XNAS:BERK Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

 

xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended      June 30, 2012

 

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 No.)
     
160 Broadway, New York, New York   10038
(Address of Principal Executive Offices)   (Zip Code)

 

Registrant's Telephone Number, Including Area Code: (212) 791-5362

 

N/A

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No £

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. (See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.) (Check one):

 

Large accelerated filer ¨ Accelerated filer ¨
   
Non-accelerated filer ¨ Smaller reporting company x

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act. Yes ¨ No x

 

As of August 10, 2012, there were 14,416,198 outstanding shares of the issuer's Common Stock, $.10 par value.

 

 
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

 

FORWARD-LOOKING STATEMENTS

 

Forward-Looking Statements. Statements in this Quarterly Report on Form 10-Q that are not based on historical fact may be "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Words such as "believe", "may", "will", "expect", "estimate", "anticipate", "continue" or similar terms identify forward-looking statements. A wide variety of factors could cause the actual results and experiences of Berkshire Bancorp Inc. (the "Company") to differ materially from the results expressed or implied by the Company's forward-looking statements. Some of the risks and uncertainties that may affect operations, performance, results of the Company's business, the interest rate sensitivity of its assets and liabilities, and the adequacy of its loan loss allowance, include, but are not limited to: (i) deterioration in local, regional, national or global economic conditions which could result, among other things, in an increase in loan delinquencies, a decrease in property values, or a change in the housing turnover rate; (ii) changes in market interest rates or changes in the speed at which market interest rates change; (iii) changes in laws and regulations affecting the financial services industry; (iv) changes in competition; (v) changes in consumer preferences, (vi) changes in banking technology; (vii) ability to maintain key members of management, (viii) possible disruptions in the Company's operations at its banking facilities, (ix) cost of compliance with new corporate governance requirements, rules and regulations, and other factors referred to in this Quarterly Report and in Item 1A, "Risk Factors", of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

 

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 Quarterly 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.

 

 
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q

 

INDEX

 

    Page No.
PART I. FINANCIAL INFORMATION  
     
Item 1. Financial Statements  
     
  Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011 (unaudited) 4
     
  Consolidated Statements of Operations For The Three and Six Months Ended June 30, 2012 and 2011 (unaudited) 5
     
  Consolidated Statements of Comprehensive Income For The Six Months Ended June 30, 2012 and 2011 (unaudited) 6
     
  Consolidated Statement of Stockholders' Equity and Comprehensive Income (Loss) For The Six Months Ended June 30, 2012 and 2011 (unaudited) 7
     
  Consolidated Statements of Cash Flows For The Six Months Ended June 30, 2012 and 2011 (unaudited) 8
     
  Notes to Consolidated Financial Statements (unaudited) 10
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 38
     
Item 3. Quantitative and Qualitative Disclosure About Market Risk 59
     
Item 4. Controls and Procedures 60
     
PART II OTHER INFORMATION  
     
Item 6. Exhibits 61
     
Signature 61
   
Index of Exhibits 62

 

3
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in Thousands)

(unaudited)

 

   June 30,
2012
   December 31,
2011
 
ASSETS          
Cash and due from banks  $7,270   $12,105 
Interest bearing deposits   131,218    88,931 
Total cash and cash equivalents   138,488    101,036 
Investment Securities:          
Available-for-sale   393,503    415,170 
Held-to-maturity, fair value of $286 in 2012 and $293 in 2011   286    298 
Total investment securities   393,789    415,468 
Loans, net of unearned income   320,298    317,021 
Less: allowance for loan losses   (17,718)   (17,720)
Net loans   302,580    299,301 
Accrued interest receivable   2,979    3,224 
Premises and equipment, net   7,321    7,474 
Other assets   42,890    35,626 
Total assets  $888,047   $862,129 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
Deposits:          
Non-interest bearing  $75,717   $74,073 
Interest bearing   605,100    584,819 
Total deposits   680,817    658,892 
Securities sold under agreements to repurchase   50,000    50,000 
Borrowings   3,794    6,139 
Subordinated debt   22,681    22,681 
Accrued interest payable   2,124    6,996 
Other liabilities   2,178    1,893 
Total liabilities   761,594    746,601 
           
Stockholders' equity          
Preferred stock - $.01 Par value:          
2,000,000 shares authorized - none issued          
Common stock - $.10 par value          
Authorized — 25,000,000 shares          
Issued        — 14,416,198 shares          
Outstanding —          
June 30, 2012,           14,416,198 shares          
December 31, 2011, 14,443,183 shares   1,442    1,444 
Additional paid-in capital   143,903    143,900 
Accumulated Deficit   (13,819)   (19,299)
Accumulated other comprehensive loss, net   (5,073)   (10,517)
Total stockholders' equity   126,453    115,528 
Total liabilities and stockholders' equity  $888,047   $862,129 

 

The accompanying notes are an integral part of these statements

 

4
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Share Data)

(unaudited)

 

   For The
Three Months Ended
June 30,
   For The
Six Months Ended
June 30,
 
   2012   2011   2012   2011 
INTEREST INCOME                    
Loans, including related fees  $4,882   $5,498   $9,787   $11,177 
Investment securities   2,300    3,480    4,737    6,661 
Interest bearing deposits   125    73    184    134 
Total interest income   7,307    9,051    14,708    17,972 
INTEREST EXPENSE                    
Deposits   1,174    1,543    2,400    3,109 
Securities sold under agreements to repurchase   447    495    891    994 
Interest expense on borrowings   144    250    341    512 
Total interest expense   1,765    2,288    3,632    4,615 
Net interest income   5,542    6,763    11,076    13,357 
PROVISION FOR LOAN LOSSES       400        1,600 
Net interest income after provision for loan losses   5,542    6,363    11,076    11,757 
NON-INTEREST INCOME                    
Service charges on deposits accounts   148    110    234    237 
Investment securities (losses) gains   (112)   (192)   108    (137)
Other income   85    43,067    302    43,164 
Total non-interest income   121    42,985    644    43,264 
NON-INTEREST EXPENSE                    
Salaries and employee benefits   2,380    2,399    4,860    4,834 
Net occupancy expense   577    500    1,161    1,065 
Equipment expense   88    78    166    160 
FDIC assessment   300    268    600    652 
Data processing expense   112    152    224    261 
Other   696    911    1,332    1,747 
Total non-interest expense   4,153    4,308    8,343    8,719 
Income before provision for taxes   1,510    45,040    3,377    46,302 
(Benefit) provision for income taxes   (1,834)   2,311    (2,103)   2,093 
Net income  $3,344   $42,729   $5,480   $44,209 
Dividends on preferred stock       1,200        2,400 
Income allocated to common stockholders  $3,344   $41,529   $5,480   $41,809 
Net income per common share:                    
Basic  $0.23   $5.89   $0.38   $5.93 
Diluted  $0.23   $5.89   $0.38   $5.93 
Number of shares used to compute net income per common share:                    
Basic   14,416    7,054    14,416    7,054 
Diluted   14,416    7,054    14,416    7,054 

 

The accompanying notes are an integral part of these statements.

 

5
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(unaudited)

 

   For The Six Months Ended
June 30,
 
   2012   2011 
Net earnings  $5,480   $44,209 
Other comprehensive income, net of tax:          
Unrealized gains on available-for-sale securities, net of taxes of $3,673 and $3,309,in 2012 and 2011, respectively   5,509    4,964 
Reclassification adjustment for realized gains (losses) included in net earnings, net of taxes (benefits) of $43 and $55, in 2012 and 2011, respectively   65    (82)
           
Comprehensive income  $10,924   $49,255 

 

The accompanying notes are an integral part of these statements

 

6
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

and COMPREHENSIVE INCOME (LOSS)

 

For The Six Months Ended June 30, 2012 and 2011

(In Thousands)

(Unaudited)

 

   Common
Shares
   Preferred
Shares
   Common
Stock
Par
Value
   Preferred
Stock
Par
Value
   Additional
paid-in
capital
   Accumulated
other
comprehensive
(loss), net
   Retained
Earnings/
(Accumulated
deficit)
   Treasury
stock
   Comprehensive
income
(loss)
   Total
stockholders'
equity
 
Balance at December 31, 2010   7,698    60   $770   $1   $150,985   $(8,589)  $(65,123)  $(6,411)       $71,633 
Net income                                 44,209        $44,209    44,209 
Other comprehensive income net of taxes                            5,046              5,046    5,046 
Comprehensive income                                          $49,255      
Cash dividends - Preferred Stock                                 (2,400)             (2,400)
Balance at June 30, 2011   7,698    60   $770   $1   $150,985   $(3,543)  $(23,314)  $(6,411)       $118,488 
                                                   
Balance at December 31, 2011   14,443       $1,444   $   $143,900   $(10,517)  $(19,299)  $        $115,528 
Net income                                 5,480        $5,480    5,480 
Other comprehensive income net of taxes                            5,444              5,444    5,444 
Comprehensive income                                          $10,924      
Adjustment   (27)        (2)        3                        1 
Balance at June 30, 2012   14,416       $1,442   $   $143,903   $(5,073)  $(13,819)  $        $126,453 

 

The accompanying notes are an integral part of these statements.

 

7
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

   For The Six Months Ended
June 30,
 
   2012   2011 
         
Cash flows from operating activities:          
Net income  $5,480   $44,209 
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:          
Realized (gains) losses on investment securities   (108)   137 
Net amortization of premiums of investment securities   1,313    632 
Depreciation and amortization   252    (211)
Provision for loan losses       1,600 
Decrease in accrued interest receivable   245    221 
(Increase) decrease in other assets   (7,264)   16,929 
(Decrease) increase in accrued interest payable and other liabilities   (4,587)   9,979 
Net cash (used in) provided by operating activities   (4,669)   73,496 
           
Cash flows from investing activities:          
Investment securities available for sale          
Purchases   (228,191)   (249,474)
Sales, maturities and calls   254,097    188,664 
Investment securities held to maturity          
Maturities   12    9 
Net (increase) decrease in loans   (3,279)   19,607 
(Acquisition) disposition of premises and equipment   (99)   745 
Net cash provided by (used in) investing activities   22,540    (40,449)

 

8
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

   For The Six Months Ended
June 30,
 
   2012   2011 
         
Cash flows from financing activities:          
Net increase in non interest bearing deposits   1,644    9,427 
Net increase (decrease) in interest bearing deposits   20,281    (5,344)
Repayment of borrowings   (2,344)   (2,237)
Net cash provided by financing activities   19,581    1,846 
           
Net increase in cash and cash equivalents   37,452    34,893 
Cash and cash equivalents at beginning of period   101,036    79,117 
Cash and cash equivalents at end of period  $138,488   $114,010 
           
Supplemental disclosure of cash flow information:          
Cash used to pay interest  $8,504   $4,724 
Cash used to pay income taxes, net of refunds  $78   $2,618 
Schedule of non-cash financing activities:          
Dividends declared and not paid  $   $2,400 

 

The accompanying notes are an integral part of these statements.

 

9
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

June 30, 2012 and 2011

(unaudited)

 

Note 1. General

 

Berkshire Bancorp Inc., a Delaware corporation, is a bank holding company registered under the Bank Holding Company Act of 1956. References herein to "Berkshire", the "Company" or "we" and similar pronouns, shall be deemed to refer to Berkshire Bancorp Inc. and its consolidated subsidiaries unless the context otherwise requires. Berkshire's principal activity is the ownership and management of its indirect wholly-owned subsidiary, The Berkshire Bank (the "Bank"), a New York State chartered commercial bank. The Bank is owned through Berkshire's wholly-owned subsidiary, Greater American Finance Group, Inc. ("GAFG").

 

The accompanying financial statements of Berkshire Bancorp Inc. and subsidiaries include the accounts of the parent company, Berkshire Bancorp Inc., and its wholly-owned subsidiaries: The Berkshire Bank, GAFG and East 39, LLC.

 

We have prepared the accompanying financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (the "SEC") for interim financial reporting. These consolidated financial statements, including the notes thereto, are unaudited and, in our opinion, include all adjustments, consisting of normal recurring adjustments and accruals necessary for a fair presentation of our consolidated balance sheets, operating results, and cash flows for the periods presented. Operating results for the periods presented are not necessarily indicative of the results that may be expected for the remaining quarters of fiscal 2012 due to a variety of factors. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States ("GAAP") have been omitted in accordance with the rules and regulations of the SEC. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in the Company's 2011 Annual Report on Form 10-K.

 

10
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 2. Earnings (Loss) Per Share

 

Basic earnings (loss) per common share is calculated by dividing income (loss) available to common stockholders by the weighted average common stock outstanding, excluding stock options from the calculation. As of and for the three and six-month periods ended June 30, 2012 and 2011, there were no potential dilutive shares. The following tables present the Company's calculation of income per common share:

 

   For The Three Months Ended 
   June 30, 2012   June 30, 2011 
   Income
(numerator)
   Shares
(denominator)
   Per
share
amount
   Income
(numerator)
   Shares
(denominator)
   Per
share
amount
 
   (In thousands, except per share data) 
Basic earnings per common share                              
Net income  $3,344             $42,729           
Dividends paid to preferred shareholders                 (1,200)          
Net income available to common stockholders   3,344    14,416   $0.23    41,529    7,054   $5.89 

 

   For The Six Months Ended 
   June 30, 2012   June 30, 2011 
   Income
(numerator)
   Shares
(denominator)
   Per
share
amount
   Income
(numerator)
   Shares
(denominator)
   Per
share
amount
 
   (In thousands, except per share data) 
Basic earnings per common share                              
Net income  $5,480             $44,209           
Dividends paid to preferred shareholders                 (2,400)          
Net income available to common stockholders   5,480    14,416   $0.38    41,809    7,054   $5.93 

 

11
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 3. Loan Portfolio

 

The following table sets forth information concerning the Company's loan portfolio by type of loan at the dates indicated:

 

   June 30, 2012   December 31, 2011 
  

Amount

  

% of

Total

  

Amount

   % of
Total
 
   (Dollars in thousands) 
Commercial and Industrial and Finance Leases  $17,907    5.6%  $15,660    4.9%
Secured by Real Estate                    
Residential   102,412    31.9    104,854    33.0 
Multi family   13,931    4.3    12,169    3.8 
Commercial Real Estate and Construction   186,016    58.0    183,819    57.9 
Consumer   672    0.2    1,240    0.4 
Total loans   320,938    100.0%   317,742    100.0%
Deferred loan fees   (640)        (721)     
Allowance for loan losses   (17,718)        (17,720)     
Loans, net  $302,580        $299,301      

 

The Bank had $520,000 and $647,000 of non-accrual loans as of June 30, 2012 and December 31, 2011, respectively, and no loans delinquent more than ninety days and still accruing interest at both June 30, 2012 and December 31, 2011. The Bank did not foreclose on any loans during both the six months ended June 30, 2012 and the year ended December 31, 2011. The Bank classified the non-accrual loans as impaired loans at both June 30, 2012 and December 31, 2011. However, no specific reserves for impaired loans was made because the collateral underlying the impaired loans was deemed to be sufficient to cover any loss in the event of a default. Therefore, the allowance for loan loss is includable in the calculation of regulatory capital up to a maximum of 125% of risk-weighted assets or approximately $5.0 million and $5.2 million at June 30, 2012 and December 31, 2011, respectively.

 

Average impaired loans for the three and six months ended June 30, 2012 and 2011 were approximately $25.6 million and $25.6 million, respectively, and $3.6 million and $3.8 million, respectively. Interest income that would have been recognized had these loans performed in accordance with their contractual terms was approximately $9,000 and $17,000 for the three and six months ended June 30, 2012, respectively, and $3,000 and $6,000 for the three and six months ended June 30, 2011, respectively.

 

12
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 3. - (continued)

 

The following table sets forth information concerning activity in the Company's allowance for loan losses for the indicated periods.

 

   For The Three Months Ended   For The Six Months Ended 
   June 30, 2012   June 30, 2011   June 30, 2012   June 30, 2011 
   (In thousands) 
Balance at beginning of period  $17,720   $17,324   $17,720   $16,105 
Provision charged to operations       400        1,600 
Loans charged-off   (2)       (2)   (2)
Recoveries       6        27 
Balance at end of period  $17,718   $17,730   $17,718   $17,730 

 

Allowance for Credit Losses and Recorded Investment in Financing Receivables

 

The qualitative factors are determined based on the various risk characteristics of each loan class. Relevant risk characteristics are as follows:

 

Commercial and industrial loans - Loans in this class are made to businesses. Generally these loans are secured by assets of the business and repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased consumer and/or business spending will have an effect on the credit quality in this loan class.

 

Commercial real estate - Loans in this class include income-producing investment properties and owner-occupied real estate used for business purposes. The underlying properties are generally located largely in our primary market area. The cash flows of the income producing investment properties are adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, will have an effect on credit quality. In the case of owner-occupied real estate used for business purposes a weakened economy and resultant decreased consumer and/or business spending will have an adverse effect on credit quality.

 

Construction loans - Loans in this class primarily include land loans to local individuals, contractors and developers for developing the land for sale or for the purpose of making improvements thereon. Repayment is derived from sale of the lots/units including any pre-sold units. Credit risk is affected by market conditions, time to sell at an adequate price and cost overruns. To a lesser extent this class includes commercial development projects we finance which in most cases have an interest-only phase during construction and then convert to permanent financing. Credit risk is affected by cost overruns, market conditions and the availability of permanent financing, to the extent such permanent financing is not being provided by us.

 

Residential real estate - Loans in this class are made to and secured by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this loan class. The Company generally does not originate loans with a loan-to-value ratio greater than 80 percent and does not grant subprime loans.

 

13
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 3. - (continued)

 

Multi-Family real estate - Loans in this class are made to and secured by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this loan class. The Company generally does not originate loans with a loan-to-value ratio greater than 80 percent and does not grant subprime loans.

 

Consumer loans - Loans in this class may be either secured or unsecured and repayment is dependent on the credit quality of the individual borrower and, if applicable, sale of the collateral securing the loan (such as automobile or other secured assets). Therefore the overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this loan class.

 

Financing Leases - Loans in this class may be either secured or unsecured and repayment is dependent on the credit quality of the individual borrower and, if applicable, sale of the collateral securing the loan (such as equipment or other secured assets). Therefore the overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this loan class.

 

14
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 3. - (continued)

 

Allowance for Credit Losses and Recorded Investment in Loans

For the Six Months Ended June 30, 2012

(In thousands)

 

   Commercial &
Industrial
   Commercial
Real Estate
   Construction   Multi Family   Residential
Real Estate
   Consumer   Finance
Leases
   Unallocated   Total 
                                     
Allowance for credit losses:                                             
Beginning balance  $950   $7,857   $609   $411   $6,490   $53   $126   $1,224   $17,720 
Charge-offs   (2)                                      (2)
Recoveries                                             
Provision   (275)   (199)   504    59    (408)   (27)   (63)   409    0 
Ending balance  $673   $7,658   $1,113   $470   $6,082   $26   $63   $1,633   $17,718 
Ending balance: individually evaluated for impairment  $0   $0   $0   $0   $0   $0   $0   $0   $0 
Ending balance: collectively evaluated for impairment  $673   $7,658   $1,113   $470   $6,082   $26   $63   $1,633   $17,718 
                                              
Financing Receivables:                                             
Ending balance  $15,348   $165,396   $20,620   $13,931   $102,412   $672   $2,559   $0   $320,938 
Ending balance: individually evaluated for impairment  $0   $13,371   $9,750   $0   $2,348   $14   $0   $0   $25,483 
Ending balance: collectively evaluated for impairment  $15,348   $152,025   $10,870   $13,931   $100,064   $658   $2,559   $0   $295,455 

 

The Company believes the unallocated amount included in the allowance for credit losses is appropriate given the nature of the portfolio with the size of individual loans and the current economy's impact on the real estate market. The Company will continue to closely monitor the environment and loan portfolio and make adjustments when appropriate.

 

Among the loans reviewed for impairment, $2.4 million of residential loans and $1.3 million of commercial real estate loans were identified as troubled debt restructurings ("TDRs"). TDRs are the result of an economic concession being granted to borrowers experiencing financial difficulties. Certain TDRs are classified as nonperforming at the time of restructuring and may only return to performing status after considering the borrower's sustained repayment performance under the revised payment terms for a reasonable period, generally six months. We evaluated all of the impaired loans by analyzing the collateral value and by evaluating the discounted cash flow. Based on the nature of the modifications no impairment was required.

  

15
 

  

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 3. - (continued)

 

Allowance for Credit Losses and Recorded Investment in Loans

For the Year Ended December 31, 2011

(In thousands)

 

  

Commercial &

Industrial

  

Commercial

Real Estate

  

 

Construction

  

 

Multi Family

  

Residential

Real Estate

  

 

Consumer

  

Finance

Leases

  

 

Unallocated

  

 

Total

 
                                     
Allowance for credit losses:                                             
Beginning balance  $417   $8,610   $2,784   $147   $2,066   $25   $419   $1,637   $16,105 
Charge-offs   (12)                                      (12)
Recoveries   27                                       27 
Provision   518    (753)   (2,175)   264    4,424    28    (293)   (413)   1,600 
Ending balance  $950   $7,857   $609   $411   $6,490   $53   $126   $1,224   $17,720 
Ending balance: individually evaluated for impairment  $0   $0   $0   $0   $0   $0   $0   $0   $0 
Ending balance: collectively evaluated for impairment  $950   $7,857   $609   $411   $6,490   $53   $126   $1,224   $17,720 
                                              
Financing Receivables:                                             
Ending balance  $11,006   $169,015   $14,804   $12,169   $104,854   $1,240   $4,654   $0   $317,742 
Ending balance: individually evaluated for impairment  $122   $23,343   $0   $0   $1,566   $0   $0   $0   $25,031 
Ending balance: collectively evaluated for impairment  $10,884   $145,672   $14,804   $12,169   $103,288   $1,240   $4,654   $0   $292,711 

 

The Company believes the unallocated amount included in the allowance for credit losses is appropriate given the nature of the portfolio with the size of individual loans and the current economy's impact on the real estate market. The Company will continue to closely monitor the environment and loan portfolio and make adjustments when appropriate.

 

Among the loans reviewed for impairment, $2.4 million of residential loans and $1.3 million of commercial real estate loans were identified as troubled debt restructurings ("TDRs"). TDRs are the result of an economic concession being granted to borrowers experiencing financial difficulties. Certain TDRs are classified as nonperforming at the time of restructuring and may only return to performing status after considering the borrower's sustained repayment performance under the revised payment terms for a reasonable period, generally six months. We evaluated all of the impaired loans by analyzing the collateral value and by evaluating the discounted cash flow. Based on the nature of the modifications no impairment was required.

 

16
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 3. - (continued)

 

Age Analysis of Past Due Loans

As of June 30, 2012

(In thousands)

 

  

30-59 Days

 Past Due 

  

60-89 Days

 Past Due 

  

Greater

Than

 90 Days 

  

Total

 Past Due 

   Current  

Total

Loans

  

Recorded

Loans >

90 Days and

  Accruing  

 
                             
Commercial & industrial  $   $   $   $   $15,348   $15,348   $ 
Construction                   20,620    20,620     
Commercial real estate   12    16        28    165,368    165,396     
Consumer                   467    467     
Overdrafts                   205    205     
Residential - prime           520    520    101,892    102,412     
Residential - multi family                   13,931    13,931     
Finance leases                   2,559    2,559     
Total  $12   $16   $520   $548   $320,390   $320,938   $ 

 

Age Analysis of Past Due Loans

As of December 31, 2011

(In thousands)

 

  

 

 

30-59 Days

 Past Due 

  

 

 

60-89 Days

 Past Due 

  

 

Greater

Than

 90 Days 

  

 

 

Total

 Past Due 

  

 

 

 

 Current 

  

 

 

Total

Loans

  

Recorded

Loans >

90 Days and

  Accruing  

 
                             
Commercial & industrial  $11   $   $122   $133   $10,873   $11,006   $ 
Construction                   14,804    14,804     
Commercial real estate   21            21    168,994    169,015     
Consumer                   778    778     
Overdrafts                   462    462     
Residential - prime   63        525    588    104,266    104,854     
Residential - multi family                   12,169    12,169     
Finance leases                   4,654    4,654     
Total  $95   —0   $647   $742   $317,000   $317,742   $ 

 

17
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 3. - (continued)

 

Impaired Loans

For the Six Months Ended June 30, 2012

(In thousands)

 

  

 

 

Recorded

  Loan  

  

 

Unpaid

Principal

 Balance 

  

 

 

Related

Allowance

  

 

Average

Recorded

   Loan   

  

 

Interest

Income

Recognized

  

 

Interest

Income

Foregone

 
                         
With no related allowance recorded:                              
Commercial & industrial  $   $   $   $   $   $ 
Construction   9,750    9,750        9,786    336     
Commercial real estate   13,371    13,371        13,483    449     
Consumer   14    14        15         
Residential - prime   2,348    2,348        2,362    43    17 
Residential - multi family                        
Finance leases                        
                               
Total  $25,483   $25,483   $   $25,646   $828   $17 
Commercial   23,121    23,121        23,269    785     
Consumer   14    14        15         
Residential   2,348    2,348        2,362    43    17 
Finance leases                        

 

18
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 3. - (continued)

 

Impaired Loans

For the Year Ended December 31, 2011

(In thousands)

 

  

 

 

Recorded

Loan

  

 

Unpaid

Principal

Balance

  

 

 

Related

Allowance

  

 

Average

Recorded

Loan

  

 

Interest

Income

Recognized

  

 

Interest

Income

Foregone

 
                         
With no related allowance recorded:                              
Commercial & industrial  $122   $122   $   $31   $   $13 
Construction                        
Commercial real estate   23,343    23,343        18,898    2,021    3 
Consumer                        
Residential - prime   1,566    1,566        1,235    56    54 
Residential - multi family                        
Finance leases                        
                               
Total  $25,031   $25,031   $   $20,164   $2,077   $70 
Commercial   23,465    23,465        18,929    2,021    16 
Consumer                        
Residential   1,566    1,566        1,235    56    54 
Finance leases                        

 

19
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 3. - (continued)

 

Loans on Nonaccrual Status

As of

 

   June 30, 2012   December 31, 2011 
   (In thousands) 
Commercial & industrial  $   $122 
Construction        
Commercial real estate        
Consumer        
Residential   520    525 
Residential - multi family        
Finance leases        
Total  $520   $647 

 

Credit Exposure

Credit Risk Profile by Internally Assigned Grades

For the Six Months Ended June 30, 2012

(In thousands)

 

  

Commercial

&

Industrial

  

Commercial

Real Estate

Construction

  

Commercial

Real Estate

Other

 
Grade:               
Pass  $15,192   $10,870   $124,651 
Watch           8,475 
Special Mention           20,214 
Substandard   156    9,750    12,056 
Total  $15,348   $20,620   $165,396 

 

  

 

Residential

  

Residential

Multi Family

 
Grade:          
Pass  $94,125   $13,931 
Watch   722     
Special Mention   1,544     
Substandard   6,021     
Total  $102,412   $13,931 

 

  

Consumer

Overdrafts

  

Consumer

Other

  

Finance

Leases

 
Performing  $205   $467   $2,559 
Nonperforming            
Total  $205   $467   $2,559 

 

20
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 3. - (continued)

 

Credit Exposure

Credit Risk Profile by Internally Assigned Grades

For the Year Ended December 31, 2011

(In thousands)

 

  

Commercial

&

Industrial

  

Commercial

Real Estate

Construction

  

Commercial

Real Estate

   Other   

 
Grade:               
Pass  $10,840   $14,804   $114,508 
Watch           8,650 
Special Mention           19,489 
Substandard   166        26,368 
 Total  $11,006   $14,804   $169,015 

 

  

 

 Residential

  

Residential

Multi Family

 
Grade:          
Pass  $96,475   $12,169 
Watch   731     
Special Mention   1,561     
Substandard   6,086     
 Total  $104,853   $12,169 

 

  

Consumer

Overdrafts

  

Consumer

  Other 

  

Finance

Leases 

 
Performing  $463   $778   $4,654 
Nonperforming            
Total  $463   $778   $4,654 

 

21
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 3. - (continued)

 

The Company utilizes a grade risk rating system for commercial and industrial, commercial real estate and construction loans.

 

On a quarterly basis, or more often if needed, the Company formally reviews the ratings on all classified commercial and industrial, commercial real estate and construction loans. Semi-annually, the Company engages an independent third-party to review a significant portion of loans within these segments. Management uses the results of these reviews as part of its periodic review process.

 

   Loan Modifications
(Dollars in Thousands)
 
             
   As of June 30, 2012 
Troubled Debt Restructuring  Number
of
Loans
   Pre-Modification
Outstanding
Recorded Loans
   Post-Modification
Outstanding
Recorded Loans
 
Residential - prime   8   $2,362   $2,362 
Commercial Real Estate   4    1,314    1,314 
    12   $3,676   $3,676 

 

   As of December 31, 2011 
Troubled Debt Restructuring  Number
of
Loans
   Pre-Modification
Outstanding
Recorded Loans
   Post-Modification
Outstanding
Recorded Loans
 
Residential   8   $2,388   $2,388 
Commercial Real Estate   3    1,326    1,326 
    11   $3,714   $3,714 

 

The loans restructured during the six months ended June 30, 2012 were restructured by extending maturity dates or reducing interest rates. No loans were restructured into two notes nor are there any commitments to extend additional funds on any TDRs. The commercial real estate loans are individually evaluated for impairment with any loss recognized in the allowance for loan losses.

 

22
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 4. Investment Securities

 

The following is a summary of held to maturity investment securities as of the dates indicated:

 

   June 30, 2012 
  

 

Amortized Cost

   Gross
unrealized
gains
   Gross
unrealized
losses
  

 

Fair

value

 
       (In thousands)     
Mortgage-backed securities  $286   $   $   $286 

 

 

   December 31, 2011 
  

 

Amortized Cost

   Gross
unrealized
gains
   Gross
unrealized
losses
  

 

Fair

value

 
       (In thousands)     
U.S. Government Agencies  $298   $1   $(6)  $293 

 

23
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 4. - (continued)

 

The following is a summary of available-for-sale investment securities as of the dates indicated:

 

   June 30, 2012 
  

 

Amortized Cost

   Gross
unrealized
gains
   Gross
unrealized
losses
  

 

Fair

value

 
       (In thousands)     
U.S. Treasury Notes  $84,988   $37   $(6)  $85,019 
U.S. Government Agencies   123,606    722    (21)   124,307 
Mortgage-backed securities   120,950    2,836    (420)   123,366 
Corporate notes   10,124    90    (5)   10,209 
Municipal securities   2,706    263    (428)   2,541 
Auction rate securities   58,200        (12,087)   46,113 
Marketable equity securities and other   2,201    4    (257)   1,948 
Totals  $402,775   $3,952   $(13,224)  $393,503 

 

   December 31, 2011 
  

 

Amortized Cost

   Gross
unrealized
gains
   Gross
unrealized
losses
  

 

Fair

value

 
       (In thousands)     
U.S. Treasury Notes  $80,072   $141   $   $80,213 
U.S. Government Agencies   130,389    510    (33)   130,866 
Mortgage-backed securities   140,049    2,750    (440)   142,359 
Corporate notes   12,949    103    (49)   13,003 
Municipal securities   2,682        (687)   1,995 
Auction rate securities   65,700        (21,205)   44,495 
Marketable equity securities and other   2,284        (45)   2,239 
 Totals  $434,125   $3,504   $(22,459)  $415,170 

 

24
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 4. - (continued)

 

Management uses a multi-factor approach to determine whether each investment security in an unrealized loss position is other-than-temporarily impaired ("OTTI"). An unrealized loss position exists when the current fair value of an investment is less than its amortized cost basis. The valuation factors utilized by management incorporate the ideas and concepts outlined in relevant accounting guidance. These include such factors as:

 

*The length of time and the extent to which the market value has been less than cost;

 

*The financial condition of the issuer of the security as well as the near and long-term prospect for the issuer;

 

*The rating of the security by a national rating agency;

 

*Historical volatility and movement in the fair market value of the security; and

 

*Adverse conditions relative to the security, issuer or industry.

 

The following table shows the outstanding auction rate securities aggregated by type of underlying collateral at June 30, 2012 and December 31, 2011:

 

   June 30, 2012   December 31, 2011 
   Amortized
 Cost
   Fair Value   Amortized
Cost
   Fair Value 
       (In thousands)     
Preferred Shares of Money Center Banks  $58,200   $46,113   $63,700   $42,495 
Public Utility Debt and Equity Securities           2,000    2,000 
 Totals  $58,200   $46,113   $65,700   $44,495 

 

In accordance with ASC 320-10, Investment - Debt and Equity Securities, Management's impairment analysis for the corporate and auction rate securities that were in a loss position as of June 30, 2012 began with management's determination that it had the intent to hold these securities for sufficient time to recover the cost basis. Management also concluded that it was unlikely that it would be required to sell any of the securities before recovery of the cost basis.

 

At June 30, 2012 and December 31, 2011, the amortized cost of our auction rate securities was $58.2 million and $65.7 million, respectively. The fair value of the auction rate securities was $46.1 million and $44.5 million at June 30, 2012 and December 31, 2011, respectively.

 

25
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 4. - (continued)

 

The fair value of the auction rate securities is determined by management valuing the underlying security. The auction rate securities allow for conversion to the underlying preferred security after two failed auctions. As of June 30, 2012, there have been more than two failed auctions for all outstanding auction rate securities. It is our intention to continue to hold these securities and not convert to the underlying preferred securities. We also perform a discounted cash flow analysis, but we considered the market value of the underlying preferred shares to be more objective and relevant in pricing auction rate securities.

 

In determining whether there is OTTI, management considers the factors noted above. The financial performance indicators we review include, but are not limited to, net earnings, change in liquidity, and change in cash from operating activities, and, for money center banks, the regulatory capital ratios and the allowance for loan losses to the nonperforming loans. Through June 30, 2012, the auction rate securities have continued to pay interest at the highest rate as stipulated in the original prospectus. Currently, the interest rate paid approximates the rate paid on money market deposit accounts.

 

At June 30, 2012, we had four auction rate securities and three preferred stock issues with an aggregate fair market value of $27.6 million which were below investment grade. At December 31, 2011, we had four auction rate securities with an aggregate fair market value of $15.3 million which were below investment grade.

 

Based upon our methodology for determining the fair value of the auction rate securities, we concluded that as of June 30, 2012, the unrealized loss for the auction rate securities is due to the market interest volatility, the continued illiquidity of the auction rate markets, and uncertainty in the financial markets as there has not been a deterioration in the credit quality of the issuer of the auction rate securities or a downgrade of additional auction rate securities from investment grade. It is not more likely than not that the Company would be required to sell the auction rate securities prior to recovery of the unrealized loss, nor does the Company intend to sell the security at the present time.

 

During the six months ended June 30, 2012 and the year ended December 31, 2011, $2.0 million and zero auction rate securities, respectively, were redeemed.

 

There has been one credit rating down grade on our auction rate securities subsequent to December 31, 2011.

 

26
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 4. - (continued)

 

At June 30, 2012 and December 31, 2011, the Company owned preferred and common stock (collectively "equity securities"), with an amortized cost of $2.2 million and $2.3 million, respectively. The fair value of the equity securities was $1.9 million and $2.2 million at June 30, 2012 and December 31, 2011, respectively.

 

The Company has investments in certain debt securities that have unrealized losses or may be otherwise impaired, but an OTTI has not been recognized in the financial statements as management believes the decline is due to the credit markets coupled with the interest rate environment.

 

The following table indicates the length of time individual securities that we consider temporarily impaired have been in a continuous unrealized loss position at June 30, 2012 (in thousands): 

 

   Less than 12 months   12 months or longer   Total 
   Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
   Fair Value   Unrealized
Losses
 
Description of Securities                              
U.S. Treasury Notes  $14,956   $6   $   $   $14,956   $6 
U.S. Government Agencies   9,968    20    26    1    9,994    21 
Mortgage-backed securities   8,791    67    9,181    353    17,972    420 
Corporate notes   1,774    5            1,774    5 
Auction rate securities           46,113    12,087    46,113    12,087 
Municipal securities           427    428    427    428 
Subtotal, debt securities   35,489    98    55,747    12,869    91,236    12,967 
Marketable equity securities and other   763    236    40    21    803    257 
Total temporarily impaired securities  $36,252   $334   $55,787   $12,890   $92,039   $13,224 

 

The Company had a total of 46 debt securities with a fair market value of $91.2 million which were temporarily impaired at June 30, 2012. The total unrealized loss on these securities was $13.0 million, which is attributable to the market interest volatility, the continued illiquidity of the debt markets, and uncertainty in the financial markets. We also had 4 equity securities with a fair market value of $803,000 and an unrealized loss of $257,000. The remaining unrealized loss of $12.1 million is on 9 auction rate securities which have declined in value due to auction failures beginning in February 2008. It is not more likely than not that we would sell these securities before maturity, and we have the intent to hold all of these securities to maturity and will not be required to sell these securities, due to our ratio of cash and cash equivalents of approximately 15.6% of total assets at June 30, 2012. Therefore, the unrealized losses associated with these securities are not considered to be other than temporary.

  

27
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 4. - (continued)

 

The amortized cost and fair value of investment securities available for sale and held to maturity, by contractual maturity, at June 30, 2012 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.

 

   June 30, 2012 
   Available for Sale   Held to Maturity 
   Amortized
Cost
   Fair
Value
   Amortized
Cost
   Fair
Value
 
   (In thousands) 
Due in one year or less  $73,648   $73,698   $   $ 
Due after one through five years   42,223    42,474         
Due after five through ten years   46,111    46,940         
Due after ten years   180,392    182,330    286    286 
Auction rate securities   58,200    46,113         
Marketable equity securities and other   2,201    1,948         
Totals  $402,775   $393,503   $286   $286 

 

Gross gains realized on the sales of investment securities for the six months ended June 30, 2012, and 2011 were approximately $785,000 and $4.1 million, respectively. Gross losses realized for the six months ended June 30, 2012 and 2011 were approximately $677,000 and $4.3 million, respectively.

 

At both June 30, 2012 and December 31, 2011, securities sold under agreements to repurchase with a book value of $50.0 million were outstanding. The book value of the securities pledged for these repurchase agreements was $59.3 million and $55.6 million, respectively. As of June 30, 2012 and December 31, 2011, the Company did not own investment securities of any one issuer where the carrying value exceeded 10% of shareholders' equity.

 

28
 

  

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 5. Deposits

 

The following table summarizes the composition of the average balances of major deposit categories:

 

  

Six Months Ended

  June 30, 2012  

  

Twelve Months Ended

 December 31, 2011 

 
   Average
Amount
  

Average

Yield

   Average
Amount
  

Average

Yield

 
   (Dollars in thousands) 
Demand deposits  $72,182       $76,900     
NOW and money market   26,515    0.23%   25,688    0.36%
Savings deposits   198,061    0.18    191,316    0.40 
Time deposits   366,002    1.20    379,860    1.34 
Total deposits  $662,760    0.72%  $673,764    0.87%

 

Note 6. Other Comprehensive Income (Loss)

 

The Company follows the provisions of FASB ASC 220, Comprehensive Income, ("ASC 220") which includes net income as well as certain other items which result in a change to equity during the period. The following table presents the components of comprehensive income (loss):

 

   For The Six Months Ended 
   June 30, 2012   June 30, 2011 
  

 

Before tax

amount

   Tax
(expense)
benefit
  

 

Net of tax

amount

  

 

Before tax

amount

   Tax
(expense)
benefit
  

 

Net of tax

amount

 
   (In thousands) 
Unrealized gains (losses) on investment securities:                              
Unrealized holding gains (losses) arising during period  $9,182   $(3,673)  $5,509   $8,273   $(3,309)  $4,964 
Less reclassification adjustment for gains (losses) realized in net income   108    (43)   65    (137)   55    (82)
Unrealized gain (loss) on investment securities   9,074    (3,630)   5,444    8,410    (3,364)   5,046 
Other comprehensive income, net  $9,074   $(3,630)  $5,444   $8,410   $(3,364)  $5,046 

 

29
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 7. Fair Value of Financial Instruments

 

FASB ASC 820, "Fair Value Measurements and Disclosure", ("ASC 820") defines fair value, establishes a framework for measuring fair value, and expands disclosure about fair value. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value. A financial instrument's level within the fair value hierarchy is based on the lowest level of input significant to the fair value measurement. There have been no material changes in valuation techniques as a result of the adoption of ASC 820.

 

Level 1 - Quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

 

Level 2 - Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities in active markets; quoted prices in markets that are not active for identical or similar assets or liabilities; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Level 3 - Unobservable inputs that are supported by little or no market activity and significant to the fair value of the assets or liabilities that are developed using the reporting entities' estimates and assumptions, which reflect those that market participants would use.

 

The Company is required to disclose the estimated fair value of its 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. However, many such instruments lack an available trading market, as characterized by a willing buyer and seller engaging in an exchange transaction. Also, it is the Company's general practice and intent to hold its financial instruments to maturity and not to engage in trading or sales activities, except for certain loans. Therefore, the Company had to use significant estimations and present value calculations to prepare this disclosure.

 

Changes in the assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Also, 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 June 30, 2012 and December 31, 2011 are outlined below.

 

30
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 7. - (continued)

 

   June 30, 2012   December 31, 2011 
   Carrying
amount
   Estimated
fair value
   Carrying
amount
   Estimated
fair value
 
   (In thousands) 
Investment securities  $393,789   $393,788   $415,468   $415,463 
Loans, net of unearned income   320,298    316,128    317,021    359,989 
Time Deposits   366,232    367,919    369,259    371,266 
Repurchase Agreements   50,000    51,717    50,000    52,432 
Borrowings   3,794    3,843    6,139    6,256 
Subordinated debt   22,681    22,681    22,681    22,681 

 

For cash and cash equivalents, the recorded book values of $138.5 million and $101.0 million at June 30, 2012 and December 31, 2011, respectively, approximates fair value because of the relatively short term between the origination of the instrument and its expected realization. Therefore, the Company believes the measurement of fair value of cash and cash equivalents is derived from Level 1 inputs.

 

The estimated fair values of investment securities are based on quoted market prices (Level 1 inputs), if available. Estimated fair values are based on quoted market prices of comparable instruments if quoted market prices are not available (Level 2 inputs). Estimated fair values are also determined using unobservable inputs that are supported by little or no market values and significant assumptions and estimates (Level 3 inputs).

 

The net loan portfolio at June 30, 2012 and December 31, 2011 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 Company believes the fair value of portfolio loans is derived from Level 3 inputs.

 

The carrying value of interest receivable and payable approximates fair value and is derived from Level 1 inputs.

 

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 fair value of such deposits is derived from Level 2 inputs. The fair value of time deposits have been valued using net present value discounted cash flow and is derived from Level 2 inputs.

 

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. As such, no disclosures are made on the fair value of commitments.

 

The fair value of interest rate caps, included in borrowings, 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 zero at both June 30, 2012 and December 31, 2011.

 

The fair value of borrowings, repurchase agreements and subordinated debt approximates the carrying value due to the re-pricing of the debt. The Company measures the fair value of borrowings, repurchase agreements and subordinated debt using Level 2 inputs.

 

31
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 7. - (continued)

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

A description of the valuation methodologies used for financial instruments measured at fair value on a recurring basis, as well as the classification of the instruments pursuant to the valuation hierarchy, are as follows:

 

Securities Available for Sale

 

When quoted market prices are available in an active market, securities are classified within Level 1 of the fair value hierarchy. If quoted market prices are not available or accessible, then fair values are estimated using pricing models, matrix pricing, or discounted cash flow models. The fair values of securities estimated using pricing models or matrix pricing are generally classified within Level 2 of the fair value hierarchy. When discounted cash flow models are used there is omitted activity or less transparency around inputs to the valuation and securities are classified within Level 3 of the fair value hierarchy.

 

Level 1 securities generally include equity securities valued based on quoted market prices in active markets. Level 2 instruments include U.S. government agency obligations, state and municipal bonds, mortgage-backed securities, collateralized mortgage obligations and corporate bonds. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond's terms and conditions, among other things. Level 3 securities available for sale consist of instruments that are not readily marketable and may only be redeemed with the issuer at par such as Federal Home Loan Bank and Federal Reserve Bank stock. These securities are valued at par value.

 

32
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 7. - (continued)

 

Assets measured at fair value at June 30, 2012 and at December 31, 2011 are summarized below.

 

   At June 30, 2012 
Fair Value Measurement Using
 
   Quoted Prices in
Active Markets
for Identical
Assets/Liabilities
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Balance
June 30,
2012
 
   (Dollars in thousands) 
Assets                    
Impaired Loans (1)  $   $   $25,483   $25,483 
Investment securities available for sale: (2)                    
U.S. Treasury Notes   85,019            85,019 
U.S. Government Agencies       124,307        124,307 
Mortgage-backed securities       123,366        123,366 
Corporate notes   10,209            10,209 
Municipal securities   2,541            2,541 
Auction rate securities           46,113    46,113 
Marketable equity securities and other   66    1,882        1,948 
Total Investment securities available for sale   97,835    249,555    46,113    393,503 
Total assets  $97,835   $249,555   $71,596   $418,986 

 

(1) Non-recurring basis

(2) Recurring basis

 

The above table includes $9.3 million in net unrealized losses on the Company's available for sale securities. The Company has reviewed its investment portfolio at June 30, 2012, and determined that the unrealized losses are temporary.

 

The fair value of the derivative is zero and valued as a Level 3 input. Further disclosures are not included because they were not deemed material.

 

33
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 7. - (continued)

 

   At December, 31, 2011
Fair Value Measurement Using
 
   Quoted Prices in
Active Markets
for Identical
Assets/Liabilities
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
   Balance
December 31,
2011
 
   (Dollars in thousands) 
Assets                    
Impaired Loans (1)  $   $   $25,031   $25,031 
Investment securities available for sale: (2)                    
U.S. Treasury Notes   80,213            80,213 
U.S. Government Agencies       130,866        130,866 
Mortgage-backed securities       142,359        142,359 
Corporate notes   13,003            13,003 
Municipal securities   1,995            1,995 
Auction rate securities           44,495    44,495 
Marketable equity securities and other   803    1,436        2,239 
Total Investment securities available for sale   96,014    274,661    44,495    415,170 
Total assets  $96,014   $274,661   $69,526   $440,201 

 

(1) Non-recurring basis

(2) Recurring basis

 

The above table includes $19.0 million in net unrealized losses on the Company's available for sale securities. The Company has reviewed its investment portfolio at December 31, 2011, and determined that the unrealized losses are temporary.

 

The fair value of the derivative is zero and valued as a Level 3 input. Further disclosures are not included because they were not deemed material.

 

34
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 7. - (continued)

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs (Level 3)

 

The following table presents a reconciliation for assets measured at fair value on a recurring basis for which the Company has utilized significant unobservable inputs (Level 3).

 

(Dollars in thousands)  Investment
Securities
Available
for Sale
 
     
Balance, January 1, 2012  $44,495 
Total gains/losses (realized/unrealized)     
Included in earnings    
Included in other comprehensive income   9,118 
Purchases    
Sales   (7,500)
Issuances    
Settlements    
Redemptions    
Interest    
Other than temporary impairment expense    
Capital deductions for operating expenses    
Balance, June 30, 2012  $46,113 
      
The amount of total gains (losses) for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at June 30, 2012  $ 

 

Note 8. New Accounting Pronouncements

 

In April 2011, the FASB issued ASU No. 2011-03, which amends the accounting for repurchase agreements and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The amendments remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. ASU No. 2011-03 is effective for the first interim or annual period beginning on or after December 15, 2011. Adoption of this update did not have a material effect on the Company's results of operations or financial condition.

 

In May 2011, the FASB issued ASU No. 2011-04, which results in common fair value measurement and disclosure requirements for US GAAP and International Financial Reporting Standards. ASU No. 2011-04 is effective for the first interim or annual period beginning after December 15, 2011. Adoption of this update did not have a material effect on the Company's results of operations or financial condition but resulted in additional disclosures.

 

35
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Note 8. - (continued)

 

In June 2011, the FASB issued ASU No. 2011-05 in order to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. This standard eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders' equity. This update requires all nonowner changes in stockholders' equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. This update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. Early adoption is permitted because compliance with the amendments is already permitted. Adoption of this update did not have a material effect on the Company's results of operations or financial condition. See the Consolidated Statements of Comprehensive Income.

 

In December 2011, the FASB issued ASU No. 2011-11, which amends Topic 210, "Balance Sheet," to require an entity to disclose both gross and net information about financial instruments, such as sales and repurchase agreements and reverse sale and repurchase agreements and securities borrowing/lending arrangements, and derivative instruments that are eligible for offset in the statement of financial position and/or subject to a master netting arrangement or similar agreement. ASU 2011-11 is effective for annual and interim periods beginning on January 1, 2013, and is not expected to have a material effect on the Company's results of operations or financial condition.

 

Note 9. Subsequent Events

 

On April 2, 2012, we received a notice from the Federal Reserve Bank of New York stating that they do not object to the Company's request to redeem $15.5 million of Floating Rate Junior Subordinated Debt Securities Due 2034. Accordingly, on July 23, 2012, we redeemed said security.

 

We evaluated subsequent events under ASC Topic 855, Subsequent Events. We did not identify any items which would require disclosure in or adjustment to the interim financial statements except as disclosed in Form 10-Q as of and for the period ended June 30, 2012.

 

36
 

 

BERKSHIRE BANCORP INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements (continued)

(unaudited)

 

Internal Control Over Financial Reporting

 

The objective of the Company's Internal Control Program is to allow the Bank and management to comply with Part 363 of the FDIC's regulations ("FDICIA") and to allow the Company to comply with Sections 302 and 404 of the Sarbanes-Oxley Act of 2002 ("SOX"). In November 2005, the FDIC amended Part 363 of its regulations by raising the asset-size threshold from $500 million to $1 billion for internal control assessments by management and external auditors. The final rule was effective December 28, 2005.

 

Section 302 of SOX requires the CEOs and CFOs of the Company to, among other matters, (i) certify that the annual and quarterly reports filed with the Securities and Exchange Commission are accurate and (ii) acknowledge that they are responsible for establishing, maintaining and periodically evaluating the effectiveness of the disclosure controls and procedures. Section 404 of SOX requires management to (i) report on internal control over financial reporting, (ii) assess the effectiveness of such internal controls, and (iii) obtain an external auditor's report on management's assessment of its internal control.

 

The Company is not an accelerated filer as defined in Rule 12b-2 of the Securities Exchange Act of 1934. On July 21, 2010, President Obama signed the Dodd-Frank Act into law. The Dodd-Frank Act includes a provision which permanently exempts non-accelerated filers, including the Company, from the requirement to obtain an external audit on the effectiveness of internal financial reporting controls provided in Section 404(b) of SOX. Disclosure of management's attestations on internal control over financial reporting under Section 404(a) of SOX is still required. See the Section of this Report entitled "Business - The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010."

 

The Committee of Sponsoring Organizations (COSO) methodology may be used to document and test the internal controls pertaining to the accuracy of Company issued financial statements and related disclosures. COSO requires a review of the control environment (including anti-fraud and audit committee effectiveness), risk assessment, control activities, information and communication, and ongoing monitoring.

 

37
 

 

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

 

Executive Summary

 

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

 

The Bank's principal business consists of gathering deposits from the general public and investing those deposits together with funds generated from ongoing operations and borrowings, primarily in residential and commercial loans, debt obligations issued by the U.S. Government and its agencies, debt obligations of business corporations, and mortgage-backed securities. The Bank operates from seven deposit-taking offices in New York City, four deposit-taking offices in Orange and Sullivan Counties, New York, and one deposit-taking office in Teaneck, New Jersey. The Bank's revenues are derived principally from interest on loans, and interest and dividends on investments in the securities portfolio. The Bank's primary regulator at the state level is by the New York Superintendent of Banks and the New York Banking Board, while at the federal level its primary regulator is the Federal Deposit Insurance Corporation (the "FDIC"). Deposits are insured to the maximum allowable amount by the FDIC. The Bank is a member of the Federal Home Loan Bank system.

 

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

 

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

 

38
 

 

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

 

We did not record a provision for loan losses during the three and six- month periods ended June 30, 2012, compared to a provision for loan losses of $400,000 and $1.6 million recorded during the three and six-month periods ended June 30, 2011, respectively. We deemed this appropriate as a result of the regular quarterly analysis of the allowance for loan losses. The regular quarterly analysis is based on management's evaluation of the risk inherent in the various components of the loan portfolio and other factors, including historical loan loss experience (which is updated at least annually), changes in the composition and volume of the portfolio, collection policies and experience, trends in the volume of non-accrual loans and regional and national economic conditions. See "Provision for Loan Losses" below in this Item 2 for further discussion of the allowance for loan losses.

 

Net income, before benefit for income taxes, for the three and six months ended June 30, 2012 was $1.5 million and $3.4 million, respectively, compared to net income, before dividends on our Series A Preferred Stock and before the provision for income taxes, for the three and six months ended June 30, 2011 of $45.0 million and $46.3 million, respectively. Net income for the three and six months ended June 30, 2011 includes a one time gain of $42.5 million. No Series A Preferred Stock was outstanding during the three and six months ended June 30, 2012. Net income allocated to common stockholders, after the benefit for income taxes, was $3.3 million and $5.5 million for the three and six months ended June 30, 2012, respectively, compared to net income allocated to common stockholders, including dividends on our Series A Preferred Stock and the provision for income taxes, of $41.5 million and $41.8 million for the three and six months ended June 30, 2011, respectively.

 

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

 

The following discussion and analysis is intended to provide a better understanding of the consolidated financial condition and results of operations of Berkshire Bancorp Inc. and subsidiaries. All references to earnings per share, unless stated otherwise, refer to earnings per diluted share. References to Notes herein are references to the "Notes to Consolidated Financial Statements" of the Company located in Item 1 herein.

 

39
 

 

Critical Accounting Policies, Judgments and Estimates

 

The accounting and reporting policies of the Company conform with accounting principles generally accepted in the United States of America ("GAAP") and general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.

 

The Company considers that the determination of the allowance for loan losses involves a higher degree of judgment and complexity than any of its other significant accounting policies. The allowance for loan losses is calculated with the objective of maintaining a reserve level believed by management to be sufficient to absorb estimated credit losses. Management's determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective as it requires material estimates, including, among others, expected default probabilities, loss given default, the amounts and timing of expected future cash flows on impaired loans, mortgages, and general amounts for historical loss experience. The process also considers economic conditions, uncertainties in estimating losses and inherent risks in the loan portfolio. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required that would adversely impact earnings in future periods. See "Provision for Loan Losses" below in this Item 2 for further discussion of the allowance for loan losses.

 

The Company recognizes deferred tax assets and liabilities for the future tax effects of temporary differences, net operating loss carryforwards and tax credits. Deferred tax assets are subject to management's judgment based upon available evidence that future realization is more likely than not. If management determines that the Company may be unable to realize all or part of net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the expected realizable amount.

 

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

 

40
 

 

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

 

   For The Three Months Ended June 30, 
   2012   2011 
   Average
Balance
   Interest
and
Dividends
   Average
Yield/Rate
   Average
Balance
   Interest
and
Dividends
   Average
Yield/Rate
 
           (Dollars in Thousands)         
INTEREST-EARNING ASSETS:                              
Loans (1)  $322,629   $4,882    6.05%  $346,118   $5,498    6.35%
Investment securities   419,466    2,300    2.19    387,685    3,480    3.59 
Other (2)(5)   108,948    125    0.46    96,914    73    0.30 
Total interest-earning assets   851,043    7,307    3.43    830,717    9,051    4.36 
Noninterest-earning assets   26,366              31,032           
Total Assets  $877,409             $861,749           
                               
INTEREST-BEARING LIABILITIES:                              
Interest bearing deposits   232,445    97    0.17%   212,469    238    0.45%
Time deposits   365,344    1,077    1.18    386,614    1,305    1.35 
Other borrowings   76,973    591    3.07    81,582    745    3.65 
Total interest-bearing liabilities   674,762    1,765    1.05    680,665    2,288    1.34 
                               
Demand deposits   72,897              80,293           
Noninterest-bearing liabilities   4,727              6,241           
Stockholders' equity (5)   125,023              94,550           
                               
Total liabilities and stockholders' equity  $877,409             $861,749           
                               
Net interest income        5,542              6,763      
                               
Interest-rate spread (3)             2.38%             3.02%
                               
Net interest margin (4)             2.60%             3.26%
                               
Ratio of average interest-earning assets to average interest bearing liabilities   1.26              1.22           

______________________

(1)Includes nonaccrual loans.

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

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

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

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

 

41
 

 

   For The Six Months Ended June 30, 
   2012   2011 
   Average
Balance
   Interest
and
Dividends
   Average
Yield/Rate
   Average
Balance
   Interest
and
Dividends
   Average
Yield/Rate
 
   (Dollars in Thousands) 
INTEREST-EARNING ASSETS:                              
Loans (1)  $320,569   $9,787    6.11%  $349,474   $11,177    6.40%
Investment securities   415,576    4,737    2.28    376,623    6,661    3.54 
Other (2)(5)   103,644    184    0.71    86,699    134    0.31 
Total interest-earning assets   839,789    14,708    3.50    812,796    17,972    4.42 
Noninterest-earning assets   28,391              32,851           
Total Assets  $868,180             $845,647           
                               
INTEREST-BEARING LIABILITIES:                              
Interest bearing deposits   224,576    207    0.18%   210,335    500    0.48%
Time deposits   366,002    2,193    1.20    385,957    2,609    1.35 
Other borrowings   77,557    1,232    3.18    82,141    1,506    3.67 
Total interest-bearing liabilities   668,135    3,632    1.09    678,433    4,615    1.36 
                               
Demand deposits   72,182              78,324           
Noninterest-bearing liabilities   4,923              5,643           
Stockholders' equity (5)   122,940              83,247           
                               
Total liabilities and stockholders' equity  $868,180             $845,647           
                               
Net interest income        11,076              13,357      
                               
Interest-rate spread (3)             2.41%             3.06%
                               
Net interest margin (4)             2.64%             3.29%
                               
Ratio of average interest-earning assets to average interest bearing liabilities   1.26              1.20           

______________________

(1)Includes nonaccrual loans.

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

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

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

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

 

42
 

 

Results of Operations

 

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

 

Net Income Allocated to Common Stockholders. Net income allocated to common stockholders for the three and six-month periods ended June 30, 2012 was $3.3 million and $5.5 million, respectively, or $0.23 and $0.38 per common share, respectively. Net income allocated to common stockholders for the three and six-month periods ended June 30, 2011 was $41.5 million and $41.8 million, respectively, or $5.89 and $5.93 per common share, respectively.

 

The net income allocated to common stockholders for the three and six months ended June 30, 2012 includes a benefit for income taxes of $1.8 million and $2.1 million, respectively, or $.13 and $.15 per common share, respectively. The net income allocated to common stockholders for the three and six months ended June 30, 2011 includes (i) the accrual of dividends on our Series A Preferred Stock of $1.2 million and $2.4 million, respectively, or $.17 and $.34 per common share, respectively, (ii) a provision for income taxes of $2.3 million and $2.1 million, respectively, or $.33 and $.30 per common share, respectively, and (iii) a one-time settlement payment of $42.5 million, or $6.02 per common share.

 

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

 

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

 

For the three and six-month periods ended June 30, 2012, net interest income was $5.5 million and $11.1 million, respectively, compared to net interest income of $6.8 million and $13.4 million, respectively, for the three and six-month periods ended June 30, 2011. The decrease in net interest income during the 2012 periods was primarily due to the decrease in the average yields earned on total interest-earning assets, partially offset by the increase in the average amounts of interest-earning assets, the decrease in the average amounts of total interest-bearing liabilities and the decrease in the average rates paid on interest-bearing liabilities.

 

The average yields earned on total interest-earning assets declined to 3.43% and 3.50% during the three and six-month periods ended June 30, 2012, respectively, from 4.36% and 4.42% during the three and six-month periods ended June 30, 2011, respectively. The average rates paid on total interest-bearing liabilities declined to 1.05% and 1.09% during the three and six-month periods ended June 30, 2012, respectively, from 1.34% and 1.36% during the three and six-month periods ended June 30, 2011, respectively. The Company's interest-rate spread, the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities, declined to 2.38% and 2.41% during the three and six-month periods ended June 30, 2012, respectively, from 3.02% and 3.06% during the three and six-month periods of 2011, respectively.

 

Net Interest Margin. Net interest margin, or annualized net interest income as a percentage of average interest-earning assets, was 2.60% and 2.64% for the three and six months ended June 30, 2012, respectively, compared to 3.26% and 3.29% during the three and six months ended June 30, 2011. We seek to secure and retain customer deposits with competitive products and rates, while making strategic use of the prevailing interest rate environment to borrow funds at what we believe to be attractive rates. We invest such deposits and borrowed funds in a prudent mix of fixed and adjustable rate loans, investment securities and short-term interest-earning assets. The decrease in net interest margin is primarily due to the decrease in the average amounts of higher yielding loans as a percentage of our total mix of interest-earning assets.

  

43
 

  

Interest Income. Total interest income for the quarter ended June 30, 2012 decreased by $1.8 million to $7.3 million from $9.1 million for the quarter ended June 30, 2011. The decrease was due to the decrease in the average yield earned on the average amount of interest-earning assets to 3.43% during the 2012 quarter from 4.36% during the 2011 quarter, and the decrease in the average amount of higher yielding loans to $322.6 million during the 2012 quarter from $346.1 million during the 2011 quarter.

 

Total interest income for the six months ended June 30, 2012 decreased by $3.3 million to $14.7 million from $18.0 million for the six months ended June 30, 2011. The decrease was due to the decrease in the average yield earned on the average amount of interest-earning assets to 3.50% during the 2012 six-month period from 4.42% during the 2011 six-month period, and the decrease in the average amount of higher yielding loans to $320.6 million during the 2012 period from $349.5 million during the 2011 period.

 

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

 

   Three Months Ended June 30, 
   2012   2011 
   Interest
Income
   % of
Total
   Interest
Income
   % of
Total
 
   (In thousands, except percentages) 
Loans  $4,882    66.81%  $5,498    60.74%
Investment Securities   2,300    31.48    3,480    38.45 
Other   125    1.71    73    0.81 
Total Interest Income  $7,307    100.00%  $9,051    100.00%

 

44
 

 

   Six Months Ended June 30, 
   2012   2011 
   Interest
Income
   % of
Total
   Interest
Income
   % of
Total
 
   (In thousands, except percentages) 
Loans  $9,787    66.54%  $11,177    62.19%
Investment Securities   4,737    32.21    6,661    37.06 
Other   184    1.25    134    0.75 
Total Interest Income  $14,708    100.00%  $17,972    100.00%

 

Loans, which are inherently risky and therefore command a higher return than our portfolio of investment securities and other interest-earning assets, decreased to 37.9% and 38.2% of our total amount of average interest-earning assets during the three and six month-periods ended June 30, 2012, respectively, from 41.7% and 43.0% during the three and six month-periods ended June 30, 2011, respectively. The average amounts of investment securities increased to 49.3% and 49.5% of total average interest-earning assets during the three and six-month periods ended June 30, 2012, respectively, from 46.7% and 46.3% during the three and six-month periods ended June 30, 2011, respectively. While we actively seek to originate new loans with qualified borrowers who meet the Bank's underwriting standards, our strategy has been to maintain those standards, sacrificing some current income to avoid possible large future losses in the loan portfolio.

 

At June 30, 2012 and 2011, total non-performing loan assets were $520,000 and $3.4 million, respectively, of non-accrual loans. Depending upon the contractual interest rate of a loan, significant additions to non-performing loans, were such additions to occur, could have a material adverse effect on our results of operations. The effect of the decrease in non-accrual loans in 2012 from 2011 was negligible.

 

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

 

Interest Expense. Total interest expense for the quarter ended June 30, 2012 decreased by $500,000 to $1.8 million from $2.3 million for the quarter ended June 30, 2011. The decrease in total interest expense was due to the decrease in the average rates paid on the average amount of interest-bearing liabilities to 1.05% in the 2012 quarter from 1.34% in the 2011 quarter, and the decrease in the average amounts of interest-bearing liabilities to $674.8 million for the quarter ended June 30, 2012 from $680.7 million for the quarter ended June 30, 2011.

 

45
 

 

Total interest expense for the six-month period ended June 30, 2012 decreased by $1.0 million to $3.6 million from $4.6 million for the six-month period ended June 30, 2011. The decrease in total interest expense was due to the decrease in the average rates paid on the average amount of interest-bearing liabilities to 1.09% during the 2012 six-month period from 1.36% during the 2011 six-month period, and the decrease in the average amounts of interest-bearing liabilities to $668.1 million from $678.4 million during the six months ended June 30, 2012 and 2011, respectively.

 

The following tables present the components of interest expense for the indicated periods:

 

   Three Months Ended June 30, 
   2012   2011 
   Interest
Expense
   % of
Total
   Interest
Expense
   % of
Total
 
   (In thousands, except percentages) 
Interest-Bearing Deposits  $97    5.50%  $238    10.40%
Time Deposits   1,077    61.02    1,305    57.04 
Other Borrowings   591    33.48    745    32.56 
Total Interest Expense  $1,765    100.00%  $2,288    100.00%

 

   Six Months Ended June 30, 
   2012   2011 
   Interest
Expense
   % of
Total
   Interest
Expense
   % of
Total
 
   (In thousands, except percentages) 
Interest-Bearing Deposits  $207    5.70%  $500    10.83%
Time Deposits   2,193    60.38    2,609    56.53 
Other Borrowings   1,232    33.92    1,506    32.64 
Total Interest Expense  $3,632    100.00%  $4,615    100.00%

 

Non-Interest Income. Non-interest income consists primarily of realized gains on sales of marketable securities and service fee income. Total non-interest income for the three and six months ended June 30, 2012 was $121,000 and $644,000 million, respectively. For the three and six months ended June 30, 2011, total non-interest income amounted to $43.0 million and $43.3 million, respectively.

 

46
 

 

In May 2011, we entered into a settlement agreement with the selling financial institution of the auction rate securities in the Bank's investment portfolio. Pursuant to the agreement, the institution paid to the Bank the sum of $42.5 million which was included in other non-interest income. Excluding the settlement payment of $42.5 million, total non-interest income for the three and six months ended June 30, 2011 was approximately $500,000 and $800,000, respectively.

 

Non-Interest Expense. Non-interest expense includes salaries and employee benefits, occupancy and equipment expenses, legal and professional fees and other operating expenses associated with the day-to-day operations of the Company. Total non-interest expense for the three and six months ended June 30, 2012 was $4.2 million and $8.3 million, respectively, compared to $4.3 million and $8.7 million for the three and six months ended June 30, 2011, respectively.

 

The following tables present the components of non-interest expense for the indicated periods:

 

   Three Months Ended June 30, 
   2012   2011 
   Non-Interest
Expense
   % of
Total
   Non-Interest
Expense
   % of
Total
 
   (In thousands, except percentages) 
Salaries and Employee Benefits  $2,380    57.31%  $2,399    55.68%
Net Occupancy Expense   577    13.89    500    11.61 
Equipment Expense   88    2.12    78    1.81 
FDIC Assessment   300    7.22    268    6.22 
Data Processing Expense   112    2.70    152    3.53 
Other   696    16.76    911    21.15 
Total Non-Interest Expense  $4,153    100.00%  $4,308    100.00%

 

47
 

 

   Six Months Ended June 30, 
   2012   2011 
   Non-Interest
Expense
   % of
Total
   Non-Interest
Expense
   % of
Total
 
   (In thousands, except percentages) 
Salaries and Employee Benefits  $4,860    58.25%  $4,834    55.44%
Net Occupancy Expense   1,161    13.92    1,065    12.21 
Equipment Expense   166    1.99    160    1.84 
FDIC Assessment   600    7.19    652    7.48 
Data Processing Expense   224    2.68    261    2.99 
Other   1,332    15.97    1,747    20.04 
Total Non-Interest Expense  $8,343    100.00%  $8,719    100.00%

 

Provision (Benefit) for Income Tax. During the three and six months ended June 30, 2012, the Company recorded an income tax benefit of $1.8 million and $2.1 million, respectively, compared to income tax expense of $2.3 million and $2.1 million, respectively, for the three and six months ended June 30, 2011. The Company has net operating loss carry forwards which can be offset against current taxable income. In addition, the Company had significant valuation allowances on the deferred tax asset for the remaining net operating loss carry forwards. The valuation allowance was released during the three and six-month periods ended June 30, 2012 due to additional current earnings and the expectation that we will recognize the remaining benefit of the net operating loss carry forwards within the next few years. This release was the primary driver of the tax benefits recorded during the three and six months ended June 30, 2012. The tax expense recorded during the three and six months ended June 30, 2011 mainly relates to changes in deferred taxes.

 

Issuer Purchases of Equity Securities

 

On May 15, 2003, The Company's Board of Directors authorized the purchase of up to an additional 450,000 shares of its Common Stock in the open market, from time to time, depending upon prevailing market conditions, thereby increasing the maximum number of shares which may be purchased by the Company from 1,950,000 shares of Common Stock to 2,400,000 shares of Common Stock. Since 1990 through June 30, 2012, the Company has purchased a total of 1,898,909 shares of its Common Stock. We did not repurchase shares of the Company's Common Stock during the first and second quarters of 2012. At June 30, 2012, there were 501,091 shares of Common Stock which may yet be purchased under our stock repurchase plan.

 

Provision for Loan Losses. The allowance for loan losses is the estimated amount considered necessary to cover credit losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses that is charged against income. In determining the allowance for loan losses, management makes significant estimates which involve a high degree of judgment, subjectivity of the assumptions utilized, and potential for changes in the economic environment that could result in changes to the amount of the recorded allowance for loan losses.

 

48
 

 

The allowance for loan losses has been determined in accordance with U.S. GAAP, principally FASB ASC 450, "Contingencies", ("ASC 450") and FASB ASC 310, "Receivables", ("ASC 310"). Under the above accounting principles, we are required to maintain an allowance for probable losses at the balance sheet date. We are responsible for the timely and periodic determination of the amount of the allowance required. Management believes that the allowance for loan losses is adequate to cover specifically identifiable losses, as well as estimated losses inherent in our portfolio for which certain losses are probable but not specifically identifiable.

 

Management performs a monthly evaluation of the adequacy of the allowance for loan losses. The analysis of the allowance for loan losses has two components: specific and general reserves. Specific reserves are made for loans determined to be impaired. Impairment is measured by determining the present value of expected future cash flows or, as a practical expedient for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. The Bank considers its investment in one-to-four family real estate loans and consumer loans to be smaller balance homogeneous loans and therefore excluded from separate identification for evaluation of impairment. These homogeneous loan groups are evaluated for impairment on a collective basis under FASB ASC 310.

 

The general reserve is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history. Management also analyzes historical loss experience, delinquency trends, general economic conditions, geographic concentrations, and industry and peer comparisons. This analysis establishes factors that are applied to the loan segments to determine the amount of the general reserves. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revisions based upon changes in economic and real estate market conditions. Actual loan losses may be significantly more than the allowance for loan losses management has established which could have a material negative effect on the Company's financial results.

 

On a monthly basis, the Bank's management committee reviews the current status of various loan assets in order to evaluate the adequacy of the allowance for loan losses. In this evaluation process, specific loans are analyzed to determine their potential risk of loss. This process includes all loans, concentrating on non-accrual and classified loans. Each non-accrual or classified loan is evaluated for potential loss exposure. Any shortfall results in a recommendation of a specific allowance if the likelihood of loss is evaluated as probable. To determine the adequacy of collateral on a particular loan, an estimate of the fair market value of the collateral is based on the most current appraised value available. This appraised value is then reduced to reflect estimated liquidation expenses.

 

49
 

 

As a substantial amount of our loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans are critical in determining the amount of the allowance required for specific loans. Assumptions for appraisal valuations are instrumental in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly impact the valuation of a property securing a loan and the related allowance determined. The assumptions supporting such appraisals are carefully reviewed by management to determine that the resulting values reasonably reflect amounts realizable on the related loans. Based on the composition of our loan portfolio, management believes the primary risks are increases in interest rates, a decline in the economy, generally, and a decline in real estate market values in the New York metropolitan area. Any one or combination of these events may adversely affect our loan portfolio resulting in increased delinquencies, loan losses and future levels of loan loss provisions. Management believes the allowance for loan losses reflects the inherent credit risk in our portfolio, the level of our non-performing loans and our charge-off experience.

 

A loan is considered nonperforming when it becomes delinquent ninety days or when other adverse factors become known to us. We generally order updated appraisals from independent third party licensed appraisers at the time the loan is identified as nonperforming. Depending upon the property type, we receive appraisals within thirty to ninety days from the date the appraisals are ordered. Upon receipt of the appraisal, which is discounted by us to take account of estimated selling and other holding costs, we compare the adjusted appraisal amount to the carrying amount of the real estate dependent loan and record any impairment through the allowance for loan loss at that time.

 

The majority of our real estate dependent loans are concentrated in the New York City metropolitan area, we do not make adjustments to the appraisals for this concentration. We do not increase the appraised value of any property. Any adjustments we make to the appraisals are to decrease the appraised value due to selling and other holding costs.

 

Although management believes that we have established and maintained the allowance for loan losses at adequate levels, additions may be necessary if future economic and other conditions differ substantially from the current operating environment. Although management uses what it believes is the best information available, the level of the allowance for loan losses remains an estimate that is subject to significant judgment and short-term change. In addition, the Federal Deposit Insurance Corporation, the New York State Department of Financial Services, and other regulatory bodies, as an integral part of their examination process, will periodically review our allowance for loan losses. Such agencies may require us to recognize adjustments to the allowance based on its judgments about information available to them at the time of their examination.

 

50
 

 

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):

 

   Three Months Ended
June 30,
   Six Months Ended
June 30,
 
   2012   2011   2012   2011 
                 
Average loans outstanding  $322,629   $346,118   $320,569   $349,474 
Allowance at beginning of period   17,720    17,324    17,720    16,105 
Charge-offs:                    
Commercial and other loans   2        2    2 
Real estate loans                
Total loans charged-off   2        2    2 
Recoveries:                    
Commercial and other loans       6        27 
Real estate loans                
Total loans recovered       6        27 
Net recoveries (charge-offs)   (2)   6    (2)   25 
Provision for loan losses charged to operating expenses       400        1,600 
Allowance at end of period   17,718    17,730    17,718    17,730 
Ratio of net recoveries (charge-offs) to average loans outstanding   0.00%   0.00%   0.00%   0.01%
Allowance as a percent of total loans   5.52%   5.10%   5.52%   5.10%
Total loans at end of period  $320,938   $347,583   $320,938   $347,583 

 

51
 

 

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 June 30, 2012 and December 31, 2011, the Company had loans, net of unearned income, of $320.3 million and $317.0 million, respectively, and an allowance for loan losses of $17.7 million and $17.7 million, respectively. From time to time, the Bank may originate residential mortgage loans, sell them on the secondary market, normally recognizing fee income in connection with the sale.

 

Interest rates on loans are affected by the demand for loans, the supply of money available for lending, credit risks, the rates offered by competitors and other conditions. These factors are in turn affected by, among other things, economic conditions, monetary policies of the federal government, and legislative tax policies.

 

In order to manage interest rate risk, the Bank focuses its efforts on loans with interest rates that adjust based upon changes in the prime rate or changes in United States Treasury or similar indices. Generally, credit risks on adjustable-rate loans are somewhat greater than on fixed-rate loans primarily because, as interest rates rise, so do borrowers' payments, increasing the potential for default. The Bank seeks to impose appropriate loan underwriting standards in order to protect against these and other credit related risks associated with its lending operations.

 

In addition to analyzing the income and assets of its borrowers when underwriting a loan, the Bank obtains independent appraisals on all material real estate in which the Bank takes a mortgage. The Bank generally obtains title insurance in order to protect against title defects on mortgaged property.

 

Commercial 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.

 

52
 

 

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 mortgage loans, with maturities of one year, after which the borrower's financial condition and the terms of the loan are re-evaluated. At June 30, 2012 and December 31, 2011, $17.9 million and $15.7 million, respectively, or 5.6% and 4.9%, respectively, of the Company's total loan portfolio consisted of such loans.

 

Commercial loans tend to present greater risks than mortgage loans because the collateral, if any, tends to be rapidly depreciable, difficult to sell at full value and is often easier to conceal. In order to limit these risks, the Bank evaluates these loans based upon the borrower's ability to repay the loan from ongoing operations. The Bank considers the business history of the borrower and perceived stability of the business as important factors when considering applications for such loans. Occasionally, the borrower provides commercial or residential real estate collateral for such loans, in which case the value of the collateral may be a significant factor in the loan approval process.

 

Residential Mortgage Loans (1 to 4 family loans). The Bank makes residential mortgage loans secured by first liens on one-to-four family owner-occupied or rental residential real estate. At June 30, 2012 and December 31, 2011, $102.4 million and $104.9 million, respectively, or 31.9% and 33.0%, respectively, of the Company's total loan portfolio consisted of such loans. The Bank 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 June 30, 2012, 14% of the Bank's residential one-to-four family owner-occupied first mortgage portfolio were ARMs and 86% were fixed-rate loans. At December 31, 2011, approximately 8% of the Bank's residential one-to-four family owner-occupied first mortgage portfolio were ARMs and 92% 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.

 

53
 

 

The Bank's residential loan underwriting criteria are generally comparable to those required by Fannie Mae 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. At June 30, 2012 and December 31, 2011, $218.5 million and $212.9 million, respectively, or 68% and 67%, respectively, of the Company's total loan portfolio consisted of such other loan products.

 

Origination of Loans. Loan originations can be attributed to depositors, retail customers, phone inquiries, advertising, the efforts of the Bank's loan officers, and referrals from other borrowers, real estate brokers and builders. The Bank originates loans primarily through its own efforts, occasionally obtaining loan opportunities as a result of referrals from loan brokers.

54
 

 

At June 30, 2012, the Bank was generally not permitted to make loans to one borrower in excess of approximately $21.6 million, with an additional amount of approximately $14.4 million being permitted if secured by readily marketable collateral. The Bank was also not permitted to make any single loan in an amount in excess of approximately $21.6 million. At June 30, 2012, the Bank was in compliance with these standards.

 

Delinquency Procedures. When a borrower fails to make a required payment on a loan, the Bank attempts to cause the deficiency to be cured by contacting the borrower. The Bank reviews past due loans on a case by case basis, taking the action it deems appropriate in order to collect the amount owed. Litigation may be necessary if other procedures are not successful. Judicial resolution of a past due loan can be delayed if the borrower files a bankruptcy petition because collection action cannot be continued unless the Bank first obtains relief from the automatic stay provided by the Bankruptcy Code.

 

If a non-mortgage loan becomes delinquent and satisfactory arrangements for payment cannot be made, the Bank seeks to realize upon any personal property collateral to the extent feasible and collect any remaining amount owed from the borrower through legal proceedings, if necessary.

 

It is the Bank's policy to discontinue accruing interest on a loan when it is 90 days past due or if management believes that continued interest accruals are unjustified. The Bank may continue interest accruals if a loan is more than 90 days past due if the Bank determines that the nature of the delinquency and the collateral are such that collection of the principal and interest on the loan in full is reasonably assured. When the accrual of interest is discontinued, all accrued but unpaid interest is charged against current period income. Once the accrual of interest is discontinued, the Bank records interest as and when received until the loan is restored to accruing status. If the Bank determines that collection of the loan in full is in reasonable doubt, then amounts received are recorded as a reduction of principal until the loan is returned to accruing status.

 

Capital Adequacy

 

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 I capital (as defined in the regulations) to risk- weighted assets, and of Tier I capital to average assets. Management believes that, as of June 30, 2012, the Bank meets all capital adequacy requirements to which it is subject.

 

As of June 30, 2012, 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 I risk-based and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that date that management believes have changed the Bank's category.

 

55
 

 

The following table sets forth the actual and required regulatory capital amounts and ratios of the Company and the Bank as of June 30, 2012 (dollars in thousands):

 

   Actual   For capital
adequacy purposes
   To be well
capitalized under
prompt corrective
action provisions
 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
                         
June 30, 2012                              
Total Capital (to Risk-Weighted Assets)                              
Company  $157,420    39.6%  $31,814    >8.0%       N/A 
Bank   144,148    37.0%   31,158    >8.0%  $38,948    >10.0%
                               
Tier I Capital (to Risk-Weighted Assets)                              
Company   152,449    38.3%   15,907    >4.0%       N/A 
Bank   139,127    35.7%   15,579    >4.0%   23,369    >6.0%
                               
Tier I Capital (to Average Assets)                              
Company   152,449    17.4%   35,096    >4.0%       N/A 
Bank   139,127    16.0%   34,814    >4.0%   43,518    >5.0%

 

RECENT PROPOSED CHANGES TO REGULATORY CAPITAL RULES

 

During the second quarter of 2012, the federal bank regulatory agencies jointly issued three notices of proposed rulemaking ("NPRs") that would revise and replace the agencies' current capital rules. The NPRs include numerous revisions to the existing capital regulations, including, but not limited, to the following:

 

*Revises the definition of regulatory capital components and related calculations.

 

*Adds a new common equity tier 1 capital ratio.

 

*Increases the minimum tier 1 capital ratio requirement from 4 percent to 6 percent.

 

*Incorporates the revised regulatory capital requirements into the Prompt Corrective Action framework.

 

*Implements a new capital conservation buffer that would limit payment of capital distributions and certain discretionary bonus payments to executive officers and key risk takers if the banking organization does not hold certain amounts of common equity tier 1 capital in addition to those needed to meet its minimum risk-based capital requirements.

 

56
 

 

*Provides a transition period for several aspects of the proposed rule, including the phase-out period for certain non-qualifying capital instruments, the new minimum capital ratio requirements, the capital conservation buffer, and the regulatory capital adjustments and deductions.

 

*Revises risk weights for residential mortgages based on loan-to-value ratios and certain product and underwriting features.

 

*Increases capital requirements for past-due loans, high volatility commercial real estate exposures, and certain short-term loan commitments.

 

*Removes references to credit ratings consistent with Section 939A of the Dodd-Frank Act.

 

*Establishes due diligence requirements for securitization exposures.

 

The proposed NPRs will result in the Company, in addition to the Bank, becoming subject to capital requirements. Based on our preliminary assessment of the NPRs, we believe we will see an increase in our total risk-weighted assets. However, the Company and the Bank would meet the requirements of the NPRs to be considered well-capitalized.

 

Liquidity

 

The management of the Company's liquidity focuses on ensuring that sufficient funds are available to meet loan funding commitments, withdrawals from deposit accounts, the repayment of borrowed funds, and ensuring that the Bank and the Company comply with regulatory liquidity requirements. Liquidity needs of the Bank have historically been met by deposits, investments in federal funds sold, principal and interest payments on loans, and maturities of investment securities. Additional liquidity, up to approximately $414 million is available from the Federal Reserve Bank and the FHLB-NY.

 

57
 

 

The current uncertainties in the credit markets have negatively impacted our ability to liquidate, if necessary, investments in auction rate securities. We are not certain as to when the liquidity issues relating to these investments will improve; however, we have the intent to hold these available for sale securities to maturity, and do not believe we will be required to sell these securities prior to maturity.

 

Based on our expected operating cash flows, and our other sources of cash, we do not expect the potential lack of liquidity in these auction rate securities to affect our capital, liquidity or our ability to execute our current business plan. We have cash and cash equivalents totaling $138.5 million, or 15.6% of total assets at June 30, 2012. In addition, we have the capacity to borrow up to approximately $125 million from the Federal Reserve Bank and approximately $289 million from the FHLB-NY if the need should arise.

 

For the parent company, Berkshire Bancorp Inc., liquidity means having cash available to fund its operating expenses and to pay stockholder dividends on its common stock, when and if declared by the Company's Board of Directors. On March 31, 2009, the Company announced that it would temporarily suspend its previously announced policy of paying a regular cash dividend on the Company's common stock.

 

The ability of the Company to fund its normal operating expenses is not currently dependent upon the receipt of dividends from the Bank. At June 30, 2012, the Company had cash of $634,000 and investment securities with a fair market value of $2.6 million. However, the payment of dividends on its common stock when and if declared by the Board of Directors, will be dependent upon the receipt of dividends from the Bank.

 

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, $10.3 million at June 30, 2012, include commitments to extend credit, stand-by letters of credit and loan commitments. The Bank also had interest rate caps with a notional amount of $40.0 million.

 

At June 30, 2012, the Bank had outstanding commitments of $374.1 million; including $3.8 million of borrowings, $4.1 million of operating leases, and $366.0 million of time deposits. These commitments include $278.4 million that mature or renew within one year, $94.8 million that mature or renew after one year and within three years, $917,000 that mature or renew after three years and within five years and none that mature or renew after five years.

 

58
 

 

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.

 

ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

 

Interest Rate Risk. Fluctuations in market interest rates can have a material effect on the Bank's net interest income because the yields earned on loans and investments may not adjust to market rates of interest with the same frequency, or with the same speed, as the rates paid by the Bank on its deposits.

 

Most of the Bank's deposits are either interest-bearing demand deposits or short term certificates of deposit and other interest-bearing deposits with interest rates that fluctuate as market rates change. Management of the Bank seeks to reduce the risk of interest rate fluctuations by concentrating on loans and securities investments with either short terms to maturity or with adjustable rates or other features that cause yields to adjust based upon interest rate fluctuations. In addition, to cushion itself against the potential adverse effects of a substantial and sustained increase in market interest rates, the Bank has from time to time purchased off balance sheet interest rate cap contracts which generally provide that the Bank will be entitled to receive payments from the other party to the contract if interest rates exceed specified levels. These contracts 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.

 

59
 

 

ITEM 4 - CONTROLS AND PROCEDURES

 

Disclosure Controls and Procedures.

 

As of the end of the period covered by this Quarterly Report on Form 10-Q, the Company evaluated the effectiveness of the design and operation of its "disclosure controls and procedures" as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended ("Disclosure Controls"). The Disclosure Controls are designed to allow the Company to reach 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 SEC's rules and forms and that any information relating to the Company is accumulated and communicated with management, including its principal executive/financial officer to allow timely decisions regarding required disclosure. The evaluation of the Disclosure Controls ("Controls Evaluation") was done under the supervision and with the participation of the Company's management, including the Chief Executive Officer ("CEO"), who is also the Chief Financial Officer ("CFO"). Based upon the Controls Evaluation, the CEO/CFO has concluded that as of June 30, 2012, the Disclosure Controls were effective at the reasonable assurance level.

 

Changes in Internal Control over Financial Reporting.

 

In accordance with SEC requirements, the CEO/CFO notes that during the fiscal quarter ended June 30, 2012, no changes in the Company's "internal control over financial reporting", as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934, as amended ("Internal Control") have occurred that have materially affected or are reasonably likely to materially affect the Company's Internal Control.

 

Limitations on the Effectiveness of Controls.

 

The Company's management, including the CEO/CFO, does not expect that its Disclosure Controls and/or its Internal Control will prevent all errors 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.

 

60
 

 

PART II. OTHER INFORMATION

 

Item 6. Exhibits

 

Exhibit    
Number   Description
     
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.
     
101.   The following materials from the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2012, formatted in Extensible Business Reporting Language (XBRL), pursuant to Rule 406T of Regulation S-T: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Stockholders' Equity and Comprehensive Income, (v) Consolidated Statements of Cash Flows and (vi) related notes to consolidated financial statements. Users of this data are advised pursuant to Rule 401 of Regulation S-T that the information contained in the XBRL documents is unaudited and these are not the official publicly filed financial statements of the Company.
     
    Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    BERKSHIRE BANCORP INC.  
    (Registrant)  
       
Date: August 14, 2012  By: /s/ Steven Rosenberg  
    Steven Rosenberg  
    President and Chief  
    Financial Officer  

 

61
 

 

EXHIBIT INDEX

 

Exhibit    
Number   Description
     
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.
     
101.   The following materials from the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2012, formatted in Extensible Business Reporting Language (XBRL), pursuant to Rule 406T of Regulation S-T: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Stockholders' Equity and Comprehensive Income, (v) Consolidated Statements of Cash Flows and (vi) related notes to consolidated financial statements. Users of this data are advised pursuant to Rule 401 of Regulation S-T that the information contained in the XBRL documents is unaudited and these are not the official publicly filed financial statements of the Company.
     
    Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

 

62

XNAS:BERK Quarterly Report 10-Q Filling

XNAS:BERK Stock - Get Quarterly Report SEC Filing of XNAS:BERK stocks, including company profile, shares outstanding, strategy, business segments, operations, officers, consolidated financial statements, financial notes and ownership information.

XNAS:BERK Quarterly Report 10-Q Filing - 6/30/2012
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