowance for loan losses is allocated to specific loans as necessary.
December 31, 2002
------------------------------------
Allowance
for Loan Percent of Percent of
Losses Allowance Total Loans
--------- ---------- -----------
Commercial and
professional loans $ 225 9.7% 0.08%
Secured by real estate
1 - 4 family 452 19.5 0.16
Multi family 121 5.2 0.04
Non-residential 888 38.4 0.32
Consumer and other 55 2.4 0.02
General allowance (1) 574 24.8 0.21
------ ----- ----
Total allowance
for loan losses $2,315 100.0% 0.83%
====== ===== ====
----------
(1) The allowance for loan losses is allocated to specific loans as necessary.
December 31, 2001
------------------------------------
Allowance
for Loan Percent of Percent of
Losses Allowance Total Loans
--------- ---------- -----------
Commercial and
professional loans $ 188 9.3% 0.07%
Secured by real estate
1 - 4 family 804 39.6 0.32
Multi family 84 4.1 0.03
Non-residential 790 38.9 0.32
Consumer and other 24 1.2 0.06
General allowance (1) 140 6.9 0.06
------ ----- ----
Total allowance
for loan losses $2,030 100.0% 0.79%
====== ===== ====
----------
(1) The allowance for loan losses is allocated to specific loans as necessary.
27
December 31, 2000
------------------------------------
Allowance
for Loan Percent of Percent of
Losses Allowance Total Loans
--------- ---------- -----------
Commercial and
professional loans $ 89 8.0% 0.12%
Secured by real estate 654 59.0 0.86
Personal and other 13 1.2 0.02
General allowance (1) 352 31.8 0.47%
------ ----- ----
Total allowance
for loan losses $1,108 100.0% 1.47%
====== ===== ====
----------
(1) The allowance for loan losses is allocated to specific loans as necessary.
October 31, 1999(2)
------------------------------------
Allowance
for Loan Percent of Percent of
Losses Allowance Total Loans
--------- ---------- -----------
Commercial and
professional loans $ 69 7.6% 0.11%
Secured by real estate 569 63.0 0.94
Personal and other 77 8.5 0.13
General allowance (1) 190 20.9 0.31
---- ----- ----
Total allowance
for loan losses $905 100.0% 1.49%
==== ===== ====
----------
(1) The allowance for loan losses is allocated to specific loans as necessary.
(2) Information is prepared on a proforma basis for comparability purposes.
Balances stated are not reflected in the historical financial statements of
the Company.
The following tables set 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, 2003
---------------------------------------
Within 1 to After
1 Year 5 Years 5 Years Total
------- ------- -------- --------
(In thousands)
Fixed Rate
Commercial, financial and $ 2,164 $15,496 $145,725 $163,385
agricultural
Non-residential 3,881 13,405 33,591 50,877
------- ------- -------- --------
Total fixed rate $ 6,045 $28,901 $179,316 $214,262
------- ------- -------- --------
Adjustable Rate
Commercial, financial and 7,583 11,111 18,585 37,279
agricultural
Non-residential 19,162 8,971 15,946 44,079
Total adjustable rate $26,745 $20,082 $ 34,531 $ 81,358
------- ------- -------- --------
Total $32,790 $48,983 $213,847 $295,620
======= ======= ======== ========
28
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):
Two Months
Ended
Years Ended December 31, December 31,
------------------------------------------- ------------
2003 2002 2001 2000 1999
-------- -------- -------- -------- --------
Average loans outstanding $291,586 $265,961 $195,296 $70,357 $61,691
======== ======== ======== ======= =======
Allowance at beginning
of period 2,315 2,030 1,108 923 905
Charge-offs:
Commercial and other
loans 4 199 97 -- --
Real estate loans 13 -- -- -- --
-------- -------- -------- ------- -------
Total loans charged-off 17 199 97 -- --
-------- -------- -------- ------- -------
Recoveries:
Commercial and other
loans 55 97 41 130 8
Real estate loans -- -- -- -- --
-------- -------- -------- ------- -------
Total loans recovered 55 97 41 130 8
-------- -------- -------- ------- -------
Net recoveries
(charge-offs) 38 (102) (56) 130 8
-------- -------- -------- ------- -------
Provision for loan losses
charged to operating
expenses 240 387 287 55 10
Acquisition of GSB -- -- 691 -- --
-------- -------- -------- ------- -------
Allowance at end of period $ 2,593 $ 2,315 $ 2,030 $ 1,108 $ 923
-------- -------- -------- ------- -------
Ratio of net recoveries
(charge-offs) to average
loans outstanding (2) 0.01% (.03)% (.02)% .18% .08%
======== ======== ======== ======= =======
Allowance as a percent
of total loans 0.88% 0.83% 0.80% 1.47% 1.41%
======== ======== ======== ======= =======
Total loans at end
of period $295,620 $276,252 $252,233 $75,623 $65,591
======== ======== ======== ======= =======
(1) Information is prepared on a proforma basis for comparability purposes.
Balances stated are not reflected in the historical financial statements of
the Company.
(2) Net recoveries have been annualized to calculate ratios for comparability
purposes.
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.
29
The following table summarizes the composition of the average balances of
major deposit categories:
December 31,
------------------------------------------------------------
2003 2002 2001
------------------ ------------------ ------------------
Average Average Average Average Average Average
Amount Yield Amount Yield Amount Yield
-------- ------- -------- ------- -------- -------
(Dollars in thousands)
Demand deposits $ 32,592 -- $ 30,102 -- $ 21,857 --
NOW and money market 58,723 1.02% 60,114 1.28% 51,026 2.64%
Savings deposits 143,094 1.95 56,217 1.56 34,168 2.69
Time deposits 333,112 2.26 273,452 3.21 155,079 5.07
-------- ---- -------- ---- -------- ----
Total deposits $567,521 1.78% $419,885 2.48% $262,130 3.89%
======== ==== ======== ==== ======== ====
The aggregate amount of jumbo certificates of deposit, each with a minimum
denomination of $100,000, was approximately $110.08 million, $108.72 million and
$68.88 million at December 31, 2003, 2002 and 2001, respectively.
The following table summarizes the maturity distribution of time deposits
of $100,000 or more as of December 31, 2003:
(In thousands)
3 months or less $ 48,136
Over 3 months but within 6 months 30,913
Over 6 months but within 12 months 22,746
Over 12 months 8,285
--------
Total $110,080
========
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
Treasury Tax and Loan Note Options 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,
----------------------------
2003 2002 2001
-------- ------- -------
(Dollars in thousands)
Securities sold under repurchase
agreements and federal funds purchased
Balance at year-end $114,391 $46,673 $53,756
Average during the year $ 57,554 $38,443 $13,372
Maximum month-end balance $114,391 $47,407 $53,756
Weighted average rate during the year 1.68% 1.79% 3.62%
Rate at December 31 1.73% 1.46% 1.67%
30
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 Berkshire Bank have historically been met by deposits, investments
in federal funds sold, principal and interest payments on loans, and maturities
of investment securities.
For the parent company, Berkshire Bancorp Inc., liquidity means having cash
available to fund operating expenses and to pay shareholder dividends, when and
if declared by our Board of Directors. We paid cash dividends of $.27 per share,
$.22 per share, $.24 per share, $.64 per share, $.32 per share and $.72 per
share in fiscal 2003, 2002, 2001, 2000, 1999 and 1998, respectively. The ability
to fund our operations and to pay dividends is not dependent upon the receipt of
dividends from The Berkshire Bank. At December 31, 2003, we had cash of
approximately $12.0 million and investment securities of $2.90 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, 2003.
Expiration By Period
--------------------------------------------
Less More
Than 1-3 3-5 Than
Total 1 Year Years Years 5 Years
------- ------ ------ ------ -------
(In thousands)
Lines of Credit $11,243 $4,360 $3,814 $1,097 $1,972
Standby Letters
of Credit 775 744 31 -- --
Loan Commitments 2,011 2,011 -- -- --
------- ------ ------ ------ ------
Total $14,029 $7,115 $3,845 $1,097 $1,972
======= ====== ====== ====== ======
Contractual Obligations
The following table presents the Company's contractual obligations at
December 31, 2003.
Payments Due By Periods
-------------------------------------------------
Less More
Than 1-3 3-5 Than
Total 1 Year Years Years 5 Years
-------- -------- ------- ------- -------
(In thousands)
Long-Term Debt $ 77,745 $ -- $17,010 $46,735 $14,000
Operating Leases 2,215 533 705 468 509
Time Deposits 317,480 297,434 18,042 2,004 --
-------- -------- ------- ------- -------
Total Contractual
Obligations $397,440 $297,967 $35,757 $49,207 $14,509
======== ======== ======= ======= =======
The Company currently does not have any unconsolidated subsidiaries or
special purpose entities.
31
Capital
The capital ratios of the Bank and Berkshire 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 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 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.
32
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, 2003
(in thousands, except for percentages)
--------------------------------------------------------------
3 Months 3 Through 1 Through Over Fair
or Less 12 Months 3 Years 3 Years Total Value
-------- --------- --------- ------- ------- -------
Interest bearing deposits in banks 1,832 -- -- -- 1,832 1,832
(Rate) 0.26% 0.26%
Loans (1)(2)
Adjustable rate loans 43,227 13,835 14,132 10,164 81,358 83,799
(Rate) 5.40% 4.53% 5.85% 7.12% 5.55%
Fixed rate loans 1,772 4,273 7,832 200,385 214,262 217,848
(Rate) 7.74% 7.15% 7.62% 6.40% 6.47%
-------- -------- -------- ------- -------
Total loans 44,999 18,108 21,964 210,549 295,620 301,647
Investments (3)(4) 50,543 35,198 202,447 281,660 569,848 569,852
(Rate) 2.69% 3.11% 2.68% 4.94% 3.82%
-------- -------- -------- ------- -------
Total rate-sensitive assets 97,374 53,306 224,411 492,209 867,300
-------- -------- -------- ------- -------
Deposit accounts (5)
Savings and NOW 219,470 -- -- -- 219,470 219,470
(Rate) 1.45% 1.45%
Money market 28,882 -- -- -- 28,882 28,882
(Rate) 0.84% 0.84%
Time Deposits 131,826 165,608 18,042 2,004 317,480 318,450
(Rate) 1.94% 1.93% 2.48% 1.98% 1.97%
-------- -------- -------- ------- -------
Total deposit accounts 380,178 165,608 18,042 2,004 565,832
Repurchase Agreements 46,835 29,556 35,000 3,000 114,391 114,462
(Rate) 1.04% 1.24% 2.77% 3.52% 1.69%
Other borrowings 17,010 60,735 77,745 81,053
(Rate) % 3.07% 4.05% 3.91%
-------- -------- -------- ------- -------
Total rate-sensitive liabilities 427,013 195,164 70,052 65,739 757,968
-------- -------- -------- ------- -------
Interest rate caps 30,000 (5,000) (5,000) (20,000) 180
Gap (repricing differences) (359,639) (136,858) 159,359 446,470 109,332
======== ======== ======== ======= =======
Cumulative Gap (359,639) (496,497) (337,138) 109,332
======== ======== ======== =======
Cumulative Gap to Total Rate
Sensitive Assets (41.47)% (57.25)% (38.87)% 12.61%
======== ======== ======== =======
----------
(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 loans) 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.
33
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
Employers' Disclosure About Pensions and Other Postretirement Benefits
In December 2003, the Financial Accounting Standards Board (the "FASB")
issued Statement 132 (revised 2003), Employers' Disclosure About Pensions and
Other Postretirement Benefits ("Statement 132(R)"). Statement 132(R) retains all
of the disclosures that are required by FASB Statement 132, Employers'
Disclosure About Pensions and Other Postretirement Benefits, and includes
several additional disclosures. It also amends APB Opinion 28, Interim Financial
Reporting, to require certain disclosures about pensions and other
postretirement benefit plans in interim financial statements. Statement 132(R)
is effective for annual financial statements for fiscal years ending December
31, 2003, and is effective for interim-period disclosures beginning after March
31, 2004. The adoption of Statement 132(R) did not have a material impact on
the Company's balance sheets, statements of income or cash flows.
Accounting for Loans or Certain Debt Securities Acquired in a Transfer
In October 2003, the AICPA issued SOP 03-3 Accounting for Loans or Certain
Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan with the
evidence of deterioration of credit quality since origination acquired by
completion of a transfer for which it is probable at acquisition, that the
Company will be unable to collect all contractually required payments
receivable. SOP 03-3 requires that the Company recognize the excess of all cash
flows expected at acquisition over the investor's initial investment in the loan
as interest income on a level-yield basis over the life of the loan as the
accretable yield. The loan's contractual required payments receivable in excess
of the amount of its cash flows excepted at acquisition (nonaccretable
difference) should not be recognized as an adjustment to yield, a loss accrual
or a valuation allowance for credit risk. SOP 03-3 is effective for loans
acquired in fiscal years beginning after December 31, 2004. Early adoption is
permitted. Management is currently evaluating the provisions of SOP 03-3.
Derivative Instruments and Hedging Activities
The Company adopted Statement of Financial Accounting Standard 149 (SFAS
No. 149), Amendment of Statement 133 on Derivative Instruments and Hedging
Activities, on July 1, 2003. SFAS No. 149 clarifies and amends SFAS No. 133 for
implementation issues raised by constituents or includes the conclusions reached
by the FASB on certain FASB Staff Implementation Issues. Statement 149 also
amends SFAS No. 133 to require a lender to account for loan commitments related
to mortgage loans that will be held for sale as derivatives. SFAS No. 149 is
effective for contracts entered into or modified after September 30, 2003. The
Company periodically enters into commitments with its customers, which it
intends to sell in the future. Management does not anticipate the adoption of
SFAS No. 149 to have a material impact on the Company's financial position or
results of operations.
Financial Instruments with Characteristics of both Liabilities and Equity
The FASB issued SFAS No. 150, Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity, on May 15, 2003. SFAS No.
150 changes the classification in the statement of financial position of certain
common financial instruments from either equity or mezzanine presentation to
liabilities and requires an issuer of those financial statements to recognize
changes in fair value or redemption amount, as applicable, in earnings. SFAS No.
150 is effective for public companies for financial instruments entered into or
34
modified after May 31, 2003 and is effective at the beginning of the first
interim period beginning after June 15, 2003. Management does not anticipate the
adoption of SFAS No. 150 to have a material impact on the Company's financial
position or results of operations. The adoption of SFAS No. 150 did not have
a material impact on the Company's balance sheets, statements of income or
cash flows.
Off Balance Sheet Guarantees
The Company adopted FASB Interpretation 45 (FIN 45) Guarantor's Accounting
and Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others on January 1, 2003. FIN 45 requires a guarantor entity,
at the inception of a guarantee covered by the measurement provisions of the
interpretation, to record a liability for the fair value of the obligation
undertaken in issuing the guarantee. The Company has financial and performance
letters of credit. Financial letters of credit require the Company to make
payment if the customer's financial condition deteriorates, as defined in the
agreements. Performance letters of credit require the Company to make payments
if the customer fails to perform certain non-financial contractual obligations.
The Company previously did not record an initial liability, other than the fees
received for these letters of credit, when guaranteeing obligations unless it
became probable that the Company would have to perform under the guarantee. FIN
45 applies prospectively to letters of credit the Company issues or modifies
subsequent to December 31, 2002.
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, 2003 are $775,000
and they expire through 2005. Amounts due under these letters of credit would be
reduced by any proceeds that the Company would be able to obtain in liquidating
the collateral for the loans, which varies depending on the customer.
Variable Interest Entities
In January 2003, the FASB released Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN 46"). Fin 46 requires that all primary
beneficiaries of Variable Interest Entities ("VIE") consolidate that entity. FIN
46 is effective immediately for VIEs created after January 31, 2003 and to VIEs
to which an enterprise obtains an interest after that date. It applies in the
first fiscal year or interim period beginning after June 15, 2003, to VIEs in
which an enterprise holds a variable interest it acquired before February 1,
2003. In December 2003, the FASB published a revision to FIN 46 ("FIN 46R") to
clarify some of the provisions of the interpretation and defer to the effective
date of implementation for certain entities. Under the guidance of FIN 46R,
entities that do not have interests in structures that are commonly referred to
as special purpose entities are required to apply the provisions of the
interpretation in financial statements for periods ending after March 14, 2004.
We do not have interests in special purpose entities and will apply the
provisions of FIN 46R with our first quarter 2004 financial statements.
The Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments
In November 2003, the FASB's Emerging Issues Task Force (the "EITF")
reached consensus opinion on EITF Issue 03-1, "The Meaning of Other Than
Temporary Impairment and Its Application to Certain Investments. The Company
adopted EITF 03-1 as of December 31, 2003. EITF 03-1 includes certain
disclosures regarding quantitative and qualitative disclosures for investment
securities accounted for under FAS No. 115, Accounting for Certain Investments
in Debt and Equity Securities that are impaired at the balance sheet date, but
an other-than-temporary impairment has not been recognized. The disclosure under
EITF 03-1 are required for financial statements for years ending after December
15, 2003 and are included in these financial statements.
35
ITEM 7A. Quantitative and Qualitative Disclosure About Market Risk.
See Item 7. Managements' Discussion and Analysis of Financial Condition and
Results of Operations - Interest Rate Risk
ITEM 8. Financial Statements and Supplementary Data.
Inasmuch as the acquisition of the GSB Financial Corporation and Goshen
Savings Bank was consummated on March 30, 2001, the financial statements set
forth below include the results of operations of GSB Financial and Goshen Bank
from April 1, 2001, through December 31, 2001.
36
Report of Independent Certified Public Accountants
Board of Directors and Stockholders
Berkshire Bancorp Inc.
We have audited the accompanying consolidated balance sheets of Berkshire
Bancorp Inc. and its subsidiaries as of December 31, 2003 and 2002, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the three years in the period ended December 31, 2003. 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 auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes 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 its subsidiaries as of December 31, 2003 and 2002, and the consolidated
results of their operations and their consolidated cash flows for each of the
three years ended December 31, 2003 in conformity with accounting principles
generally accepted in the United States of America.
As discussed in Note B6 to the consolidated financial statements, the Company
adopted Statement of Financial Accounting Standards No. 142 Goodwill and Other
Intangible Assets on January 1, 2002.
/s/ GRANT THORNTON LLP
Philadelphia, Pennsylvania
February 12, 2004
37
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in Thousands)
December 31, December 31,
2003 2002
------------ ------------
ASSETS
Cash and due from banks $ 7,478 $ 6,183
Interest bearing deposits 1,832 127
Total cash and cash equivalents 9,310 6,310
Investment Securities:
Available-for-sale 569,137 370,625
Held-to-maturity, fair value of $715
in 2003 and $835 in 2002 711 833
-------- --------
Total investment securities 569,848 371,458
Loans, net of unearned income 294,756 275,497
Less: allowance for loan losses (2,593) (2,315)
-------- --------
Net loans 292,163 273,182
Accrued interest receivable 5,298 4,106
Premises and equipment, net 8,665 8,976
Goodwill, net 18,549 18,549
Other assets 1,836 1,157
-------- --------
Total assets $905,669 $683,738
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 38,422 $ 31,320
Interest bearing 565,833 442,498
-------- --------
Total deposits 604,255 473,818
Securities sold under agreements to repurchase 114,391 46,673
Long term borrowings 77,745 57,699
Accrued interest payable 2,208 3,348
Other liabilities 3,580 3,675
-------- --------
Total liabilities 802,179 585,213
-------- --------
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 -- 2,566,095 shares
Outstanding --
December 31, 2003, 2,207,080 shares
December 31, 2002, 2,237,976 shares 256 256
Additional paid-in capital 89,866 89,890
Retained earnings 22,960 16,145
Accumulated other comprehensive income, net 775 1,480
Treasury Stock
December 31, 2003, 359,015 shares
December 31, 2002, 328,119 shares (10,367) (9,246)
-------- --------
Total stockholders' equity 103,490 98,525
-------- --------
$905,669 $683,738
======== ========
The accompanying notes are an integral part of these statements
38
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Data)
For The Years Ended December 31,
--------------------------------
2003 2002 2001
------- ------- --------
INTEREST INCOME
Federal funds sold and interest bearing deposits $ 44 $ 136 $ 642
Investments 15,321 13,383 9,156
Loans, including related fees 19,061 18,723 15,143
------- ------- -------
Total interest income 34,426 32,242 24,941
------- ------- -------
INTEREST EXPENSE
Deposits 10,130 10,410 10,158
Short-term borrowings 794 687 483
Long-term borrowings 2,723 2,319 1,236
------- ------- -------
Total interest expense 13,647 13,416 11,877
------- ------- -------
Net interest income 20,779 18,826 13,064
PROVISION FOR LOAN LOSSES 240 387 287
------- ------- -------
Net interest income after
provision for loan losses 20,539 18,439 12,777
------- ------- -------
NON-INTEREST INCOME
Service charges on deposit accounts 640 548 395
Investment securities gains 2,746 1,539 637
Other income 597 200 391
------- ------- -------
Total non-interest income 3,983 2,287 1,423
------- ------- -------
NON-INTEREST EXPENSE
Salaries and employee benefits 5,873 5,183 4,153
Net occupancy expense 1,611 1,625 1,170
Equipment expense 397 312 201
FDIC assessment 80 66 42
Data processing expense 183 193 138
Amortization of goodwill -- -- 935
Other 3,319 3,401 2,134
------- ------- -------
Total non-interest expense 11,463 10,780 8,773
------- ------- -------
Income before provision for taxes 13,059 9,946 5,427
Provision for income taxes 5,644 4,349 2,128
------- ------- -------
Net income $ 7,415 $ 5,597 $ 3,299
======= ======= =======
Net income per share:
Basic $ 3.35 $ 2.44 $ 1.41
======= ======= =======
Diluted $ 3.30 $ 2.43 $ 1.41
======= ======= =======
Dividends per share $ .27 $ .22 $ .24
The accompanying notes are an integral part of these statements
39
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
For The Years Ended December 31, 2003, 2002 and 2001
(In Thousands)
Accumulated
Stock Additional other
Common Par paid-in comprehensive
Shares value capital income, net
------ ----- ---------- -------------
Balance at January 1, 2001 2,566 $256 $78,549 $ (85)
Net income
Treasury shares issued
for acquisition of
GSB Financial Corp 11,386
Acquisition of treasury shares
Treasury shares issued for
options exercised (21)
Other comprehensive (loss) net
of reclassification adjustment
and taxes (196)
Comprehensive income
Cash dividends
----- ---- ------- -------
Balance at December 31, 2001 2,566 $256 $89,914 $ (281)
Net income
Acquisition of treasury shares
Exercise of stock options (24)
Other comprehensive income net
of reclassification adjustment
and taxes 1,761
Comprehensive income
Cash dividends
----- ---- ------- -------
Balance at December 31, 2002 2,566 $256 $89,890 $1,480
Net income
Acquisition of treasury shares
Exercise of stock options (24)
Other comprehensive (loss) net
of reclassification adjustment
and taxes (705)
Comprehensive income
Cash dividends
Balance at December 31, 2003 2,566 $256 $89,866 $ 775
===== ==== ======= ======
Total
Accumlated Treasury Comprehensive stockholders'
earnings stock income equity
---------- -------- ------------- -------------
Balance at January 1, 2001 $ 8,352 $ (7,965) $ 79,107
Net income 3,299 3,299 3,299
Treasury shares issued
for acquisition of
GSB Financial Corp 7,887 19,273
Acquisition of treasury shares (4,983) (4,983)
Treasury shares issued for
options exercised 111 90
Other comprehensive (loss) net
of reclassification adjustment
and taxes (196)
------
Comprehensive income $3,103
======
Cash dividends (598) (598)
------- --------- --------
Balance at December 31, 2001 $11,053 $ (4,950) $ 95,992
Net income 5,597 5,597 5,597
Acquisition of treasury shares (4,422) (4,422)
Exercise of stock options 126 102
Other comprehensive income net
of reclassification adjustment
and taxes 1,761 1,761
------ --------
Comprehensive income $7,358
======
Cash dividends (505) (505)
------- -------- -------
Balance at December 31, 2002 $16,145 $ (9,246) $98,525
Net income 7,415 7,415 7,415
Acquisition of treasury shares (1,350) (1,350)
Exercise of stock options 229 205
Other comprehensive (loss) net
of reclassification adjustment
and taxes (705) (705)
------
Comprehensive income $6,710
======
Cash dividends (600) (600)
Balance at December 31, 2003 $22,960 $(10,367) $103,490
======= ======== ========
The accompanying notes are an integral part of these statements
40
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For The Years Ended December 31,
-------------------------------------
2003 2002 2001
----------- ----------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 7,415 $ 5,597 $ 3,299
Adjustments to reconcile net income
to net cash provided by (used in)
operating activities:
Realized gain on investment securities (2,746) (1,539) (637)
Depreciation and amortization 605 414 1,197
Provision for loan losses 240 387 287
Increase in deferred taxes 204 (133) (426)
CHANGES IN ASSETS AND LIABILITIES:
(Increase) in accrued interest receivable (1,192) (707) (659)
(Increase) decrease in other assets (1,064) 3,026 1,320
(Decrease) increase in accrued interest
payable and other liabilities (1,054) 1,316 616
----------- ----------- ---------
Net cash provided by operating activities 2,408 8,361 4,997
----------- ----------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Cash paid for business acquired -- -- (20,222)
Cash of entities acquired -- -- 6,047
Investment securities available for sale
Purchases (1,837,653) (1,729,416) (461,048)
Sales 1,641,186 1,603,261 359,278
Investment securities held to maturity
Purchases -- -- (167,800)
Maturities 118 780 187,724
Net increase in loans (19,221) (23,559) (42,003)
Acquisition of premises and equipment (294) (2,055) (4,138)
----------- ----------- ---------
Net cash (used in) investing activities (215,864) (150,989) (142,162)
----------- ----------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in non interest
bearing deposits 7,102 1,157 15,654
Net increase in interest bearing deposits 123,335 133,885 57,611
Increase (decrease) in securities sold
under agreements to repurchase 67,718 (7,083) 30,629
Issuance of long term debt 20,046 34,923 24,778
Repayment of long term debt -- (19,502) (12,000)
Acquisition of treasury stock (1,350) (4,422) (4,983)
Proceeds from exercise of common
stock options 205 102 90
Dividends paid (600) (505) (598)
----------- ----------- ---------
Net cash provided by financing activities 216,456 138,555 111,181
----------- ----------- ---------
41
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For The Years Ended December 31,
--------------------------------
2003 2002 2001
------- ------- --------
Net increase (decrease) in cash
and cash equivalents 3,000 (4,073) (25,984)
Cash and cash equivalents at
beginning of year $ 6,310 $10,383 36,367
------- ------- -------
Cash and cash equivalents at
end of year $ 9,310 $ 6,310 $ 10,383
======= ======= ========
SUPPLEMENTAL DISCLOSURES OF CASH
FLOW INFORMATION:
Cash used to pay interest $14,787 $12,474 $ 10,804
Cash used to pay income taxes $ 2,015 $ 5,692 $ 1,637
The accompanying notes are an integral part of these statements
42
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2003 and 2002
NOTE A - ORGANIZATION AND PLAN OF MERGER AND CAPITALIZATION
Organization
Berkshire Bancorp Inc. ("Berkshire" or the "Company"), 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 wholly owned subsidiary, The Berkshire Bank (the "Bank").
The Bank, a New York State chartered commercial 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. It has three branches in Brooklyn,
NY, one branch in downtown Manhattan and four branches in Orange and Sullivan
Counties in New York state.
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.
Mergers and Acquisitions
On March 30, 2001, Berkshire completed its acquisition of GSB Financial
Corporation ("GSB Financial"). As a result, GSB Financial merged with and into
Berkshire and Goshen Savings Bank ("Goshen Bank") merged with and into The
Berkshire Bank. Under the terms of the merger, each share of GSB Financial
common stock was redeemed for $20.75, or converted into 0.6027 shares of
Berkshire's common stock. As a result of this transaction, 978,032 shares of GSB
Financial common stock were converted into 589,460 shares of Berkshire common
stock, and 974,338 shares of GSB Financial common stock were purchased for
$20.75 per share, totaling approximately $20.2 million.
This transaction was accounted for under the purchase method of accounting
and accordingly, the results of operations of the Company for the year ended
December 31, 2001, include only the results of operations of GSB Financial from
April 1, 2001 through December 31, 2001. The acquisition resulted in the
recording of approximately $7.5 million of goodwill, which, through December 31,
2001, has been amortized on a straight-line basis over 15 years.
The following represents the unaudited pro forma financial information of
the Company as if the acquisition occurred on the first date of the period
indicated. The pro forma information should be read in conjunction with the
related historical information and is not necessarily indicative of the results
that would have been attained had the transaction actually taken place.
43
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note A - (continued)
For The Year Ended
December 31, 2001
------------------
(In thousands)
Interest income $31,499
Interest Expense 15,396
-------
Net interest income 16,103
Provision for loan losses 547
Non-interest income 1,696
Non-interest expense 11,007
Net income $ 3,427
NOTE B - SUMMARY OF ACCOUNTING POLICIES
1. Basis of Financial Statement Presentation
The consolidated financial statements include the accounts of Berkshire
Bancorp and its wholly owned subsidiaries, Greater American Finance Group, Inc.
("GAFG") and the Bank, (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 estimate that is susceptible to significant change in the
near term relates to the allowance for loan losses and goodwill. 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.
The Company provides disclosures under SFAS 131 Disclosures About Segments
of an Enterprise and Related Information. Operating segments are components of
an enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and assess performance. The Company has one operating segment
and, accordingly, one reportable segment, "Community Banking." All of the
Company's activities are interrelated, and each activity is dependent and
assessed based on how each of the activities of the Company supports the others.
For example, commercial lending is dependent upon the ability of the Bank to
fund itself with retail deposits and other borrowings
44
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE B - (continued)
and to manage interest rate and credit risk. This situation is also similar for
consumer and residential mortgage lending. Accordingly, all significant
operating decisions are based upon analysis of the Company as one operating
segment or unit.
2. Investment Securities
The Company accounts for its investment securities in accordance with 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, and 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.
In November 2003, the FASB's Emerging Issues Task Force (the "EITF")
reached consensus opinion on EITF Issue 03-1, "The Meaning of Other Than
Temporary Impairment and Its Application to Certain Investments. The Company
adopted EITF 03-1 as of December 31, 2003. EITF 03-1 includes certain
disclosures regarding quantitative and qualitative disclosures for investment
securities accounted for under FAS No. 115, Accounting for Certain Investments
in Debt and Equity Securities that are impaired at the balance sheet date, but
an other-than-temporary impairment has not been recognized. The disclosure under
EITF 03-1 are required for financial statements for years ending after December
15, 2003 and are included in these financial statements.
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 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 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.
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.
45
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE B - (continued)
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." This standard requires 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.
The Company follows the provisions of SFAS No. 140 "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,"
SFAS No. 140 is based on consistent application of a financial-components
approach that recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has been
surrendered and derecognizes liabilities when extinguished. SFAS No. 140
provides consistent guidelines for distinguishing transfers of financial assets
from transfers that are secured borrowings. The Company adopted SFAS 140 on
April 1, 2001 and the adoption did not have a material impact upon the Company's
consolidated financial statements.
Staff Accounting Bulletin (SAB) No. 102, Selected Loan Loss Allowance
Methodology and Documentation Issues. SAB No. 102 provides guidance on the
development, documentation, and application of a systematic methodology for
determining the allowance for loans and leases in accordance with US GAAP. The
adoption of SAB No. 102 is not expected to have a material impact on the
Company's financial position or results of operations.
In October 2003, the AICPA issued SOP 03-3 Accounting for Loans or Certain
Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan with the
evidence of deterioration of credit quality since origination acquired by
completion of a transfer for which it is probable at acquisition, that the
Company will be unable to collect all contractually required payments
receivable. SOP 03-3 requires that the Company recognize the excess of all cash
flows expected at acquisition over the investor's initial investment in the loan
as interest income on a level-yield basis over the life of the loan as the
accretable yield. The loan's contractual required payments receivable in excess
of the amount of its cash flows excepted at acquisition (nonaccretable
difference) should not be recognized as an adjustment to yield, a loss accrual
or a valuation allowance for credit risk. SOP 03-3 is effective for loans
acquired in fiscal years beginning after December 31, 2004. Early adoption is
permitted. Management is currently evaluating the provisions of SOP 03-3.
The Company adopted Statement of Financial Accounting Standard 149 (SFAS
No. 149), Amendment of Statement 133 on Derivative Instruments and Hedging
Activities, on July 1, 2003. SFAS No. 149 clarifies and amends SFAS No. 133 for
implementation issues raised by constituents or includes the conclusions reached
by the FASB on certain FASB Staff Implementation Issues. Statement 149 also
amends SFAS No. 133 to require a lender to account for loan commitments related
to mortgage loans that will be held for sale as derivatives. SFAS No. 149 is
effective for contracts entered into or modified after September 30, 2003. The
Company periodically enters into commitments with its customers, which it
intends to sell in the future. Management does not anticipate the adoption of
SFAS No. 149 to have a material impact on the Company's financial position or
results of operations.
46
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE B - (continued)
The Company adopted FASB Interpretation 45 (FIN 45) Guarantor's Accounting
and Disclosure Requirements for Guarantees, including Indirect Guarantees of
Indebtedness of Others on January 1, 2003. FIN 45 requires a guarantor entity,
at the inception of a guarantee covered by the measurement provisions of the
interpretation, to record a liability for the fair value of the obligation
undertaken in issuing the guarantee. The Company has financial and performance
letters of credit. Financial letters of credit require the Company to make
payment if the customer's financial condition deteriorates, as defined in the
agreements. Performance letters of credit require the Company to make payments
if the customer fails to perform certain non-financial contractual obligations.
The Company previously did not record an initial liability, other than the fees
received for these letters of credit, when guaranteeing obligations unless it
became probable that the Company would have to perform under the guarantee. FIN
45 applies prospectively to letters of credit the Company issues or modifies
subsequent to December 31, 2002.
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, 2003 are $775,000
and they expire through 2005. Amounts due under these letters of credit would be
reduced by any proceeds that the Company would be able to obtain in liquidating
the collateral for the loans, which varies depending on the customer.
4. 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.
On January 1, 2002 the Company adopted SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 retains the existing
requirements to recognize and measure the impairment of long-lived assets to be
held and used or to be disposed of by sale. However, SFAS No. 144 makes changes
to the scope and certain measurement requirements of existing accounting
guidance. The adoption of this statement did not have a significant impact on
the financial condition or results of operations of the Company.
5. 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.
6. Goodwill
Goodwill resulting from the acquisition of the Berkshire Bank and GSB
Financial has been amortized on a straight-line basis over approximately 20
years and 15 years, respectively. Amortization expense for the year ended
December 31, 2001 was approximately $935,000.
47
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE B - (continued)
On June 29, 2001, SFAS No. 141, Business Combinations, and SFAS No. 142,
Goodwill and Intangible Assets were issued. These statements resulted in
significant modifications relative to the Company's accounting for goodwill and
other intangible assets. SFAS No. 141, which was effective upon issuance,
requires that all business combinations initiated after June 30, 2001 must be
accounted for under the purchase method of accounting. SFAS No. 142 modifies the
accounting for all purchased goodwill and intangible assets. SFAS No. 142
includes requirements to test goodwill and indefinite lived intangible assets
for impairment rather than amortize them. Upon adoption of SFAS 142, on January
1, 2002, the Company no longer amortized goodwill, thereby eliminating annual
amortization expense of approximately $1.0 million.
The following table presents a reconciliation of net income and
earnings-per-share amounts, as reported in the financial statements, to those
amounts adjusted for goodwill and intangible asset amortization determined in
accordance with the provisions of SFAS No. 142.
For The Year Ended December 31,
----------------------------------------
2003 2002 2001
------ ------ ------
(In thousands, except per share amounts)
Reported net income $7,415 $5,597 $3,299
Add back: goodwill amortization -- -- 935
------ ------ ------
Adjusted net income $7,415 $5,597 $4,234
====== ====== ======
Basic earnings per share:
Reported basic earnings per share $ 3.35 $ 2.44 $ 1.41
Goodwill amortization -- -- .40
------ ------ ------
Adjusted basic earnings per share $ 3.35 $ 2.44 $ 1.81
====== ====== ======
Diluted earnings per share:
Reported diluted earnings per share $ 3.30 $ 2.43 $ 1.41
Goodwill amortization -- -- .40
------ ------ ------
Adjusted diluted earnings per share $ 3.30 $ 2.43 $ 1.81
====== ====== ======
7. 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.
8. 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.
48
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE B - (continued)
9. Stock Based Compensation
The Company follows SFAS No. 123 "Accounting for Stock Based Compensation."
This statement introduced a method of accounting for employee stock-based
compensation plans based upon the fair value of the awards on the date they are
granted. Under this fair value based method, public companies estimate the fair
value of stock options using a pricing model, such as the Black-Scholes model,
which requires inputs such as the expected volatility of the stock price and an
estimate of the dividend yield over the option's expected life. The FASB,
however, does not require the use of this method. Entities that continue to
account for stock option plans under the existing method (APB No. 25) are
required to disclose proforma net income and earnings per share, as if the fair
value method had been used.
At December 31, 2003, the Company has one stock-based employee compensation
plan, which is more fully described in Note K. The Company accounts for that
plan under the recognition and measurement principles of APB No. 25, "Accounting
for Stock Issued to Employees," and related interpretations. Stock-based
employee compensation costs are not reflected in net income, as all options
granted under the plan had an exercise price equal to the market value of the
underlying common stock on the date of the grant. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation," to stock-based employee compensation.
For The Years Ended December 31,
----------------------------------------
2003 2002 2001
------ ------ ------
(In thousands, except per share amounts)
Net income As Reported: $7,415 $5,597 $3,299
Less: Stock based compensation
costs determined under fair
value methods for all awards 32 680 316
------ ------ ------
Pro Forma: $7,383 $4,917 $2,983
====== ====== ======
Basic earnings per share As Reported: $ 3.35 $ 2.44 $ 1.41
Pro Forma: 3.34 2.14 1.28
Diluted earnings per share As Reported: 3.30 2.43 1.41
Pro Forma: 3.28 2.14 1.28
The fair value of each option is estimated on the date of grant using the
Black-Scholes options-pricing model with the following weighted-average
assumptions used for grants as of December 31, 2001, expected volatility of 22%,
risk-free interest of 5.34%, and expected lives of 5 years. The Company did not
grant options in 2003 and 2002.
10. Cash Equivalents
The Company considers all highly liquid debt investments purchased with an
original maturity of three months or less, and amounts due from brokers to be
cash equivalents.
49
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE B - (continued)
11. 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 $1,032,000, $1,155,000 and $900,000 at December 31, 2003, 2002 and
2001, respectively.
12. 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, 2003
-----------------------------------
Tax
Before tax (expense) Net of tax
amount benefit Amount
---------- --------- ----------
Unrealized gains (losses)
on investment securities:
Unrealized holding gains
arising during period $ 1,231 $ (491) $ 740
Less reclassification
adjustment for gains
realized in net income 2,746 (1,097) 1,649
------- ------- ------
Unrealized (loss) on investment
securities (1,515) 606 (909)
Change in minimum pension
liability 340 (136) 204
------- ------- ------
Other comprehensive
income (loss), net $(1,175) $ 470 $ (705)
======= ======= ======
Year Ended
December 31, 2002
-----------------------------------
Tax
Before tax (expense) Net of tax
amount benefit Amount
---------- --------- ----------
Unrealized gains on
investment securities:
Unrealized holding gains
arising during period $4,760 $(1,872) $2,888
Less reclassification
adjustment for gains
realized in net income 1,539 (616) 923
------ ------- ------
Unrealized gain (loss) on
investment securities 3,221 (1,256) 1,965
Minimum pension liability (340) 136 (204)
------ ------- ------
Other comprehensive
income, net $2,881 $(1,120) $1,761
====== ======= ======
50
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note B - (continued)
Year Ended
December 31, 2001
-----------------------------------
Tax
Before tax (expense) Net of tax
amount benefit Amount
---------- --------- ----------
Unrealized gains (losses)
on investment securities:
Unrealized holding (losses)
arising during period $ 357 $(171) $ 186
Less reclassification
adjustment for gains
realized in net income 637 (255) 382
----- ----- -----
Other comprehensive
loss, net $(280) $ 84 $(196)
===== ===== =====
13. Reclassifications
Certain amounts in the December 31, 2002 and 2001 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, 2003
------------------------------------------------
Gross Gross
Amortized Cost unrealized unrealized Fair
gains losses value
-------------- ---------- ---------- -----
(In thousands)
Investment securities
U.S. Government
Agencies $711 $4 $-- $715
---- --- --- ----
Totals $711 $4 $-- $715
==== === === ====
December 31, 2002
------------------------------------------------
Gross Gross
Amortized Cost unrealized unrealized Fair
gains losses value
-------------- ---------- ---------- -----
(In thousands)
Investment securities
U.S. Government
Agencies $833 $3 $(1) $835
---- --- --- ----
Totals $833 $3 $(1) $835
==== === === ====
51
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, 2003
----------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
--------- ---------- ---------- --------
(In thousands)
Investment securities
U.S. Treasury and Notes $ 39,941 $ -- $ (94) $ 39,847
U.S. Government Agencies 419,175 637 (3,059) 416,753
Mortgage-backed securities 93,875 3,838 (265) 97,448
Corporate notes 1,570 214 (122) 1,662
Municipal securities 991 70 -- 1,061
Marketable equity
securities and other 12,305 177 (116) 12,366
-------- ------ ------- --------
Totals $567,857 $4,936 $(3,656) $569,137
======== ====== ======= ========
December 31, 2002
----------------------------------------------
Gross Gross
Amortized unrealized unrealized Fair
Cost gains losses value
--------- ---------- ---------- --------
(In thousands)
Investment securities
U.S. Treasury and Notes $ 20,110 $ 103 $ -- $ 20,213
U.S. Government Agencies 301,224 2,376 (3) 303,597
Mortgage-backed securities 6,256 6 -- 6,262
Corporate notes 3,878 495 (297) 4,076
Marketable equity
securities and other 36,383 242 (148) 36,477
-------- ------ ----- --------
Totals $367,851 $3,222 $(448) $370,625
======== ====== ===== ========
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. The following
table indicates the length of time individual securities have been in a
continuous unrealized loss position at December 31, 2003 (in thousands):
Less than 12 months 12 months or longer Total
------------------------ ----------------------- -----------------------
Unrealized Unrealized Unrealized
Fair Value Losses Fair Value Losses Fair Value Losses
---------- ---------- ---------- ---------- ---------- ----------
Description of Securities
U.S. Treasury and Notes $ 39,847 $ 94 $ -- $ -- $ 39,847 $ 94
U.S. Government Agencies 308,680 3,059 51 -- 308,731 3,059
Mortgage-backed securities 10,432 265 -- -- 10,432 265
Corporate notes -- -- -- 122 -- 122
Municipal securities -- -- -- -- -- --
-------- ------ ---- ---- -------- ------
Subtotal, debt securities 358,959 3,418 51 122 359,010 3,540
Marketable equity securities
and other 213 27 126 89 339 116
-------- ------ ---- ---- -------- ------
Total temporarily impaired
securities $359,172 $3,445 $177 $211 $359,439 $3,656
======== ====== ==== ==== ======== ======
52
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE C - (continued)
The Company had a total of 63 securities with a fair market value of
$359.01 million which were temporarily impaired at December 31, 2003. The total
unrealized loss on these securities was $3.45 million, all but $27,000 of such
unrealized loss is attributable to interest rate movements. We have the ability
to hold these US Government and US Government Agency securities to maturity,
therefore, the unrealized losses associated with these securities are not
considered to be other than temporary.
We also had 1 corporate note and 7 equity securities with an aggregated
fair market value of $339,000 which were temporarily impaired at December 31,
2003. The total unrealized loss on these 8 securities was $211,000. Based upon
our review of the available information, such unrealized losses are not
considered to be other than temporary.
The amortized cost and fair value of investment securities available for
sale and held to maturity, by contractual maturity, at December 31, 2003 and
2002 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, 2003
----------------------------------------
Available for Sale Held to Maturity
-------------------- -----------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- -------- --------- -----
(In thousands)
Due in one year or less $ -- $ -- $ -- $ --
Due after one through
five years 102,626 102,654 74 74
Due after five through
ten years 196,934 195,168 70 70
Due after ten years 255,992 258,949 567 571
Marketable equity
securities and other 12,305 12,366 -- --
-------- -------- ---- ----
Totals $567,857 $569,137 $711 $715
======== ======== ==== ====
Gross gains realized on the sales of investment securities for the years
ended December 31, 2003, 2002 and 2001 were $2.91 million, $1.54 million and
$637,000, respectively. Gross losses were $163,000 for the year ended December
31, 2003. Gross losses were not material for the years ended December 31, 2002
and 2001.
As of December 31, 2003 and 2002, securities sold under agreements to
repurchase with a book value of approximately $114.39 million and $46.67
million, respectively, were outstanding. As of December 31, 2003 and 2002, the
Company did not have any investment securities of any one issuer where the
carrying value exceeded 10% of shareholders' equity.
On November 7, 2002, we sold our 24.9% interest in a merchant credit card
processing company for $285,000, which represents our initial purchase price in
December 1999. We accounted for our interest in this company under the equity
method of accounting and have recorded approximately $200,000 in net losses
since December 1999. In addition, the Bank had loans outstanding totaling
$295,000 to his company which are being repaid as a result of this transaction.
At December 31, 2003, the purchase price to Berkshire has been paid in full.
53
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,
2003 2002
------------ ------------
(In thousands)
Commercial and professional loans $ 22,228 $ 16,704
Secured by real estate
1 - 4 family 169,589 180,730
Multi family 6,608 8,958
Non-residential 94,956 65,809
Consumer 2,239 4,051
-------- --------
295,620 276,252
Deferred loan fees (864) (755)
Allowance for loan losses (2,593) (2,315)
-------- --------
$292,163 $273,182
======== ========
Changes in the allowance for loan losses are as follows:
For The Years Ended
December 31,
------------------------
2003 2002 2001
------ ------ ------
(In thousands)
Balance at beginning $2,315 $2,030 $1,108
of year
Provision charged to 240 387 287
operations
Loans charged off 17 199 97
Recoveries 55 97 41
Acquisition of GSB
Financial Corp -- -- 691
------ ------ ------
Balance at end of year $2,593 $2,315 $2,030
====== ====== ======
The Company had $109,000, $59,000 and $9,000 non accrual loans as of
December 31, 2003, 2002 and 2001, respectively. The Company did not have any
impaired loans as of December 31, 2003, 2002 and 2001. The Company had
approximately $0, $0, and $58,000 of loans past due more than 90 days and still
accruing interest as of December 31, 2003, 2002 and 2001, respectively.
The Company, 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. At December 31,
2003, loans to these related parties amounted to $12.6 million, were current as
to principal and interest payments, and do not involve more than normal risk of
collectibility. An analysis of activity in loans to related parties at December
31, 2003, resulted in new loans of $3.1 million and repayments of approximately
$4.4 million.
54
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 2003 2002
------------- ------------ ------------
(In thousands)
Land Indefinite $ 3,817 $ 1,817
Buildings 39 years 4,059 838
Furniture and equipment 3 to 10 years 2,318 2,196
Leasehold improvements 2 to 10 years 620 612
Construction in progress -- 5,056
------- -------
10,814 10,519
Accumulated depreciation
and amortization (2,149) (1,543)
------ -------
Total $ 8,665 $ 8,976
======= =======
Depreciation and amortization expense was approximately $605,000, $279,000
and $249,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
The increase in 2003, as compared to prior years, was primarily due to the
completion of the construction and occupancy by the Bank of the property we
purchased in 2001.
NOTE F - DEPOSITS
The aggregate amount of jumbo certificates of deposits greater than
$100,000 were approximately $110.08 million and $108.72 million as of December
31, 2003 and 2002, respectively.
The scheduled maturities of all certificates of deposit are as follows:
December 31, 2003
-----------------
(In thousands)
2004 $297,434
2005 7,291
2006 10,751
2007 13
2008 1,991
--------
$317,480
========
55
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
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,
----------------------------
2003 2002 2001
-------- ------- -------
(Dollars in Thousands)
Securities sold under repurchase
agreements and federal funds purchased
Balance at year-end $114,391 $46,673 $53,756
Average during the year $ 57,554 $38,433 $13,372
Maximum month-end balance $114,391 $47,407 $53,756
Weighted average rate during the year 1.68% 1.79% 3.62%
Rate at December 31 1.73% 1.46% 1.67%
Long-Term Borrowings At December 31, 2003, advances from the Federal Home
Loan Bank ("FHLB") totaling $77.7 million will mature within one to ten years
and are reported as long-term borrowings. The advances are collateralized by
FHLB stock and certain first mortgage loans. The advances had a weighted average
rate of 3.91%. Unused lines of credit at the FHLB were $38.0 million at December
31, 2003.
Outstanding long-term borrowings mature as follows (in thousands):
Year Amount
---------- -------
2004 $ --
2005 4,000
2006 13,010
2007 27,753
2008 18,982
Thereafter 14,000
-------
Total $77,745
=======
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, 2003
(In thousands, except per share data)
---------------------------------------
Income Shares Per share
(numerator) (denominator) amount
----------- ------------- ---------
Basic earnings per share
Net income available to
common stockholders $7,415 2,212 $3.35
Effect of dilutive securities
Options -- 37 (.05)
------ ----- -----
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $7,415 2,249 $3.30
====== ===== =====
56
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE H - (continued)
Year Ended December 31, 2002
(In thousands, except per share data)
---------------------------------------
Income Shares Per share
(numerator) (denominator) amount
----------- ------------- ---------
Basic earnings per share
Net income available to
common stockholders $5,597 2,292 $2.44
Effect of dilutive securities
Options -- 11 (.01)
------ ----- -----
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $5,597 2,303 $2.43
====== ===== =====
Options to purchase 115,375 shares of common stock for $30.00 to $38.00 per
share were outstanding during the year ended December 31, 2002. These options
were not included in the computation of diluted earnings per share because the
option exercise price was greater than the average market price for the
Company's common stock during this period.
Year Ended December 31, 2001
(in thousands, except per share data)
---------------------------------------
Income Shares Per share
(numerator) (denominator) amount
----------- ------------- ---------
Basic earnings per share
Net income available to
common stockholders $3,299 2,326 $1.41
Effect of dilutive securities
Options -- 10 --
------ ----- -----
Diluted earnings per share
Net income available to
common stockholders plus
assumed conversions $3,299 2,336 $1.41
====== ===== =====
Options to purchase 119,375 shares of common stock for $30.00 to $38.00 per
share were outstanding during the year ended December 31, 2001. These options
were not included in the computation of diluted earnings per share because the
option exercise price was greater than the average market price for the
Company's common stock during this period.
57
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE I - INCOME TAXES
The components of income tax expense are as follows:
Years Ended December 31,
------------------------------------
2003 2002 2001
---------- ---------- ----------
Current $5,848,000 $4,216,000 $1,702,000
Deferred Taxes (Benefit) (204,000) 133,000 426,000
---------- ---------- ----------
$5,644,000 $4,349,000 $2,128,000
========== ========== ==========
A reconciliation of the provision for income taxes for the years ended
December 31, 2003, 2002 and 2001 and the amount computed by applying the
statutory Federal income tax rate to income from continuing operations follows:
Years Ended December 31,
------------------------------------
2003 2002 2001
---------- ---------- ----------
Effective Tax Reconciliation
Tax at statutory rate $4,439,000 $3,381,000 $1,846,000
State and City, net of federal
income tax benefit 1,211,000 940,000 612,000
Nondeductible expenses,
including goodwill -- -- 217,000
Tax exempt income (76,000) (53,000) (44,000)
Other 70,000 81,000 (503,000)
---------- ---------- ----------
Actual provision for
income taxes $5,644,000 $4,349,000 $2,128,000
========== ========== ==========
The tax effect of the principal temporary differences at December 31, 2003
and 2002 are as follows:
December 31,
------------------------
2003 2002
---------- -----------
Net deferred tax assets
Loan loss provision $1,215,000 1,095,000
Depreciation 9,000 20,000
Other 80,000 (15,000)
Unrealized loss, minimum
pension liability adjustment -- 136,000
Unrealized (gain) loss on
investment securities (500,000) (1,124,000)
---------- -----------
Net deferred tax asset
included in other assets $ 804,000 $ (112,000)
========== ===========
58
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
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 200,000 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 112,375 and 115,375 as of December 31, 2003 and 2002,
respectively. As of December 31, 2003 and 2002, 57,098 options and 62,126
options, respectively, were also outstanding as a result of the GSB acquisition.
The Company did not grant options in 2003 and 2002.
A summary of activity with respect to the Stock Option Plan follows:
December 31,
------------------------------------------------------------
2003 2002 2001
------------------ ------------------ ------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------- -------- ------- -------- ------- --------
Outstanding at
beginning of year 177,501 $30.30 191,596 $29.74 50,375 $36.37
Granted -- $ -- -- $ -- 152,496 $27.68
Cancelled -- $ -- (6,509) $27.13 (7,443) $29.84
Exercised (8,028) $25.83 (7,586) $21.75 (3,832) $23.59
------- ------- -------
Outstanding at
end of year 169,473 $30.36 177,501 $30.30 191,596 $29.74
======= ======= =======
Exercisable at
end of year 165,798 $30.47 167,500 $33.09 84,799 $31.63
======= ======= =======
Weighted average
fair value of
options granted
during the year $ -- $ -- $ 9.54
====== ====== ======
The following table summarizes information about options outstanding at
December 31, 2003:
Options Outstanding Options Exercisable
-------------------------------------------------------- -----------------------
Number Weighted Number
outstanding average Weighted outstanding Weighted
at remaining average at average
Range of December 31, contractual exercise December 31, exercise
exercise prices 2003 life (years) price 2003 price
--------------- ------------ ------------ -------- ------------ --------
$17.94 - 26.34 50,323 4.93 $25.43 46,648 $25.58
27.79 - 38.00 119,150 2.95 32.66 119,150 32.66
------- -------
169,473 165,798
======= =======
59
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE K - EMPLOYEE BENEFIT PLANS
1. Retirement Income Plan
The Company has a Retirement Income Plan (the "Retirement Plan"), a
noncontributory plan covering substantially all full-time, non-union United
States employees of the Company. Benefits were based upon a combination of
employee compensation and years of service. The Company paid the entire cost of
the plan for its employees and funded such costs as they accrued. The Company's
funding policy was to make annual contributions within minimum and maximum
levels required by applicable regulations. The Company's 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.
Benefit accruals were frozen as of September 15, 1988, resulting in a plan
curtailment. As a result of such curtailment, the Company did not accrue
benefits for future services; however, the Company did continue to contribute as
necessary for any unfunded liabilities. In 2000, the Company reinstated the
Retirement Plan to cover substantially all full-time, non-union United States
employees of the Company.
The following table summarizes the major categories of Plan assets as of
the dates indicated:
December 31,
-------------------------------------------------
2003 2002
----------------------- -----------------------
Fair Value % of Total Fair Value % of Total
---------- ---------- ---------- ----------
(In thousands, except percentages
Mutual Funds
International Equity Fund $ 127 6.99% $ 101 6.67%
Large Cap Equity Growth Fund 831 45.76 646 42.64
International Investment
Grade Bond Fund 570 31.39 577 38.08
Small Cap Equity Growth Fund 122 6.72 96 6.34
Corporate Common Stocks(1) 157 8.65 95 6.27
Cash and cash equivalents 9 0.49 -- --
------ ------ ------ ------
Total Plan Assets $1,816 100.00% $1,515 100.00%
----------
(1) Includes shares of the Company's Common Stock with a market value of
$75,000 and $51,000 at December 31, 2003 and 2002, respectively.
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 will be
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 will be determined by the
Investment Manager, and will typically include 50% to 70% equities, with the
remainder invested in fixed income and 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 Retirement 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.
60
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE K - (continued)
Assumptions
Weighted-average assumptions used to determine benefit obligations were as
follows at the dates indicated:
December 31,
------------
2003 2002
---- ----
Discount rate 6.60% 7.25%
Rate of compensation increase 5.00% 5.00%
Weighted-average assumptions used to determine net periodic benefit cost
for the years ended December 31, 2003 and 2002 were as follows:
December 31,
-------------------
2003 2002
-------- --------
Discount rate 7.25% 7.50%
Rate of compensation increase 5.00% 5.00%
Expected return on plan assets 8.50% 8.50%
Measurement date 1/1/2003 1/1/2002
A summary of the components of net periodic pension cost for the years
ended December 31, 2003, 2002 and 2001 is as follows:
December 31,
---------------------------------
2003 2002 2001
--------- --------- ---------
Service cost-benefits earned
during the period $ 195,162 $ 48,883 $ 68,214
Interest cost on projected
benefit obligation 107,211 98,897 103,364
Expected return on plan assets (123,482) (148,973) (177,560)
Net amortization and deferral 43,208 18,370 10,913
--------- --------- ---------
Net pension cost/(income) of
defined benefit plan $ 222,099 $ 17,177 $ 4,931
========= ========= =========
61
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE K - (continued)
The following table sets forth the funded status and amounts recognized in
the Company's balance sheet for its defined benefit plan at December 31, 2003
and 2002:
December 31,
--------------------------
2003 2002
----------- -----------
Actuarial present value of vested
accumulated benefit obligations $ 1,807,366 $ 1,435,631
Actuarial present value of
accumulated benefit obligations 1,814,032 1,441,790
----------- -----------
Projected benefit obligations $(1,814,032) $(1,441,790)
Fair value of plan assets 1,815,905 1,515,166
----------- -----------
Excess of projected benefit
obligation over fair value
of plan assets 1,873 73,376
Unrecognized prior service cost 157,614 175,984
Unrecognized net loss 318,677 342,903
----------- -----------
Prepaid pension cost, included
in other assets $ 478,164 $ 592,263
=========== ===========
Estimated Future Benefit Payments
We estimate future benefit payments to be as follows:
Benefit
Years Payments
----- --------
2004 $126,705
2005 131,683
2006 135,430
2007 165,311
2008 149,466
Years 2009-2013 892,049
Company Contributions
During the fiscal year ending December 31, 2004, the Company expects to
contribute approximately $105,000 to its Retirement Plan.
62
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE K - (continued)
2. Former Goshen Bank Pension Plan
The Bank, as successor to Goshen Bank, had a non-contributory defined
benefit pension plan covering substantially all of its employees. In the fourth
quarter of 2000, the Goshen Bank froze its defined benefit pension plan and
provided that there would be no further accruals under the plan. On October 24,
2002, the Board of Directors of the Bank approved the termination of this plan.
In 2003, we paid out approximately $600,000 to complete the termination of this
plan and purchase annuity contracts. Upon the notice of termination, all
participant benefits vest 100%.
December 31, 2002
-----------------
(In thousands)
Change in benefit obligation
Benefit obligation at beginning of year $1,193
Service cost --
Interest cost 84
Actual loss 85
Benefits paid (91)
------
Benefits obligations at end of year 1,271
Change in plan assets
Fair value of plan assets at beginning of year 1,309
Actual return on plan assets (917)
Employer contribution --
Benefits paid (91)
------
Fair value of plan assets
at end of year 1,127
Funded status (144)
Unrecognized net actuarial loss 340
------
Prepaid benefit cost (included in other assets) $ 196
======
Net pension cost included the following components:
Year Ended December 31,
-----------------------
2003 2002 2001
---- ---- ----
(In thousands)
Service cost $-- $ -- $ --
Interest cost on projected benefit obligation -- 84 85
Expected return on plan assets -- (88) (99)
Purchase accounting change -- -- 61
--- ---- ----
Net periodic benefit cost $-- $ 4 $ 47
=== ==== ====
The assumed discount rate and rate of increase in future compensation
levels used in determining the actuarial present value of the projected benefit
obligation was 7.25% and 8.00% in 2002 and 2001, respectively.
63
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE K - (continued)
3. Postretirement Welfare Plan
In addition to pension benefits, 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,
--------------
2003 2002
----- ------
(In thousands)
Change in benefit obligation
Benefit obligation at beginning of year $ 718 $ 712
Service cost -- --
Interest cost 47 50
Actual loss 2 9
Benefits paid (52) (53)
----- -----
Benefits obligation at end of year 715 718
----- -----
Change in plan assets
Fair value of plan assets at beginning of year -- --
Actual return on plan assets -- --
Employer contribution 52 53
Benefits paid (52) (53)
----- -----
Fair value of plan assets at end of year -- --
----- -----
Funded status (715) (718)
Unrecognized net actuarial loss 15 13
----- -----
Accrued benefit cost (included in other liabilities) $ 700 $ 705
===== =====
Net benefit cost included the following components:
Year Ended December 31,
-----------------------
2003 2002
---- ----
(In thousands)
Service cost $-- $--
Interest cost on projected
benefit obligation 47 50
Actual return on plan assets -- --
--- ---
Net periodic benefit cost $47 $50
=== ===
The assumed discount rate used in determining the actuarial present value
of the projected benefit obligation was 6.75% and 7.25% in 2003 and 2002,
respectively.
64
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE K - (continued)
4. 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.
Goshen Bank had a 401(k) profit sharing plan which covered substantially
all employees of the Goshen Bank prior to the acquisition by Berkshire. Each
employee could contribute up to 10% of their salary. Goshen Bank matched 100% of
the employee contribution up to a maximum of 3% of the employee's salary. This
plan was terminated and merged into the Bank's plan effective October 2001.
The matching expense was $76,000 for the year ended December 31, 2003,
$105,000 for the year ended December 31, 2002, $57,000 for both the Bank and
Goshen Bank plans for the year ended December 31, 2001.
5. 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,
2003 and 2002, the balance accumulated under these arrangements was
approximately $241,000 and $248,000, 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.
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 2004 through 2012. 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
December 31, (In thousands)
------------
2004 $ 533
2005 413
2006 292
2007 302
2008 166
Thereafter 509
------
$2,215
======
Rental expense was approximately $699,000, $811,000 and $717,000 for the
fiscal years ended December 31, 2003, 2002 and 2001, respectively. Included in
rental expense was approximately $270,000, $255,000 and $255,000 for the fiscal
years ended December 31, 2003, 2002 and 2001, 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
65
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
Note M - (continued)
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, 2003 and 2002 are outlined
below.
For cash and cash equivalents, the recorded book values of $9.31 million
and $6.31 million at December 31, 2003 and 2002, 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.
December 31,
---------------------------------------------
2003 2002
--------------------- ---------- ----------
Carrying Estimated Carrying Estimated
amount fair value amount fair value
-------- ---------- -------- ----------
(In thousands)
Investment securities $569,848 $569,852 $371,458 $371,460
Loans, net of unearned income 294,756 301,647 275,497 278,252
Time Deposits 317,480 318,450 311,979 312,117
Repurchase Agreements 114,391 114,462 46,673 46,673
Long-term Debt 77,745 81,053 57,699 57,699
The net loan portfolio at December 31, 2003 and 2002 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 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 $180,000 and $53,000 at December 31, 2003
and 2002, respectively.
66
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,
-----------------
2003 2002
------- -------
(In thousands)
Unused lines of credit $11,243 $13,432
Commitments to extend credit 2,011 --
Standby letters of credit and financial
guarantees written 775 750
------- -------
$14,029 $14,182
======= =======
Interest rate caps-notional amount $30,000 $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,
2003 varies up to 100%.
67
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE N - (continued)
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 a diversified
loan portfolio, 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"
("SFAS No. 133"), 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. The accounting for changes in fair value of a derivative
instrument depends on whether it has been designated and qualifies as part of a
hedging relationship. 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. The Company
performs an assessment, both at the inception of the hedge and quarterly
thereafter, to determine whether these are highly effective in offsetting
changes in the value of the hedged items. The change in fair value of the swaps
attributed to hedge ineffectiveness was not material for the years ended
December 31, 2003 and 2002.
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, 2003, the Bank meets all capital adequacy
requirements to which it is subject.
As of December 31, 2003, 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.
68
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, 2003 and 2002
(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, 2003
Total Capital (to Risk-Weighted Assets)
Company 86,759 26.1% 26,630 >=8.0% -- N/A
Bank 60,675 19.1% 25,417 >=8.0% 31,772 >=10.0%
Tier I Capital (to Risk-Weighted Assets)
Company 84,166 25.3% 13,315 >=4.0% -- N/A
Bank 58,082 18.3% 12,709 >=4.0% 19,063 >=6.0%
Tier I Capital (to Average Assets)
Company 84,166 10.7% 31,410 >=4.0% -- N/A
Bank 58,082 7.0% 33,391 >=4.0% 41,739 >=5.0%
To be well
capitalized under
For capital prompt corrective
Actual adequacy purposes action provisions
------ ----------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
------- ----- ------- ----- ------- -------
December 31, 2002
Total Capital (to Risk-Weighted Assets)
Company $80,811 12.3% $23,801 >=8.0% $ -- N/A
Bank 53,687 19.4% 22,193 >=8.0% 27,741 >=10.0%
Tier I Capital (to Risk-Weighted Assets)
Company 78,496 26.4% 11,900 >=4.0% -- N/A
Bank 51,372 18.5% 11,096 >=4.0% 16,645 >=6.0%
Tier I Capital (to Average Assets)
Company 78,496 27.2% 25,468 >=4.0% -- N/A
Bank 51,372 7.8% 26,210 >=4.0% 32,763 >=5.0%
69
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,
-------------------
2003 2002
-------- --------
ASSETS
Cash $ 12,035 $ 7,439
Equity investment in subsidiaries 82,532 71,276
Investment in securities available for sale 2,901 6,147
Loans 6,244 8,420
Accrued interest receivable 74 430
Premises and equipment -- 5,056
Other assets 499 294
-------- --------
Total assets $104,285 $ 99,062
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities $ 795 $ 537
Stockholders' equity
Common stock 256 256
Additional paid-in capital 89,866 89,890
Retained earnings 22,960 16,145
Accumulated other comprehensive
income, net 775 1,480
Common stock in treasury, at cost (10,367) (9,246)
-------- --------
Total stockholders' equity 103,490 98,525
-------- --------
$104,285 $ 99,062
======== ========
70
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,
--------------------------------
2003 2002 2001
------ ------- -------
INCOME
Interest income from $ 106 $ 207 $ 836
the Bank
Interest income 795 1,149 1,079
Gain on sales of 1,131 7 31
investment securities
Other income (loss) 407 (73) (92)
------ ------- -------
Total income 2,439 1,290 1,854
EXPENSES
Salaries and employee 442 243 217
benefits
Other expenses 759 505 661
------ ------- -------
Total expenses 1,201 748 878
------ ------- -------
Income before income
taxes and equity in
undistributed net
income of the Bank 1,238 542 976
Equity in undistributed
net income of the Bank 6,710 5,405 2,199
------ ------- -------
Income before taxes 7,948 5,947 3,175
Provision (benefit) for
income taxes 533 350 (124)
------ ------- -------
Net income $7,415 $ 5,597 $ 3,299
====== ======= =======
71
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,
--------------------------------
2003 2002 2001
------- ------- --------
Operating activities:
Net income $ 7,415 $ 5,597 $ 3,299
Adjustments to reconcile net
income to net cash provided by
(used in) operating activities:
Gain on sales of investment securities (1,131) (7) (31)
Equity in undistributed net income of the Bank (6,843) (5,405) (2,199)
Increase (decrease) in other liabilities 294 214 (1,153)
Decrease in other assets 151 840 3,624
------- ------- --------
Net cash provided by (used in) operating activities (114) 1,239 3,540
------- ------- --------
Investing activities:
Cash paid for acquisition -- -- (20,222)
Investment securities available for sale
Purchases (5,172) (2,965) --
Sales 9,451 775 1,124
Net decrease (increase) in loans 2,176 (1,942) 1,465
Transfer of premises and equipment -- (1,292) (3,764)
------- ------- --------
Net cash provided by (used in) investing activities 6,455 (5,424) (21,397)
------- ------- --------
Financing activities:
Proceeds from exercise of common stock options 205 102 90
Acquisition of treasury stock (1,350) (4,422) (4,983)
Dividends paid (600) (505) (598)
------- ------- --------
Net cash (used in) financing activities (1,745) (4,825) (5,491)
------- ------- --------
Net increase (decrease) in cash and cash equivalents 4,596 (9,010) (23,348)
Cash and cash equivalents at beginning of year 7,439 16,449 39,797
------- ------- --------
Cash and cash equivalents at end of year $12,035 $ 7,439 $ 16,449
======= ======= ========
Supplemental disclosures of cash flow information:
Cash used to pay income taxes $ 375 $ 146 $ 1,385
Transfer of premises and equipment to subsidiary
for note receivable $ 5,056 -- --
72
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE Q - QUARTERLY FINANCIAL DATA (UNAUDITED)
The following represents summarized quarterly financial data of the Company
which, in the opinion of management, reflects all adjustments, consisting only
of normal recurring adjustments, necessary for a fair presentation of the
Company's results of operations. (In thousands, except per share data).
The unaudited quarterly results of operations for the three months ended
June 30, 2003 and September 30, 2003 have been restated to reflect the matters
described in the following Note R.
Three Months Ended
-----------------------------------------------
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
2003
----
Interest income $ 8,378 $ 8,480 $ 8,621 $ 8,947
Interest expense (3,388) (3,395) (3,332) (3,532)
------- ------- ------- -------
Net interest income 4,990 5,085 5,289 5,415
Provision for loan losses (105) (45) (45) (45)
Gains on sales of securities 628 1,491 183 444
Non-interest income 364 305 297 271
Non-interest expenses (2,712) (2,727) (3,093) (2,931)
------- ------- ------- -------
Income before taxes 3,165 4,109 2,631 3,154
Provision for taxes (1,423) (1,801) (1,223) (1,197)
------- ------- ------- -------
Net income $ 1,742 $ 2,308 $ 1,408 $ 1,957
======= ======= ======= =======
Per share data
Net income per common share
Basic $ .78 $ 1.05 $ .64 $ .88
======= ======= ======= =======
Diluted $ .78 $ 1.03 $ .63 $ .86
======= ======= ======= =======
Three Months Ended
-----------------------------------------------
March 31 June 30 September 30 December 31
-------- ------- ------------ -----------
2002
----
Interest income $ 7,316 $ 8,097 $ 8,495 $ 8,334
Interest expense (3,050) (3,358) (3,564) (3,444)
------- ------- ------- -------
Net interest income 4,266 4,739 4,931 4,890
Provision for loan losses (50) (107) (200) (30)
Gains on sales of securities 196 127 681 535
Non-interest income 273 218 117 140
Non-interest expenses (2,399) (2,802) (2,898) (2,681)
------- ------- ------- -------
Income before taxes 2,286 2,175 2,631 2,854
Provision for taxes (980) (988) (1,118) (1,263)
------- ------- ------- -------
Net income $ 1,306 $ 1,187 $ 1,513 $ 1,591
======= ======= ======= =======
Per share data
Net income per common share
Basic $ .55 $ .51 $ .67 $ .71
======= ======= ======= =======
Diluted $ .55 $ .51 $ .67 $ .70
======= ======= ======= =======
73
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE R - RESTATEMENT OF FINANCIAL STATEMENTS
The Company is restating previously issued financial statements for the
three months ended June 30, 2003 and September 30, 2003 to reflect the corrected
accounting treatment for the Bank's write-off between June 19, 2003 and June 26,
2003 of $633,122 of capitalized premiums related to securities held as
investments. The accounting treatment reflected in the previously reported
financial results was inconsistent with the Bank's historical practice in two
respects. First, the Bank's historical accounting practice was to amortize such
premiums over the estimated life of the securities. Second, the Bank recorded
the premium write-off as a reduction in "investment securities gains" rather
than a reduction to "interest income" as is its usual practice.
The financial effect of this departure from usual practice was to
understate the gains reported on the sales of investment securities for the
second quarter of 2003 and to overstate interest income in future periods. Thus,
the Company's net income before taxes for the three months ended June 30, 2003
and three months ended September 30, 2003, which had been reported as $3,507,000
and $2,922,000, respectively, should have been reported as $4,109,000 and
$2,631,000, respectively. These adjustments will cause the previously reported
net income per diluted share of $0.87 for the three months ended June 30, 2003
to increase to $1.03 and the previously reported net income per diluted share of
$0.70 for the three months ended September 30, 2003 to decrease to $0.63.
The Company's Financial Statements for the three months ended June 30, 2003
and September 30, 2003 are being restated as follows (in thousands, except per
share data):
Three Months Ended
June 30, 2003
--------------------------------------
As Reported Adjustment As Restated
----------- ---------- -----------
Statement of Operations Data
Interest income $8,511 $(31) $8,480
Interest expense 3,395 -- 3,395
Net interest income 5,116 (31) 5,085
Investment securities gains 858 633 1,491
Income before taxes 3,507 602 4,109
Net income 1,947 361 2,308
Net income per share:
Basic .88 .17 1.05
Diluted .87 .16 1.03
74
BERKSHIRE BANCORP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements (continued)
NOTE R - (continued)
Three Months Ended
September 30, 2003
--------------------------------------
As Reported Adjustment As Restated
----------- ---------- -----------
Statement of Operations Data
Interest income $8,912 $(291) $8,621
Interest expense 3,332 -- 3,332
Net interest income 5,580 (291) 5,289
Investment securities gains 183 -- 183
Income before taxes 2,922 (291) 2,631
Net income 1,583 (175) 1,408
Net income per share:
Basic .72 (.08) .64
Diluted .70 (.07) .63
75
ITEM 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not Applicable.
ITEM 9A. Controls and Procedures
Special Committee Investigation and Remedial Action Plan
During the course of their audit of the Company's Consolidated Financial
Statements for the year ended December 31, 2003, the Company's external
auditors, Grant Thornton LLP ("Grant Thornton"), advised management, the Audit
Committee of the Company (the "Audit Committee") and the Company's Board of
Directors (the "Board") of concerns about the accounting by the Company's
wholly-owned subsidiary, The Berkshire Bank (the "Bank"), for certain investment
premiums in June 2003. Moreover, Grant Thornton advised the Board that the
circumstances surrounding the questionable accounting amounted to a deficiency
in internal controls that was considered a "material weakness", as defined under
standards established by the American Institute of Certified Public Accountants.
In response, the Board formed a Special Committee of the Audit Committee
(the "Special Committee") comprised of the members of the Audit Committee that
are not members of the Board of the Bank, to oversee an investigation into the
issues raised by Grant Thornton. The Special Committee engaged the Company's
principal outside law firm to provide legal advice with respect to the
investigation and its findings. The law firm, in turn, engaged a firm of
forensic accountants to provide assistance with respect to the accounting and
financial reporting aspects of the investigation. These accountants presented
their report to the Special Committee on March 11, 2004.
The principal concern of Grant Thornton related to the Bank's write-off,
between June 19, 2003 and June 26, 2003, of $633,122 of capitalized premiums
related to securities held as investments. The premiums were written off upon
the sale of certain bonds that was effected in accordance with the Bank's
strategy of shortening maturities on its investment portfolio in view of the
interest rate environment prevailing at that time. The accounting treatment
applied in connection with such sale of bonds was not in accordance with
Accounting Principles generally accepted in the United States of America and was
inconsistent with the Bank's historical practice (including its practice for
other such sales) in two respects. First, the Bank's historical accounting
practice was to amortize such premiums over the expected life of the securities
whereas in these instances the Bank wrote off the premium while the security
was outstanding. Second, the Bank recorded the premium write-off as a
reduction in "investment securities gains" rather than a reduction in
"interest income" as is its normal practice.
In order to properly account for these premiums, the Company has corrected
certain items in its previously reported results of operations for the three
months ended June 30, 2003 and the three months ended September 30, 2003, as
reflected in Note Q, "Quarterly Financial Data (unaudited)" and Note R,
"Restatement of Financial Statements", to the Consolidated Financial Statements
included in this Annual Report. The corrected numbers restate the results
previously reported in the Company's quarterly reports on Form 10-Q for the
three months ended June 30, 2003 and September 30, 2003.
To address the matters raised by Grant Thornton, the Special Committee and
the Board have adopted and have begun to implement a Remedial Action Plan for
accounting and financial reporting that includes more direct communication
between the Bank's Chief Financial Officer and the Company's Audit Committee as
well as alternative software that would better maintain the investment
securities subsidiary ledger.
The specific provisions of the Remedial Action Plan that address the
foregoing matters are as follows:
* The Special Committee will meet with the Bank's President and Chief
Executive Officer, Executive Vice President and Chief Financial Officer and
Vice President, Finance, to communicate the serious nature of the
circumstances surrounding the events investigated and to reinforce a "no
tolerance" policy for exceptions to the Bank's accounting policies and
generally accepted accounting principles. This step has been implemented.
76
* The Bank's Chief Financial Officer shall have a direct line of financial
reporting responsibility to the Audit Committee with respect to all matters
involving the Bank's accounting and financial reporting.
* The Company will establish a hotline to enable employees to report
operational or financial reporting concerns on an anonymous basis. Such
hotline will be managed by an independent third party. The Audit Committee
will oversee disposition of any matters reported to the hotline. This step
has been implemented.
* The Bank's Chief Financial Officer must obtain formal approval from the
Audit Committee for any changes to established accounting policies.
* The Bank's Chief Financial Officer shall review with the Audit Committee or
its designee the accounting for material non-routine transactions prior to
effectuating such accounting.
* The Bank's Chief Financial Officer shall not personally process journal
entries into the general ledger system and shall not have access to such
system.
* The Audit Committee and Bank management will explore alternatives to the
current practice of accounting for its investment portfolio activity on an
Excel spreadsheet. Among the alternatives to be considered are use of third
party services and available software alternatives that minimize the risk
of undetected clerical errors or loss of audit trail.
* The Audit Committee will actively monitor the implementation of the
Remedial Action Plan as well as oversee the Company's response to any
weaknesses in internal accounting controls identified during audits
performed by the Company's independent auditors and/or regulators. The
Audit Committee will require reports from those parties responsible for the
implementation of the various parts of this plan on a monthly basis or more
frequently as the Audit Committee may determine.
Evaluation of the Company's Disclosure Controls and Internal Control. 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 management, including
the Chief Executive Officer ("CEO") who is also the Chief Financial Officer
("CFO").
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 over financial reporting" as defined in Rule 13(a)-15(f) of
the Securities Exchange Act of 1934 ("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.
77
Conclusions. Based upon the Controls Evaluation, the CEO/CFO has concluded that,
subject to the limitations noted above, 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.
In accordance with SEC requirements, the CEO/CFO notes that, except as discussed
in this Item 9A, during the fiscal quarter ended December 31, 2003, no changes
in internal controls have occurred that have materially affected Internal
Control.
78
PART III
ITEM 10. Directors and Executive Officers of the Registrant.
The following are the current directors and executive officers of the Company:
Name Age Position(s)
---- --- -----------
Steven Rosenberg 55 President, Director
William L. Cohen 62 Director
Thomas V. Guarino 50 Director
Moses Marx 68 Director
Randolph B. Stockwell 57 Director
Moses Krausz 63 President of The Berkshire Bank
David Lukens 54 Senior 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 been a private
investor for over five 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. Guarino was elected a director in March 2001. He served as a director
of Goshen Savings Bank from 1996, and chairman of the Board of Directors of GSB
Financial Corporation from April 1998, until the respective mergers of those
companies into The Berkshire Bank and the Company in March 2001. Mr. Guarino is
the President and Senior Portfolio Manager of the Hudson Valley Investment
Advisors, Inc., an investment management and advisory company, a position he has
held since 1995. Prior to that, he had been, since 1988, a Vice President of
Fleet Investment Advisors, Inc. and was Vice President in charge of investments
of Norstar Bank of the Hudson Valley from 1981 to 1988.
Mr. Marx was elected a director in May 1995. Mr. Marx has been a general
partner in United Equities Company (a securities brokerage firm) since 1954 and
a general partner in United Equities (Commodities) Company (a commodities
brokerage firm) since 1972. He is also President of Momar Corp. (a private
investment company). Mr. Marx is a director of The Cooper Companies, Inc.
Mr. Stockwell was elected a director in July 1988. He has been private
investor for over ten years. Since April 1999, Mr. Stockwell has served as
President of Yachting Systems of America, LLC, a small start-up company. 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 Berkshire Bank since
March 1992 and Chief Executive Officer since November 1993. Prior to joining The
Berkshire 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 Berkshire Bank since December 1999, 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.
79
Audit Committee Members, Financial Expert and Independence
The Board of Directors of the Company has established an Audit Committee
comprised of three independent directors, Messrs. William L. Cohen, Thomas V.
Guarino and Randolph B. Stockwell. All of the members of the Audit Committee
meet the independence requirements under current National Association of
Securities Dealers corporate governance standards for companies whose securities
are quoted on NASDAQ. Based upon their education and relevant experience, the
Board of Directors has determined that Messrs. Guarino 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 upon written request to the Company at
its principal executive office.
ITEM 11. Executive Compensation
The following table shows the compensation paid in or with respect to each
of the last three fiscal years to the individual who served as the Company's
Chief Executive Officer for the fiscal ended December 31, 2003, and to each of
the other executive officers who were paid more than $100,000 during the fiscal
year ended December 31, 2003.
Summary Compensation Table
Annual Compensation
--------------------
All Other
Name and Principal Position Year Salary Bonus Compensation
--------------------------- ---- -------- --------- ------------
Steven Rosenberg 2003 $175,500 $ -- $ --
President, Chief Executive 2002 $167,500 $ -- $ --
Officer and Chief Financial 2001 $152,500 $ -- $ --
Officer
Moses Krausz 2003 $358,864 $175,000 $10,405(1)
President and Chief Executive 2002 $347,288 $175,000 $10,050(1)
Officer of The Berkshire Bank 2001 $330,750 $175,000 $ 9,300(1)
David Lukens 2003 $138,500 $ 25,000 $ 5,968(2)
Senior Vice President and 2002 $125,000 $ 24,000 $ 5,367(2)
Chief Financial Officer of 2001 $115,000 $ 24,000 $ 4,988(2)
The Berkshire Bank
----------
(1) Consists of contributions by the Company to a 401(k) account of $7,000,
$6,000 and $5,250, respectively, in 2003, 2002 and 2001, and income
associated with life insurance coverage in excess of $50,000.
(2) Consists of contributions by the Company to a 401(k) account of $4,905,
$4,470 and $4,170, respectively, in 2003, 2002 and 2001, and income
associated with life insurance coverage in excess of $50,000. Does not
include the annual retirement credits of 5% of gross wages under the
Company's Retirement Income Plan.
80
Option Grants in Last Fiscal Year
There were no stock option grants during the fiscal year ended December 31,
2003.
Aggregated Option Exercises and Fiscal Year-End Option Values
The following table sets forth information concerning options exercised
during the fiscal year ended December 31, 2003, and the number of options owned
and the value of any in-the-money unexercised options as of December 31, 2003 by
any of the individuals named in the Summary Compensation Table.
Number of
Unexercised
Shares Options at
Acquired Fiscal Year-End Value of Unexercised
on Value (#) In-the-Money Options at Fiscal
Exercise Realized Exercisable Year-End ($)
Name (#) ($) /Unexercisable Exercisable/Unexercisable
---- -------- -------- --------------- ------------------------------
Steven Rosenberg -0- -0- 10,000 / 0 200,000 / 0
Moses Krausz -0- -0- 50,000 / 0 760,200 / 0
David Lukens -0- -0- 10,000 / 0 191,250 / 0
----------
Year-end values for unexercised in-the-money options represent the positive
spread between the exercise price of such options and the fiscal year end market
value of the common stock. An Option is "in-the-money" if the fiscal year end
fair market value of the Common Stock exceeds the option exercise price.
Compensation of Directors
Each director who is not also an employee of the Company (a "Non-Employee
Director") receives a stipend of $12,000 per annum and $1,000 for each day
during which he participates in a meeting of the Board or a Committee of the
Board. Each Non-Employee Director also receives fees ranging from $100 to $1,000
for telephonic meetings of the Board or a Board Committee depending upon the
length of the meeting. In addition, see "1999 Stock Incentive Plan" below.
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 200,000 shares of common stock of
the Company may be issued pursuant to the 1999 Stock Incentive Plan (subject to
appropriate adjustment in the event of changes in the corporate structure of the
Company). Officers, directors and other key employees of the Company or any
subsidiary 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, 2003,
options to acquire 187,419 shares of common stock have been granted under this
plan and 12,581 options are available for future grants.
Retirement Income Plan
The Company has a Retirement Income Plan (the "Retirement Plan"), a
noncontributory plan covering substantially all full-time, non-union United
States employees of the Company. Benefits were based upon a combination of
employee compensation and years of service. The Company paid the entire cost of
the plan for its employees and funded such costs as they accrued. The Company's
funding policy was to make annual contributions within minimum and maximum
levels required by applicable regulations. The Company's 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.
81
Benefit accruals were frozen as of September 15, 1988, resulting in a plan
curtailment. As a result of such curtailment, the Company did not accrue
benefits for future services; however, the Company did continue to contribute as
necessary for any unfunded liabilities. In 2000, the Company reinstated the
Retirement Plan to cover substantially all full-time, non-union United States
employees of the Company.
A participant in the 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. The Company pays the entire cost of the Plan for
its employees and funds such costs as they accrue.
The estimated annual benefits payable under the Plan upon retirement (at
the normal retirement age of 65) for Messrs. Rosenberg and Lukens are
approximately $160,000 and $15,000, respectively. In accordance with the laws
currently governing the Plan, the estimated annual benefit payable to Mr.
Rosenberg is not expected to increase. Mr. Krausz is not a participant in the
Plan. (see Note L of Notes to Consolidated Financial Statements).
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and
Equity Compensation Plans.
The following table sets forth certain information as of March 12, 2004
with respect to the beneficial ownership of the Company's Common Stock by (i)
each person who is known by the Company to own beneficially more than 5% of the
Company's Common Stock, (ii) each of the Company's directors and executive
officers, and (iii) all executive officers and directors as a group.
Number of Percent
Shares of Class
--------- --------
William Cohen 2,500(1) *
Thomas V. Guarino 31,781(2) 1.4%
Moses Krausz 64,503(3) 2.9%
David Lukens 10,200(4) *
Moses Marx 1,048,620(5) 47.5%
160 Broadway
New York, NY 10038
Steven Rosenberg 20,861(6) *
Randolph B. Stockwell 8,000(7) *
All executive officers and directors
as a group (7 persons) 1,186,465(8) 51.7%
----------
* Less than 1%
(1) Includes 1,000 shares issuable upon the exercise of options which have been
granted to Mr. Cohen under the Company's 1999 Stock Incentive Plan.
(2) Includes 13,195 shares issuable upon the exercise of options which have
been granted to Mr. Guarino under the Company's 1999 Stock Incentive Plan.
Includes 2,286 shares held in trust for minor children and 301 shares held
by Mr. Guarino's wife
(3) Includes 50,000 shares issuable upon the exercise of options which have
been granted to Mr. Krausz under the Company's 1999 Stock Incentive Plan.
Does not include 503 shares owned by Mr. Krausz's spouse.
(4) Includes 10,000 shares issuable upon the exercise of options which have
been granted to Mr. Lukens under the Company's 1999 Stock Incentive Plan.
(5) Includes 1,000 shares issuable upon the exercise of options which have been
granted to Mr. Marx under the Company's 1999 Stock Incentive Plan and
125,000 shares owned by Momar Corporation. Does not include 43,067 shares
owned by Eva and Esther, L.P. of which Mr.
82
Marx has an 80.5% limited partnership interest. Mr. Marx's daughters and
their husbands are the general partners of Eva and Esther, L.P.
(6) Includes 10,000 shares issuable upon the exercise of options which have
been granted to Mr. Rosenberg under the Company's 1999 Stock Incentive
Plan.
(7) Includes 1,000 shares issuable upon the exercise of options which have been
granted to Mr. Stockwell under the Company's 1999 Stock Incentive Plan.
(8) Includes 86,195 shares of Common Stock which are issuable upon the exercise
of outstanding options.
Equity Compensation Plans
The following table details information regarding the Company's existing
equity compensation plans as of December 31, 2003.
(c)
Number of securities
(a) (b) remaining available for
Number of securities to Weighted-average future issuance under
be issued upon exercise exercise price of equity compensation plans
of outstanding options, outstanding options, (excluding securities
Plan Category warrants and rights warrants and rights reflected in column (a))
------------- ----------------------- -------------------- -------------------------
Equity compensation
plans approved by
security holders 169,473 $30.36 12,581
Equity compensation
plans not approved
by security holders -- -- --
Total 169,473 $30.36 12,581
ITEM 13. Certain Relationships and Related Transactions.
In April 2001 and June 1999, the Company made term loans in the principal
amount of $2,000,000 and $2,000,000, respectively, to Pharmaceutical Holdings
Corp., a Delaware corporation, the principal stockholder of which is Momar. Such
loans were made on substantially the same terms, including interest rate, as
those prevailing at that time for comparable loans to unrelated parties and did
not involve more than normal risk of collectibility or present other unfavorable
features. The notes, which bear interest at the prime rate plus 0.50%, were
repaid in full in March 2003 and June 2003.
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. The Company 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, $270,000 and
$255,000 in fiscal 2003 and 2002, 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.
In December 1999, the Bank loaned $1,500,000 to Ecogen, Inc., a corporation
in which Mr. Marx may be deemed a principal stockholder. The loan was guaranteed
by Momar. Contemporaneously with the making of the loan, Momar purchased a 100%
interest in such loan on a non-recourse basis for a purchase price equal to the
outstanding balance of the loan. The Bank services such loan on behalf of Momar
for no additional consideration. Such loan was made on substantially the same
terms, including interest rate and collateral, as those prevailing at that time
for comparable loans to unrelated parties and did not involve more than normal
risk of collectibility or present other unfavorable features. In July 2002, the
loan was repaid in full.
See Item 1. Business - Transactions With Related Parties and Item 2.
Properties for additional information.
83
ITEM 14. Principal Accountant 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, 2003 December 31, 2002
----------------- -----------------
Audit Fees $146,153 $111,399
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 6,815 6,498
Tax Fees: Tax consulting, preparation of returns 72,096 71,009
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 2003.
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.
PART IV
ITEM 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) Documents filed as part of this Report:
(i) Financial Statements
Report of Independent Certified Public Accountants
Consolidated Balance Sheets as of December 31, 2003 and 2002
Consolidated Statements of Income for the Years Ended December 31, 2003,
2002 and 2001
Consolidated Statements of Stockholders' Equity for the Years Ended
December 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the Years Ended December 31,
2003, 2002 and 2001
Notes to Consolidated Financial Statements
84
ITEM 15. (continued)
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.
(iii) 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).
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. 1 to Employment Agreement, dated August 1, 2001, by
and between The Berkshire Bank and Moses Krausz (incorporated by
reference to Exhibit 10.6 to the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended September 30, 2001).+
10.6 Amendment No. 1 to Employment Agreement, dated June 3, 2002, by
and between The Berkshire Bank and David Lukens (incorporated by
reference to Exhibit 10.7 to the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended June 30, 2002).+
10.7 Amendment No. 2 to Employment Agreement, dated August 1, 2001, by
and between The Berkshire Bank and Moses Krausz (incorporated by
reference to Exhibit 10.8 to the Company's Quarterly Report on
Form 10-Q for the Quarterly Period Ended June 30, 2002).+
21. Subsidiaries of the Company.
23. Consent of Independent Certified Public Accountant
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.
(b) Reports on Form 8-K.
None.
85
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 29, 2004
----------------------------------
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 29, 2004
----------------------------
Steven Rosenberg
/s/ William Cohen Director March 29, 2004
----------------------------
William Cohen
/s/ Thomas V. Guarino Director March 29, 2004
----------------------------
Thomas V. Guarino
/s/ Moses Marx Director March 29, 2004
----------------------------
Moses Marx
/s/ Randolph B. Stockwell Director March 29, 2004
----------------------------
Randolph B. Stockwell
86
STATEMENT OF DIFFERENCES
The greater-than-or-equal-to sign shall be expressed as.......................>=