Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

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

 

For the fiscal year ended: December 31, 2014

 

o         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: 001-15781

 

 

BERKSHIRE HILLS BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

04-3510455

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

24 North Street, Pittsfield, Massachusetts

 

01201

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (413) 443-5601

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Title of each class

 

Name of Exchange on which registered

 

 

Common stock, par value $0.01 per share

 

New York Stock Exchange

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o No x

 

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

 

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. x

 

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

 

Large Accelerated Filer o

 

Accelerated Filer x

 

 

 

Non-Accelerated Filer o

 

Smaller Reporting Company o

 

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

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates was approximately $569 million, based upon the closing price of $23.22 as quoted on the New York Stock Exchange as of the last business day of the registrant’s most recently completed second fiscal quarter.

 

The number of shares outstanding of the registrant’s common stock as of March 9, 2015 was 25,250,136.

 

DOCUMENTS INCORPORATED BY REFERENCE:  Portions of the Proxy Statement for the 2015 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K.

 

 

 



Table of Contents

 

INDEX

 

PART I

 

4

 

 

 

ITEM 1.

BUSINESS

4

 

 

 

ITEM 1A.

RISK FACTORS

30

 

 

 

ITEM 1B.

UNRESOLVED STAFF COMMENTS

39

 

 

 

ITEM 2.

PROPERTIES

39

 

 

 

ITEM 3.

LEGAL PROCEEDINGS

40

 

 

 

ITEM 4.

MINE SAFETY DISCLOSURES

40

 

 

 

PART II

 

41

 

 

 

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

41

 

 

 

ITEM 6.

SELECTED FINANCIAL DATA

44

 

 

 

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

49

 

 

 

ITEM 7A.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

72

 

 

 

ITEM 8.

FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

75

 

 

 

ITEM 9.

CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

75

 

 

 

ITEM 9A.

CONTROLS AND PROCEDURES

75

 

 

 

ITEM 9B.

OTHER INFORMATION

76

 

 

 

PART III

 

77

 

 

 

ITEM 10.

DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE

77

 

 

 

ITEM 11.

EXECUTIVE COMPENSATION

78

 

 

 

ITEM 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

78

 

 

 

ITEM 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

79

 

 

 

ITEM 14.

PRINCIPAL ACCOUNTING FEES AND SERVICES

79

 

 

 

PART IV

 

80

 

 

 

ITEM 15.

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

80

 

 

 

SIGNATURES

82

 

 

 

TABLE INDEX

 

 

 

 

PART I

4

 

 

 

ITEM 1.

4

 

 

 

 

ITEM 1 TABLE 1 — LOAN PORTFOLIO ANALYSIS

9

 

 

 

 

ITEM 1 TABLE 2 — MATURITY AND SENSITIVITY OF LOAN PORTFOLIO

12

 

 

 

 

ITEM 1 TABLE 3 — PROBLEM ASSETS AND ACCRUING TDR

14

 

 

 

 

ITEM 1 TABLE 4 — ALLOWANCE FOR LOAN LOSS

15

 

 

 

 

ITEM 1 TABLE 5 — ALLOCATION OF ALLOWANCE BY LOAN CATEGORY

16

 

 

 

 

ITEM 1 TABLE 6 — AMORTIZED COST AND FAIR VALUE OF SECURITIES

17

 

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ITEM 1 TABLE 7 — WEIGHTED AVERAGE YIELD ON SECURITIES

17

 

 

 

 

ITEM 1 TABLE 8 — AVERAGE BALANCE AND WEIGHTED AVERAGE INTEREST RATES ON DEPOSITS

18

 

 

 

 

ITEM 1 TABLE 9 — MATURITY OF DEPOSITS > $100,000

19

 

 

 

PART II

41

 

 

 

ITEM 6

44

 

 

 

 

ITEM 6 TABLE 3 — AVERAGE BALANCES, INTEREST AND AVERAGE YIELD COSTS

46

 

 

 

 

ITEM 6 TABLE 4 — RATE VOLUME ANALYSIS

47

 

 

 

ITEMS 7-7A.

72

 

 

 

 

ITEM 7 — 7A TABLE 1 — CONTRACTUAL OBLIGATIONS

71

 

 

 

 

ITEM 7 — 7A TABLE 2 — QUALITATIVE ASPECTS OF MARKET RISK

73

 

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PART I

 

ITEM 1. BUSINESS

 

FORWARD-LOOKING STATEMENTS

 

Certain statements contained in this document that are not historical facts may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (referred to as the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (referred to as the Securities Exchange Act), and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. You can identify these statements from the use of the words “may,” “will,” “should,” “could,” “would,” “plan,” “potential,” “estimate,” “project,” “believe,” “intend,” “anticipate,” “expect,” “target” and similar expressions. These forward-looking statements are subject to significant risks, assumptions and uncertainties, including among other things, deviations from performance expectations related to Hampden Bancorp and Hampden Bank, Berkshire Hills Bancorp may fail to integrate Hampden Bancorp and Hampden Bank in accordance with expectations, changes in general economic and business conditions, increased competitive pressures, changes in the interest rate environment, legislative and regulatory change, changes in the financial markets, and other risks and uncertainties disclosed from time to time in documents that Berkshire Hills Bancorp files with the Securities and Exchange Commission.  You should not place undue reliance on forward-looking statements, which reflect our expectations only as of the date of this report. We do not assume any obligation to revise forward-looking statements except as may be required by law.

 

GENERAL

 

Berkshire Hills Bancorp (“Berkshire” or “the Company”) is headquartered in Pittsfield, Massachusetts.  Berkshire Hills Bancorp, Inc. is a Delaware corporation and the holding company for Berkshire Bank (“the Bank”) and Berkshire Insurance Group.  Established in 1846, the Bank is one of Massachusetts’ oldest and largest independent banks.

 

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The Company profiles itself as follows:

 

 

The Company views itself as well positioned in an attractive footprint as illustrated below.  This illustration includes locations of Springfield based Hampden Bancorp with which Berkshire has a pending merger agreement:

 

 

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Berkshire’s common shares are listed on the New York Stock Exchange under the trading symbol “BHLB.”  At year-end 2014, Berkshire’s closing stock price was $26.66 and there were 25.183 million shares outstanding.  Berkshire is a regional bank and financial services company providing the service capabilities of a larger institution and the focus and responsiveness of a local partner to its communities.  The Company seeks to distinguish itself based on the following attributes:

 

·                  Strong top and bottom line momentum

 

·                  Diversified revenue drivers and controlled expenses

 

·                  Well positioned footprint in attractive markets

 

·                  AMEB culture

 

·                  Solid internal capital generation supports growth

 

·                  Focused on long-term profitability goals and shareholder value

 

·                  Acquisition disciplines a strength in a consolidating market

 

The Company operates under the brand of America’s Most Exciting Bank® providing an engaging and innovative customer experience driven by its AMEB culture which is

 

 

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The Bank has 91 full-service banking offices in its New England and upstate New York footprint, which extends along Interstate 90 from Boston to Syracuse, and along Interstate 91 from Hartford into Vermont.  The Bank also has commercial and retail lending offices located in Eastern Massachusetts.  The Company’s operations include those acquired as a result of four bank mergers in 2011 — 2012, a mortgage banking company acquisition in 2012, and the acquisition of 20 New York branches in 2014.

 

On November 3, 2014, the Company and Hampden Bancorp, Inc. (“Hampden”), the parent company of Hampden Bank, entered into an Agreement and Plan of Merger pursuant to which Hampden will merge with and into the Company. Concurrent with the merger, Hampden Bank will merge with and into Berkshire Bank. Upon completion of the acquisition of Hampden and Hampden Bank, the Bank will have acquired 10 branch offices in Hampden County, Massachusetts. As discussed further in the Proxy Statement/Prospectus dated January 29, 2015, this acquisition will expand the Bank’s footprint in Hampden County, Massachusetts and the Springfield, Massachusetts area. Completion of the acquisition is subject to the receipt of certain regulatory approvals.  The acquisition is expected to be completed early in the second quarter of 2015. The Company has announced plans to consolidate three of the acquired branches soon after the completion of the merger.

 

The Bank serves the following regions:

 

·                  Western New England, with 23 banking offices, including the Company’s headquarters in Pittsfield, MA.   This region includes Berkshire County, MA, which is the Company’s traditional market, where it has a leading market share in many of its product lines.   This region also includes Southern Vermont, and many of the region’s branches are in communities close to Route 7, which runs north/south through the valleys to the west of the Berkshire Hills and Green Mountains.  This region is within commuting range of both Albany, New York and Springfield, Massachusetts and is known throughout the world as a tourist and recreational destination area, with vacation and second home traffic from Boston and New York City.  The Pittsfield 2013 MSA GDP totaled $6 billion.

 

·                  New York, with 46 banking offices serving the Albany Capital District and Central New York.  Albany is the state capital and is part of New York’s Tech Valley which is gaining prominence as a world technology hub including leading edge nanotechnology initiatives representing a blend of private enterprise and public investment.  The Company’s Central New York area includes operations in the Rome/Utica MSA and in the Syracuse MSA.  These are markets along Interstate 90 with longstanding local industries and expansion influences from the Albany Capital District.  The Albany/Schenectady 2013 MSA GDP was $47 billion, and the Rome/Utica/Syracuse total 2013 MSA GDP was $40 billion.

 

·                  Hartford/Springfield, with 19 banking offices serving the market along the Connecticut River in this region, which is the second largest economic area in New England.  This region is centrally located between Boston and New York City at the crossroads of Interstate 91, which traverses the length of New England and Interstate 90, which traverses the width of Massachusetts.   This region also has easy access to Bradley International Airport, which is a major airport serving central New England.  The Springfield area is receiving major commercial investment including the first Massachusetts casino/entertainment complex, railcar manufacturing, and highway development.  The Hartford/Springfield combined 2013 MSA GDP was $111 billion.

 

·                  Eastern Massachusetts, with lending offices and 2 branch offices located in towns west and north of Boston.  Eastern Massachusetts is the largest economic area in New England, and the Company’s banking operations extend from Worcester within the commuting and commerce area of Boston, east to Boston and its suburbs.  Boston is viewed as a leading commercial real estate market nationally, including foreign demand for commercial and multifamily properties.  The Bank’s Asset Based Lending Group is headquartered in this region, and serves middle market businesses throughout the Company’s footprint. The Boston/Worcester combined 2013 MSA GDP was $408 billion.

 

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Total loans and deposits by region are shown below as of year-end 2014. Certain administrative balances and brokered deposits are included in Western New England. Balances related to the Tennessee branches are excluded.

 

GRAPHIC

 

These regions are viewed as having favorable demographics and provide an attractive regional niche for the Bank to distinguish itself from larger national and super-regional banks, and from smaller community banks, while serving its market area.  The Bank is the only locally headquartered regional bank serving this footprint.  The Company views its footprint as comparatively stable, with modest economic growth prospects in rural areas and higher growth prospects in more developed areas.  The strongest growth is expected to be in Eastern Massachusetts and the New York Capital District.  The Company views itself as positioned to take advantage of the best growth opportunities as they develop across its geography. The Company’s regions have competitive economic strengths in precision manufacturing, distribution, technology, health care, and education which are expected to continue to support above average personal incomes and wealth.  As a result of its growth, the Company has increased and diversified its revenues both geographically and by product type and this has improved its flexibility in pursuing growth opportunities as they arise.  The Company believes it has attractive long term growth prospects because of the Bank’s positioning as one of the leading regional banks in its markets with the ability to serve retail and commercial customers with a strong product set and responsive local management.  The Company also has a goal to deepen its wallet share as a result of its focused cross sales program across its various business lines including insurance and wealth management.

 

The Company has recruited executives with experience in regional bank management and has augmented its management team as it has expanded into a diversified regional financial services provider. In addition to business acquisitions, Berkshire’s expansion has been based on team and talent recruitment.  The Company also pursues organic growth through ongoing business development, de novo branching, and product development.  The Bank promotes itself as America’s Most Exciting Bank®.  It has set out to change the financial service experience.   Its vision is to excel as a high performing market leader with the right people, attitude, and energy providing an engaging and exciting customer and team member experience.  This brand and culture statement is expected to drive customer engagement, loyalty, market share and profitability.

 

The Company offers a wide range of deposit, lending, insurance, and wealth management products to retail, commercial, not-for-profit, and municipal customers in its market areas.  The Company’s product offerings also include retail and commercial electronic banking, commercial cash management, and commercial interest rate swaps.  The Company stresses a culture of teamwork and performance excellence to produce customer satisfaction to support its strategic growth and profitability.  The Company utilizes Six Sigma tools to improve operational effectiveness and efficiency.  The Company converted its core banking systems to a new scalable technology platform in 2012, with goals to enhance service, efficiency, reliability, customer relationship management, distribution channels, product quality, and revenue generation.  The systems provide deeper and more granular customer and operational data that Berkshire is mining in order to better inform its strategic direction and business execution.  Berkshire has also expanded its mobile banking and remote capture offerings and utilizes its internet web site and online banking tools to extend the convenience that it offers to customers.

 

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COMPANY WEBSITE AND AVAILABILITY OF SECURITIES AND EXCHANGE COMMISSION FILINGS

 

Information regarding the Company is available through the Investor Relations tab at berkshirebank.com.  The Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports filed pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge at sec.gov and at berkshirebank.com under the Investor Relations tab.  Information on the website is not incorporated by reference and is not a part of this annual report on Form 10-K.

 

COMPETITION

 

The Company is subject to strong competition from banks and other financial institutions and financial service providers. Its competition includes national and super-regional banks such as Bank of America, TD Bank, Citizens Bank, Santander Bank, and Key Bank which have substantially greater resources and lending limits. Non-bank competitors include credit unions, brokerage firms, insurance providers, financial planners, and the mutual fund industry. New technology is reshaping customer interaction with financial service providers and the increase of Internet-accessible financial institutions increases competition for the Company’s customers. The Company generally competes on the basis of customer service, relationship management, and the fair pricing of loan and deposit products and wealth management and insurance services. The location and convenience of branch offices is also a significant competitive factor, particularly regarding new offices. The Company does not rely on any individual, group, or entity for a material portion of its deposits.

 

LENDING ACTIVITIES

 

General. The Bank originates loans in the four basic portfolio categories discussed below. Lending activities are limited by federal and state laws and regulations. Loan interest rates and other key loan terms are affected principally by the Bank’s credit policy, asset/liability strategy, loan demand, competition, and the supply of money available for lending purposes. These factors, in turn, are affected by general and economic conditions, monetary policies of the federal government, including the Federal Reserve, legislative tax policies and governmental budgetary matters.   Most of the Bank’s loans are made in its market areas and are secured by real estate located in its market areas. Lending is therefore affected by activity in these real estate markets.  The Bank does not engage in subprime lending activities. The Bank monitors and manages the amount of long-term fixed-rate lending volume. Adjustable-rate loan products generally reduce interest rate risk but may produce higher loan losses in the event of sustained rate increases.  The Bank retains most of the loans it originates, although the Bank generally sells its originations of conforming fixed rate residential mortgages.  The Bank also conducts wholesale purchases and sales of loans and loan participations generally with other banks doing business in its markets.  The Bank’s loan portfolio includes loans acquired in recent business combinations and such loans generally conform to the loans from the Bank’s business activities.

 

Loan Portfolio Analysis. The following table sets forth the year-end composition of the Bank’s loan portfolio in dollar amounts and as a percentage of the portfolio at the dates indicated.  Further information about the composition of the loan portfolio is contained in the Loans footnote in the consolidated financial statements.

 

Item 1 - Table 1 - Loan Portfolio Analysis

 

 

 

2014

 

2013

 

2012

 

2011

 

2010

 

 

 

 

 

Percent

 

 

 

Percent

 

 

 

Percent

 

 

 

Percent

 

 

 

Percent

 

 

 

 

 

of

 

 

 

of

 

 

 

of

 

 

 

of

 

 

 

of

 

(In millions)

 

Amount

 

Total

 

Amount

 

Total

 

Amount

 

Total

 

Amount

 

Total

 

Amount

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential mortgages

 

$

1,496.2

 

32

%

$

1,384.3

 

33

%

$

1,324.3

 

33

%

$

1,020.4

 

34

%

$

645.0

 

30

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

1,611.6

 

35

 

1,417.1

 

34

 

1,413.5

 

35

 

1,156.2

 

39

 

925.6

 

43

 

Commercial and industrial loans

 

804.4

 

17

 

687.3

 

16

 

600.1

 

15

 

410.3

 

14

 

286.1

 

13

 

Total commercial loans

 

2,416.0

 

52

 

2,104.4

 

50

 

2,013.6

 

50

 

1,566.5

 

53

 

1,211.7

 

56

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consumer

 

768.4

 

16

 

691.8

 

17

 

650.7

 

17

 

369.6

 

13

 

285.5

 

14

 

Total loans

 

$

4,680.6

 

100

%

$

4,180.5

 

100

%

$

3,988.6

 

100

%

$

2,956.5

 

100

%

$

2,142.2

 

100

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Allowance for loan losses

 

(35.7

)

 

 

(33.3

)

 

 

(33.2

)

 

 

(32.4

)

 

 

(31.9

)

 

 

Net loans

 

$

4,645.0

 

 

 

$

4,147.2

 

 

 

$

3,955.4

 

 

 

$

2,924.1

 

 

 

$

2,110.3

 

 

 

 

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Residential Mortgages.  The Bank offers fixed-rate and adjustable-rate residential mortgage loans with maturities of up to 30 years that are fully amortizing with monthly loan payments.

 

Berkshire’s loan products are available through FNMA, FHLMC, Government Insured and State Programs.  In addition, the Bank offers a suite of portfolio products through Berkshire Bank.  Berkshire Bank is an in-house Direct Endorsed Lender for FHA. It also offers  VA, USDA, FHA Reverse, State Housing, Home Path, HARP and more.  The Company targets that its programs and pricing are highly competitive in the marketplace as it pursues opportunities to expand market share in its footprint.

 

Residential mortgages are generally underwritten according to the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Association (“Freddie Mac”) guidelines for loans they designate as “A” or “A-” (these are referred to as “conforming loans”).   Private mortgage insurance is generally required for loans with loan-to-value ratios in excess of 80%. The Bank also originates loans above conforming loan amount limits, referred to as “jumbo loans,” which are generally conforming to secondary market guidelines for these loans.  The Bank does not offer subprime mortgage lending programs.

 

The Bank generally sells most of its newly originated conforming fixed rate mortgages.  It also sometimes purchases or sells seasoned mortgage loans in the secondary mortgage market. The Bank is approved as a direct seller to Fannie Mae, retaining the servicing rights. The majority of the Bank’s secondary marketing is to national institutional secondary market investors on a servicing released basis.  Sales of mortgages generally involve customary representations and warranties and are nonrecourse in the event of borrower default.  The Bank is also an approved originator of loans for sale to the Federal Housing Administration (“FHA”), U.S. Department of Veteran Affairs (“VA”), and state housing agency programs.

 

The Bank offers adjustable rate (“ARM”) mortgages which do not contain interest-only or negative amortization features.  After an initial term of six months to ten years, the rates on these loans generally reset every year based upon a contractual spread or margin above the average yield on U.S. Treasury securities.  ARM loan interest rates may rise as interest rates rise, thereby increasing the potential for default.   At year-end 2014, the Bank’s adjustable rate mortgage portfolio totaled $475 million.  The Bank also originates loans to individuals for the construction and acquisition of personal residences. These loans generally provide fifteen-month construction periods followed by a permanent mortgage loan, and follow the Bank’s normal mortgage underwriting guidelines.

 

Following its purchase of a mortgage banking company in 2012, the Bank has expanded its residential mortgage program and in 2014 rebranded the program as Berkshire Home Lending.  Berkshire Bank is the preferred mortgage lender for the Massachusetts Teachers Association, and has been among the top ten banks in Massachusetts and Rhode Island for residential mortgage volume in certain periods in recent years.

 

Commercial Real Estate. The Bank originates commercial real estate loans on properties used for business purposes such as small office buildings, industrial, healthcare, lodging, recreation, or retail facilities. This portfolio also includes commercial 1-4 family and multifamily properties. Loans may generally be made with amortizations of up to 25 years and with interest rates that adjust periodically (primarily from short-term to five years).  Most commercial real estate loans are originated with final maturities of ten years or less.  As part of its business activities, the Bank also enters into commercial loan participations with regional and national banks and purchases and sells commercial loans in its footprint

 

Commercial real estate loans are among the largest of the bank’s loans, and may have higher credit risk and lending spreads.  At year-end 2014, the average size of a commercial mortgage was approximately $1.3 million and the Company believed that its competitive advantage for new originations was strongest in the $5-10 million size range.  Because repayment is often dependent on the successful operation or management of the properties, repayment of such loans may be affected by adverse conditions in the real estate market or the economy. The Bank seeks to minimize these risks through strict adherence to its underwriting standards and portfolio management processes. The Bank generally requires that borrowers have debt service coverage ratios (the ratio of available cash flows before debt service to debt service) of at least 1.25 times based on stabilized cash flows of leases in place, with some exceptions for national credit tenants.  For variable rate loans, the Bank underwrites debt service coverage to interest rate shocks of 300 basis points or higher based on a minimum of 1.0 times coverage and it uses loan maturities to manage risk based on the lease base

 

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and interest sensitivity.  Loans at origination may be made up to 80% of appraised value based on property type and risk, with sublimits of 75% or less for designated specialty property types.   Generally, commercial real estate loans require personal guarantees by the principals. Credit enhancements in the form of additional collateral or guarantees are normally considered for start-up businesses without a qualifying cash flow history.

 

The Bank offers interest rate swaps to certain larger commercial mortgage borrowers.  These swaps allow the Bank to originate a mortgage based on short-term LIBOR rates and allow the borrower to swap into a longer term fixed rate.  The Bank simultaneously sells an offsetting back-to-back swap to an investment grade national bank so that it does not retain this fixed-rate risk.  The Bank also records fee income on these interest rate swaps based on the terms of the offsetting swaps with the bank counterparties.

 

The Bank originates construction loans to builders and commercial borrowers in and around its markets.  The maximum loan to value limits for construction loans follow FDIC supervisory limits, up to a maximum of 80%.  The Bank commits to provide the permanent mortgage financing on most of its construction loans on income-producing property. Advances on construction loans are made in accordance with a schedule reflecting the cost of the improvements.  Construction loans include land acquisition loans up to a maximum 50% loan to value on raw land.  Construction loans may have greater credit risk due to the dependence on completion of construction and other real estate improvements, as well as the sale or rental of the improved property.  The Bank generally mitigates these risks with presale or preleasing requirements and phasing of construction.

 

Commercial and Industrial Loans. The Bank offers secured commercial term loans with repayment terms which are normally limited to the expected useful life of the asset being financed, and generally not exceeding ten years. The Bank also offers revolving loans, lines of credit, letters of credit, time notes and Small Business Administration guaranteed loans. Business lines of credit have adjustable rates of interest and are payable on demand, subject to annual review and renewal. Commercial and industrial loans are generally secured by a variety of collateral such as accounts receivable, inventory and equipment, and are generally supported by personal guarantees. Loan to value ratios depend on the collateral type and generally do not exceed 80% of orderly liquidation value.  Some commercial loans may also be secured by liens on real estate. The Bank generally does not make unsecured commercial loans.  At year-end 2014, the average commercial loan size was approximately $600 thousand. Commercial loans are of higher risk and are made primarily on the basis of the borrower’s ability to make repayment from the cash flows of its business. Further, any collateral securing such loans may depreciate over time, may be difficult to monitor and appraise and may fluctuate in value. The Bank gives additional consideration to the borrower’s credit history and the guarantor’s capacity to help mitigate these risks. Additionally, the Bank uses loan structures including shorter terms, amortizations, and advance rate limitations as further mitigants based on the loan underwriting.

 

The Asset Based Lending Group serves the commercial middle market in New England, as well as the Bank’s market in northeastern New York.  This group expands the Bank’s business lending offerings to include revolving lines of credit and term loans secured by accounts receivable, inventory, and other assets to manufacturers, distributors and select service companies experiencing seasonal working capital needs, rapid sales growth, a turnaround, buyout or recapitalization with credit needs ranging from $2 to $25 million.  Asset based lending involves monitoring loan collateral so that outstanding balances are always properly secured by business assets, which reduces the risks associated with these loans.

 

The Bank has reorganized its small business lending function to expand this important business financing capability and includes the retail division in the origination of conforming small business loans in order to provide the best service to community based small businesses. The small business lending program is for businesses generally with annual revenues of up to $10 million and whose loan relationship with the bank is $2 million or less. The program has two distinct thresholds: branch originated loans for borrowers with revenues of $2 million or less, total loan relationship with the bank is $250,000 or less and loan requests are $50 thousand or less for lines of credit and $100 thousand or less for term loans; and Business Banker originated loans for borrowers with revenues of $10 million or less, total loan relationship is $2 million or less and loan requests up to $2 million for all lending products. The program also handles an exception managed loan portfolio for loans and loan relationships under $250 thousand which require limited documentation to provide timely credit to small businesses.

 

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Table of Contents

 

Consumer Loans.  The Bank’s consumer loans consist principally of home equity lines of credit and indirect automobile loans, together with second mortgage loans and other consumer loans.  The Bank’s home equity lines of credit are typically secured by first or second mortgages on borrowers’ residences. Home equity lines have an initial revolving period up to fifteen years, followed by an amortizing term up to twenty years. These loans are normally indexed to the prime rate. Home equity loans also include amortizing fixed-rate second mortgages with terms up to fifteen years. Lending policies for combined debt service and collateral coverage are similar to those used for residential first mortgages, although underwriting verifications are more streamlined.  The maximum combined loan-to-value is 80%.  Home equity line credit risks include the risk that higher interest rates will affect repayment and possible compression of collateral coverage on second lien home equity lines. Acquired operations of Beacon Federal in 2012 included a significant consumer lending function focused on indirect originations of automobile loans, primarily in central New York.    For new automobiles, the amount financed could be up to 100% of the value of the vehicle, plus applicable taxes and dealer charges (i.e., warranty and insurance charges). For used automobiles, the amount of the loan was limited to the “loan value” of the vehicle, as established by industry guides.

 

Maturity and Sensitivity of Loan Portfolio. The following table shows contractual final maturities of selected loan categories at year-end 2014. The contractual maturities do not reflect premiums, discounts, deferred costs, and prepayments.

 

Item 1 - Table 2 - Loan Contractual Maturity -Scheduled Loan Amortizations are not included in the maturities presented.

 

Contractual Maturity

 

One Year

 

More than One

 

More Than

 

 

 

(In thousands)

 

or Less

 

to Five Years

 

Five Years

 

Total

 

 

 

 

 

 

 

 

 

 

 

Construction mortgage loans:

 

 

 

 

 

 

 

 

 

Residential

 

$

16,356

 

$

11,706

 

$

 

$

28,062

 

Commercial

 

30,836

 

142,554

 

 

173,390

 

Commercial and industrial loans

 

228,415

 

402,979

 

172,972

 

804,366

 

Total

 

$

275,607

 

$

557,239

 

$

172,972

 

$

1,005,818

 

 

For the $730 million of loans above which mature in more than one year, $199 million of these loans are fixed-rate and $531 million are variable rate.

 

Loan Administration. Lending activities are governed by a loan policy approved by the Board’s Risk Management Committee.  Internal staff perform and monitor post-closing loan documentation review, quality control, and commercial loan administration.  The lending staff assigns a risk rating to all commercial loans, excluding point scored small business loans.  Management primarily relies on internal risk management staff to review the risk ratings of the majority of commercial loan balances.

 

The Bank’s lending activities follow written, non-discriminatory underwriting standards and loan origination procedures established by the Risk Management Committee and Management. The Bank’s loan underwriting is based on a review of certain factors including risk ratings, recourse, loan-to-value ratios and material policy exceptions.   The Risk Management Committee has established individual and combined loan limits and lending approval authorities.   Management’s Executive Loan Committee is responsible for commercial and residential loan approvals in accordance with these standards and procedures.  Generally, commercial lending management has the authority to approve pass rated secured loans (with normal credit risk) up to $1 million, in conjunction with a Credit Officer up to $4.5 million and in conjunction with the Chief Credit Officer up to $10 million. The Chief Credit Officer has the authority to approve up to $7.5 million for pass rated credits with major policy exceptions and pass/watch rated credits and up to $2.5 million for special mention rated credits. The Executive Loan Committee approves secured loans over these amounts (and over $1.5 million unsecured).  The Bank tracks exceptions that are approved to loan underwriting standards and exception reports are actively monitored by executive lending management.

 

The Bank’s lending activities are conducted by its salaried and commissioned loan personnel.  Designated salaried branch staff originate conforming residential mortgages and receive bonuses based on overall performance.  Additionally, the Bank employs commissioned residential mortgage originators.  Commercial lenders receive salaries and are eligible for bonuses based on overall performance.  From time to time, the Bank will purchase whole loans or participations in loans. These loans are underwritten according to the Bank’s underwriting criteria and procedures and

 

12



Table of Contents

 

are generally serviced by the originating lender under terms of the applicable participation agreement. The Bank routinely sells newly originated fixed rate residential mortgages in the secondary market.  Customer rate locks are offered without charge and rate locked applications are generally committed for forward sale or hedged with derivative financial instruments to minimize interest rate risk pending delivery of the loans to the investors.  The Bank sells a limited number of commercial loan participations on a non-recourse basis. The Bank issues loan commitments to its prospective borrowers conditioned on the occurrence of certain events. Loan origination commitments are made in writing on specified terms and conditions and are generally honored for up to sixty days from approval; some commercial commitments are made for longer terms. The Company also monitors pipelines of loan applications and has processes for issuing letters of interest for commercial loans and preapprovals for residential mortgages, all of which are generally conditional on completion of underwriting prior to the issuance of formal commitments.

 

The loan policy sets certain limits on concentrations of credit and requires periodic reporting of concentrations to the Risk Management Committee.  In most cases the commercial loan hold limit is 5% of risk based capital for loan transactions and 8% of risk based capital for lending relationships.  Loans outstanding to the ten largest relationships averaged $24.5 million each, or 4.8% of total risk based capital in 2014.  The Bank also actively monitors its 25 largest borrower relationships.  Commercial real estate is generally managed within federal regulatory monitoring guidelines of 300% of risk based capital for commercial real estate and 100% for commercial construction loans.  At year-end 2014, non-owner occupied commercial real estate totaled 216% of Bank risk based capital and outstanding commercial construction loans were 34% of Bank risk based capital.  The Bank has hold limits for several categories of commercial specialty lending including healthcare, hospitality, designated franchises, and leasing, as well as hold limits for designated commercial loan participations purchased.  In most cases, these limits are below 100% of risk based capital for all outstandings in each monitored category.

 

Problem Assets.  The Bank prefers to work with borrowers to resolve problems rather than proceeding to foreclosure.  For commercial loans, this may result in a period of forbearance or restructuring of the loan, which is normally done at current market terms and does not result in a “troubled” loan designation.  For residential mortgage loans, the Bank generally follows FDIC guidelines to attempt a restructuring that will enable owner-occupants to remain in their home.  However, if these processes fail to result in a performing loan, then the Bank generally will initiate foreclosure or other proceedings no later than the 90th day of a delinquency, as necessary, to minimize any potential loss. Management reports delinquent loans and non-performing assets to the Board quarterly.  Loans are generally removed from accruing status when they reach 90 days delinquent, except for certain loans which are well secured and in the process of collection. All loan collections are managed through the Bank’s special assets group, except for consumer loan collections, which are managed by the Retail group.

 

Real estate acquired by the Bank as a result of loan collections is classified as real estate owned until sold. When property is acquired it is recorded at fair market value less estimated selling costs at the date of foreclosure, establishing a new cost basis. Holding costs and decreases in fair value after acquisition are expensed.  Interest income that would have been recorded for 2014 if non-accruing loans had been current according to their original terms, amounted to $1.1 million.  Included in the amount is $104 thousand related to troubled debt restructurings.  The amount of interest income on those loans that was recognized in net income in 2014 was $0.6 million.  Included in this amount is $188 thousand related to troubled debt restructurings.  Interest income on accruing troubled debt restructurings totaled $0.7 million for 2014.  The total carrying value of troubled debt restructurings was $16.7 million at year-end.

 

The following table sets forth additional information on year-end problem assets and accruing troubled debt restructurings (“TDR”).  Due to accounting standards for business combinations, non-accrual loans of acquired banks are recorded as accruing on the acquisition date.  Therefore, measures related to accruing and non-accruing loans reflect these standards and may not be comparable to prior periods.

 

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Table of Contents

 

Item 1 - Table 3 - Problem Assets and Accruing TDR

 

(In thousands)

 

2014

 

2013

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-accruing loans:

 

 

 

 

 

 

 

 

 

 

 

Residential mortgages

 

$

3,908

 

$

7,868

 

$

7,466

 

$

7,010

 

$

2,173

 

Commercial real estate

 

12,878

 

13,739

 

12,617

 

14,280

 

9,488

 

Commercial and industrial loans

 

1,705

 

2,355

 

3,681

 

990

 

1,305

 

Consumer

 

3,214

 

3,493

 

1,748

 

1,954

 

746

 

Total non-performing loans

 

21,705

 

27,455

 

25,512

 

24,234

 

13,712

 

Real estate owned

 

2,049

 

2,758

 

1,929

 

1,900

 

3,386

 

Total non-performing assets

 

$

23,754

 

$

30,213

 

$

27,441

 

$

26,134

 

$

17,098

 

 

 

 

 

 

 

 

 

 

 

 

 

Troubled debt restructurings (accruing)

 

$

12,612

 

$

8,344

 

$

3,641

 

$

1,263

 

$

7,829

 

Accruing loans 90+ days past due

 

$

4,568

 

$

9,223

 

$

18,977

 

$

10,184

 

$

1,054

 

 

 

 

 

 

 

 

 

 

 

 

 

Total non-performing loans/total loans

 

0.46

%

0.66

%

0.64

%

0.82

%

0.64

%

Total non-performing assets/total assets

 

0.37

%

0.53

%

0.52

%

0.65

%

0.59

%

 

Asset Classification and Delinquencies.  The Bank performs an internal analysis of its commercial loan portfolio and assets to classify such loans and assets in a manner similar to that employed by the federal banking regulators. There are four classifications for loans with higher than normal risk: Loss, Doubtful, Substandard and Special Mention. Usually an asset classified as Loss is fully charged-off. Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. Assets that do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated Special Mention.  Please see the additional discussion of non-accruing and potential problem loans in Item 7 and additional information in the Loan Loss Allowance Note to the consolidated financial statements. Impaired loans acquired in business combinations are normally rated Substandard or lower and the fair value assigned to such loans at acquisition includes a component for the possibility of loss if deficiencies are not corrected.

 

Allowance for Loan Losses. The Bank’s loan portfolio is regularly reviewed by management to evaluate the adequacy of the allowance for loan losses. The allowance represents management’s estimate of inherent losses that are probable and estimable as of the date of the financial statements.  The allowance includes a specific component for impaired loans (a “specific loan loss reserve”) and a general component for portfolios of all outstanding loans (a “general loan loss reserve”).  At the time of acquisition, no allowance for loan losses is assigned to loans acquired in business combinations.  These loans are carried at fair value, including the impact of expected losses, as of the acquisition date.  An allowance on such loans is established subsequent to the acquisition date through the provision for loan losses based on an analysis of factors including environmental factors.  The loan loss allowance is discussed further in the Note about Significant Accounting Policies in the consolidated financial statements.

 

Management believes that it uses the best information available to establish the allowance for loan losses.  However, future adjustments to the allowance for loan losses may be necessary, and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making its determinations. Because the estimation of inherent losses cannot be made with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loan or loan portfolio category deteriorate as a result of the factors discussed above. Additionally, the regulatory agencies, as an integral part of their examination process, also periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to make additional provisions for estimated losses based upon judgments different from those of management. Any material increase in the allowance for loan losses may adversely affect the Bank’s financial condition and results of operations.

 

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Table of Contents

 

The following table presents an analysis of the allowance for loan losses for the years indicated.

 

Item 1 - Table 4 - Allowance for Loan Loss

 

(In thousands)

 

2014

 

2013

 

2012

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at beginning of year

 

$

33,323

 

$

33,208

 

$

32,444

 

$

31,898

 

$

31,816

 

Charged-off loans:

 

 

 

 

 

 

 

 

 

 

 

Residential mortgages

 

2,596

 

2,426

 

2,647

 

1,322

 

409

 

Commercial real estate

 

5,684

 

5,026

 

4,229

 

4,046

 

6,403

 

Commercial and industrial loans

 

3,010

 

2,917

 

697

 

1,443

 

2,685

 

Consumer

 

2,563

 

2,467

 

1,877

 

885

 

1,188

 

Total charged-off loans

 

13,853

 

12,836

 

9,450

 

7,696

 

10,685

 

 

 

 

 

 

 

 

 

 

 

 

 

Recoveries on charged-off loans:

 

 

 

 

 

 

 

 

 

 

 

Residential mortgages

 

365

 

399

 

103

 

231

 

213

 

Commercial real estate

 

270

 

549

 

52

 

189

 

794

 

Commercial and industrial loans

 

228

 

211

 

96

 

109

 

1,094

 

Consumer

 

361

 

414

 

373

 

150

 

140

 

Total recoveries

 

1,224

 

1,573

 

624

 

679

 

2,241

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loans charged-off

 

12,629

 

11,263

 

8,826

 

7,017

 

8,444

 

Allowance attributed to loans acquired by merger

 

 

 

 

 

 

Provision for loan losses

 

14,968

 

11,378

 

9,590

 

7,563

 

8,526

 

Transfer of commitment reserve

 

 

 

 

 

 

Balance at end of year

 

$

35,662

 

$

33,323

 

$

33,208

 

$

32,444

 

$

31,898

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratios:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net charge-offs/average loans

 

0.29

%

0.29

%

0.26

%

0.27

%

0.42

%

Recoveries/charged-off loans

 

8.84

 

12.25

 

6.60

 

8.82

 

20.97

 

Net loans charged-off/allowance for loan losses

 

35.41

 

33.80

 

26.58

 

21.63

 

26.47

 

Allowance for loan losses/total loans

 

0.76

 

0.80

 

0.83

 

1.10

 

1.49

 

Allowance for loan losses/non-accruing loans

 

164.30

 

121.37

 

130.17

 

133.88

 

232.63

 

 

The following tables present year-end data for the approximate allocation of the allowance for loan losses by loan categories at the dates indicated (including an apportionment of any unallocated amount).  The first table shows for each category the amount of the allowance allocated to that category as a percentage of the outstanding loans in that category.  The second table shows the allocated allowance together with the percentage of loans in each category to total loans.  Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance to each category is not indicative of future losses and does not restrict the use of any of the allowance to absorb losses in any category.  Due to the impact of accounting standards for acquired loans, data in the accompanying tables may not be comparable between accounting periods.

 

15



Table of Contents

 

Item 1 - Table 5A - Allocation of Allowance for Loan Loss by Category

 

 

 

2014

 

2013

 

2012

 

2011

 

2010

 

 

 

 

 

Percent of

 

 

 

Percent of

 

 

 

Percent of

 

 

 

Percent of

 

 

 

Percent of

 

 

 

 

 

Amount
Allocated

 

 

 

Amount
Allocated

 

 

 

Amount
Allocated

 

 

 

Amount
Allocated

 

 

 

Amount
Allocated

 

 

 

 

 

to Total

 

 

 

to Total

 

 

 

to Total

 

 

 

to Total

 

 

 

to Total

 

 

 

Amount

 

Loans in
Each

 

Amount

 

Loans in
Each

 

Amount

 

Loans in
Each

 

Amount

 

Loans in
Each

 

Amount

 

Loans in
Each

 

(Dollars in thousands)

 

Allocated

 

Category

 

Allocated

 

Category

 

Allocated

 

Category

 

Allocated

 

Category

 

Allocated

 

Category

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential mortgages

 

$

7,480

 

0.50

%

$

7,562

 

0.55

%

$

6,444

 

0.49

%

$

3,420

 

0.34

%

$

3,200

 

0.50

%

Commercial real estate

 

15,539

 

0.96

 

16,112

 

1.13

 

19,275

 

1.36

 

22,176

 

1.92

 

19,923

 

2.15

 

Commercial and industrial loans

 

6,322

 

0.79

 

5,770

 

0.85

 

5,707

 

0.95

 

4,566

 

1.11

 

6,498

 

2.27

 

Consumer

 

6,321

 

0.82

 

3,879

 

0.56

 

1,782

 

0.27

 

2,282

 

0.62

 

2,277

 

0.80

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

35,662

 

0.76

%

$

33,323

 

0.80

%

$

33,208

 

0.83

%

$

32,444

 

1.10

%

$

31,898

 

1.49

%

 

Item 1 - Table 5B - Allocation of Allowance for Loan Loss

 

 

 

2014

 

2013

 

2012

 

2011

 

2010

 

 

 

 

 

Percent of

 

 

 

Percent of

 

 

 

Percent of

 

 

 

Percent of

 

 

 

Percent of

 

 

 

 

 

Loans in
Each

 

 

 

Loans in
Each

 

 

 

Loans in
Each

 

 

 

Loans in
Each

 

 

 

Loans in
Each

 

 

 

 

 

Category

 

 

 

Category

 

 

 

Category

 

 

 

Category

 

 

 

Category

 

(Dollars in thousands)

 

Amount
Allocated

 

to Total
Loans

 

Amount
Allocated

 

to Total
Loans

 

Amount
Allocated

 

to Total
Loans

 

Amount
Allocated

 

to Total
Loans

 

Amount
Allocated

 

to Total
Loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential mortgages

 

$

7,480

 

31.97

%

$

7,562

 

33.11

%

$

6,444

 

33.20

%

$

3,420

 

34.51

%

$

3,200

 

30.11

%

Commercial real estate

 

15,539

 

34.43

 

16,112

 

41.26

 

19,275

 

35.44

 

22,176

 

39.11

 

19,923

 

43.21

 

Commercial and industrial loans

 

6,322

 

17.19

 

5,770

 

9.08

 

5,707

 

15.05

 

4,566

 

13.88

 

6,498

 

13.35

 

Consumer

 

6,321

 

16.41

 

3,879

 

16.55

 

1,782

 

16.31

 

2,282

 

12.50

 

2,277

 

13.33

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

35,662

 

100.00

%

$

33,323

 

100.00

%

$

33,208

 

100.00

%

$

32,444

 

100.00

%

$

31,898

 

100.00

%

 

INVESTMENT SECURITIES ACTIVITIES

 

The securities portfolio provides cash flow to protect the safety of customer deposits and as a potential source of liquidity for funding loan commitments.  The portfolio is also used to manage interest rate risk and to earn a reasonable return on investment.  Decisions are made in accordance with the Company’s investment policy and include consideration of risk, return, duration, and portfolio concentrations.  Day-to-day oversight of the portfolio rests with the Chief Financial Officer and the Treasurer.  The Asset/Liability Committee meets monthly and reviews investment strategies.  The Risk Management Committee reviews all securities transactions and provides general oversight of the investment function.

 

The Company has historically maintained a high-quality portfolio of managed duration mortgage-backed securities, together with a portfolio of municipal bonds including national and local issuers and local economic development bonds issued to non-profit organizations.  Nearly all of the mortgage-backed securities are issued by Ginnie Mae, Fannie Mae or Freddie Mac, and consisting principally of collateralized mortgage obligations (generally consisting of planned amortization class bonds).  Other than securities issued by the above agencies, no other issuer concentrations exceeding 10% of stockholders’ equity existed at year-end 2014.  The municipal portfolio provides tax-advantaged yield, and the local economic development bonds were originated by the Company to area borrowers.  All of the Company’s available for sale municipal securities are investment grade rated and most of the portfolio carries credit enhancement protection.  The Company invests in investment grade corporate bonds and non-investment grade fixed income securities consisting primarily of capital instruments issued by local and regional financial institutions and a mutual fund investing in non-investment grade bonds of national corporate issues.  The Company also invests in equity securities of local financial institutions, including those that might be future potential partners, as well as dividend yielding equity securities of national corporate exchange traded issuers.  The Company owns restricted equity in the Federal Home Loan Bank of Boston (“FHLBB”) based on its operating relationship with the FHLBB.  The Company owns an interest rate swap against a tax advantaged economic development bond issued to a local not-for-profit organization, and as a result this security is carried as a trading account security. The Bank did not record any material losses or write-downs of investment securities during the year and none of the Company’s investment securities were other-than-temporarily impaired at year-end.

 

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Table of Contents

 

The following tables present the amortized cost and fair value of the Company’s securities, by type of security, for the years indicated.

 

Item 1 - Table 6A - Amortized Cost and Fair Value of Securities

 

 

 

2014

 

2013

 

2012

 

 

 

Amortized

 

Fair

 

Amortized

 

Fair

 

Amortized

 

Fair

 

(In thousands)

 

Cost

 

Value

 

Cost

 

Value

 

Cost

 

Value

 

Securities available for sale

 

 

 

 

 

 

 

 

 

 

 

 

 

Municipal bonds and obligations

 

$

127,013

 

$

133,699

 

$

77,852

 

$

77,671

 

$

79,498

 

$

84,757

 

Mortgage-backed securities

 

824,865

 

829,652

 

610,326

 

601,429

 

318,245

 

321,685

 

Other bonds and obligations

 

74,953

 

73,525

 

61,123

 

58,975

 

35,241

 

34,436

 

Marketable equity securities

 

48,992

 

54,942

 

20,041

 

21,973

 

22,467

 

25,291

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total securities available for sale

 

$

1,075,823

 

$

1,091,818

 

$

769,342

 

$

760,048

 

$

455,451

 

$

466,169

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Securities held to maturity

 

 

 

 

 

 

 

 

 

 

 

 

 

Municipal bonds and obligations

 

$

4,997

 

$

4,997

 

$

4,244

 

$

4,244

 

$

8,295

 

$

8,295

 

Mortgage-backed securities

 

70

 

74

 

73

 

75

 

76

 

83

 

Tax advantaged economic development bonds

 

37,948

 

39,594

 

40,260

 

41,101

 

41,678

 

43,137

 

Other bonds and obligations

 

332

 

332

 

344

 

344

 

975

 

975

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total securities held to maturity

 

$

43,347

 

$

44,997

 

$

44,921

 

$

45,764

 

$

51,024

 

$

52,490

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Trading account security

 

$

12,554

 

$

14,909

 

$

13,096

 

$

14,840

 

$

13,610

 

$

16,893

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Restricted equity securities

 

$

55,720

 

$

55,720

 

$

50,282

 

$

50,282

 

$

39,785

 

$

39,785

 

 

Item 1 - Table 6B - Amortized Cost and Fair Value of Securities

 

 

 

2014

 

2013

 

2012

 

 

 

Amortized

 

Fair

 

Amortized

 

Fair

 

Amortized

 

Fair

 

(In thousands)

 

Cost

 

Value

 

Cost

 

Value

 

Cost

 

Value

 

U.S. Treasuries,other Government agencies and corporations

 

$

873,927

 

$

884,668

 

$

630,442

 

$

623,478

 

$

340,789

 

$

347,058

 

Municipal bonds and obligations

 

182,513

 

193,199

 

135,451

 

137,855

 

143,080

 

153,082

 

Other bonds and obligations

 

131,004

 

129,577

 

111,749

 

109,601

 

76,001

 

75,197

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total Securites

 

$

1,187,444

 

$

1,207,444

 

$

877,642

 

$

870,934

 

$

559,870

 

$

575,337

 

 

The schedule includes available-for-sale and held-to-maturity securities as well as the trading security and restricted equity securities.

 

The following table summarizes year-end 2014 amortized cost, weighted average yields and contractual maturities of debt securities. A significant portion of the mortgage-based securities are planned amortization class bonds.  Their expected durations are 3-5 years at current interest rates, but the contractual maturities shown reflect the underlying maturities of the collateral mortgages.  Additionally, the mortgage-based securities maturities shown below are based on final maturities and do not include scheduled amortization.

 

Item 1 - Table 7 - Weighted Average Yield

 

 

 

 

 

 

 

More than One

 

More than Five Years

 

 

 

 

 

 

 

One Year or Less

 

Year to Five Years

 

to Ten Years

 

More than Ten Years

 

Total

 

 

 

 

 

Weighted

 

 

 

Weighted

 

 

 

Weighted

 

 

 

Weighted

 

 

 

Weighted

 

 

 

Amortized

 

Average

 

Amortized

 

Average

 

Amortized

 

Average

 

Amortized

 

Average

 

Amortized

 

Average

 

(In millions)

 

Cost

 

Yield

 

Cost

 

Yield

 

Cost

 

Yield

 

Cost

 

Yield

 

Cost

 

Yield

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Municipal bonds and obligations

 

$

1.0

 

1.50

%

$

3.1

 

4.3

%

$

12.3

 

5.4

%

$

115.5

 

5.6

%

$

132.0

 

5.5

%

Mortgage-backed securities

 

 

 

4.6

 

4.3

 

5.4

 

2.0

 

814.9

 

2.5

 

824.9

 

2.5

 

Other bonds and obligations

 

 

 

15.4

 

4.9

 

48.5

 

1.2

 

49.4

 

4.6

 

113.2

 

3.2

 

Total

 

$

1.0

 

1.50

%

$

23.1

 

4.7

%

$

66.2

 

2.0

%

$

979.8

 

3.0

%

$

1,070.2

 

2.9

%

 

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Table of Contents

 

DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS

 

Deposits are the major source of funds for the Bank’s lending and investment activities. Deposit accounts are the primary product and service interaction with the Bank’s customers.  The Bank serves personal, commercial, non-profit, and municipal deposit customers.  Most of the Bank’s deposits are generated from the areas surrounding its branch offices. The Bank offers a wide variety of deposit accounts with a range of interest rates and terms. The Bank also periodically offers promotional interest rates and terms for limited periods of time. The Bank’s deposit accounts consist of demand deposits (noninterest-bearing checking), NOW (interest-bearing checking) (NOW),  regular savings, money market savings and time certificates of deposit. The Bank emphasizes its transaction deposits — checking and NOW accounts for personal accounts and checking accounts promoted to businesses. These accounts have the lowest marginal cost to the Bank and are also often a core account for a customer relationship. The Bank offers a courtesy overdraft program to improve customer service, and also provides debit cards and other electronic fee producing payment services to transaction account customers.  The Bank is promoting remote deposit capture devices so that commercial accounts can make deposits from their place of business.  Additionally, the Bank offers a variety of retirement deposit accounts to personal and business customers.  Deposit related fee income is a significant source of fee income to the Bank, including overdraft income and interchange fees related to debit card usage.  Deposit service fee income also includes other miscellaneous transaction and convenience services sold to customers through the branch system as part of an overall service relationship.  The Bank offers compensating balance arrangements for larger business customers as an alternative to fees charged for checking account services. Berkshire’s Business Connection is a personal financial services benefit package designed for the employees of its business customers.  In addition to providing service through its branches, Berkshire provides services to deposit customers through its private bankers, MyBankers, commercial/small business relationship managers, and call center representatives.

 

The Bank’s deposits are insured by the FDIC.  The Bank has in the past offered additional 100% deposit insurance at no charge to customers through the Massachusetts Deposit Insurance Fund (“DIF”).  The Bank terminated its participation in this fund in 2014 and the related insurance protection is being phased out.  During 2014, the Bank expanded its use of brokered deposits as a significant deposit source, both to fund lending and investment activities as well as to provide enhanced insurance protection through reciprocal deposit programs to large commercial accounts.

 

The following table presents information concerning average balances and weighted average interest rates on the Bank’s interest-bearing deposit accounts for the years indicated.  Deposit amounts in the following tables include balances associated with discontinued operations.

 

Item 1 - Table 8 - Average Balance and Weighted Average Rates for Deposits

 

 

 

2014

 

2013

 

2012

 

 

 

 

 

Percent

 

 

 

 

 

Percent

 

 

 

 

 

Percent

 

 

 

 

 

 

 

of Total

 

Weighted

 

 

 

of Total

 

Weighted

 

 

 

of Total

 

Weighted

 

 

 

Average

 

Average

 

Average

 

Average

 

Average

 

Average

 

Average

 

Average

 

Average

 

(In millions)

 

Balance

 

Deposits

 

Rate

 

Balance

 

Deposits

 

Rate

 

Balance

 

Deposits

 

Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Demand

 

$

805.0

 

18

%

0.0

 

$

655.7

 

17

%

%

$

529.0

 

15

%

%

NOW

 

417.2

 

9

 

0.1

 

355.2

 

9

 

0.1

 

304.1

 

9

 

0.2

 

Money market

 

1,442.3

 

33

 

0.1

 

1,389.2

 

35

 

0.9

 

1,189.1

 

34

 

0.4

 

Savings

 

476.4

 

11

 

0.1

 

442.2

 

11

 

0.1

 

390.8

 

11

 

0.1

 

Time

 

1,265.4

 

29

 

0.7

 

1,085.8

 

28

 

1.2

 

1,056.0

 

31

 

1.6

 

Total

 

$

4,406.3

 

100

%

0.4

 

$

3,928.1

 

100

%

0.5

%

$

3,469.0

 

100

%

0.6

%

 

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Table of Contents

 

At year-end 2014, the Bank had time deposit accounts in amounts of $100 thousand or more maturing as follows:

 

Item 1 - Table 9 - Maturity of Deposits > $100,000

 

 

 

 

 

Weighted

 

 

 

 

 

Average

 

Maturity Period

 

Amount

 

Rate

 

(In thousands)

 

 

 

 

 

Three months or less

 

$

236,896

 

0.76

%

Over 3 months through 6 months

 

188,336

 

0.90

 

Over 6 months through 12 months

 

151,605

 

1.14

 

Over 12 months

 

363,339

 

1.22

 

Total

 

$

940,176

 

1.03

%

 

The Company also uses borrowings from the Federal Home Loan Bank of Boston (“FHLBB”) as an additional source of funding, particularly for daily cash management and for funding longer duration assets. FHLBB advances also provide more pricing and option alternatives for particular asset/liability needs.  The FHLBB functions as a central reserve bank providing credit for member institutions. As an FHLBB member, the Company is required to own capital stock of the FHLBB.  FHLBB borrowings are secured by a blanket lien on most of the Bank’s mortgage loans and mortgage-related securities, as well as certain other assets. Advances are made under several different credit programs with different lending standards, interest rates, and range of maturities.  The Company has a $15 million trust preferred obligation outstanding as well as $75 million in senior subordinated notes.  The Company’s common stock is listed on the New York Stock Exchange.  Subject to certain limitations, the Company can also choose to issue common stock in public stock offerings and can also potentially obtain privately placed common and preferred stock, and subordinated, and senior debt from institutional and private investors.

 

DERIVATIVE FINANCIAL INSTRUMENTS

 

The Company uses interest rate swap instruments for its own account to fix the interest rate on some of its borrowings, most of which are designated as cash flow hedges.  The Company also offers interest rate swaps to commercial loan customers who wish to fix the interest rates on their loans, and the Company backs these swaps with offsetting swaps with national bank counterparties.  These swaps are designated as economic hedges.  Additionally the Company’s mortgage banking activities also result in derivatives.  Interest rate lock commitments are provided on applications for residential mortgages intended for resale and are accounted for as non-hedging derivatives.  The Company arranges offsetting forward sales commitments for most of these rate-locks with national bank counterparties, which are designated as economic hedges.

 

The Company has a policy for managing its derivative financial instruments, and the policy and program activity are overseen by the Risk Management Committee.  Derivative financial instruments with counterparties which are not customers are limited to a select number of national financial institutions.  Collateral may be required based on financial condition tests.  The Company works with third-party firms which assist in marketing derivative transactions, executing transactions, and providing information for bookkeeping and accounting purposes.

 

WEALTH MANAGEMENT SERVICES

 

The Company’s Wealth Management Group provides consultative investment management and trust relationships to individuals, businesses, and institutions, with an emphasis on personal investment management. The Wealth Management Group has built a track record over more than a decade with its dedicated in-house investment management team.  Wealth Management services include investment management, trust administration, and estate planning.  The Bank also provides a full line of investment products, financial planning, and brokerage services utilizing Commonwealth Financial Network as the broker/dealer.  The Group’s principal operations are in Western New England and it is expanding its services in the Company’s other regions.

 

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At year-end 2014, assets under management totaled $1.4 billion, including $0.8 billion in the Bank’s traditional wealth/trust platform, $0.3 billion in the Bank’s registered investment advisor Renaissance Investment Group targeting high net worth clients, and $0.3 billion in investment accounts offered through BerkshireBanc Investment Services offered through the Commonwealth Financial Network.  Total wealth management assets have more than doubled in the past five years through acquisition and talent recruitment and reflecting investment performance and the strength of the AMEB brand and referrals from the banking business teams.   The Wealth platforms have been designed to be scalable as the Group further penetrates markets in its footprint.  Berkshire Bank employees over 20 Wealth Management professionals many of who are licensed and credentialed with the CFP®, CFA, CTFA and/or a JD.    Wealth Management is a significant element of the Berkshire’s plan to increase market and wallet share, diversify revenues, and improve profitability.  The Company will consider acquisitions of wealth management businesses in support of its growth strategy.

 

INSURANCE

 

As an independent insurance agent, the Berkshire Insurance Group represents a carefully selected group of financially sound, reputable insurance companies offering attractive coverage at competitive prices.  The Insurance Group offers a full line of personal and commercial property and casualty insurance.  It also offers employee benefits insurance and a full line of personal life, health, and financial services insurance products.  Berkshire Insurance Group operates a focused cross-sell program of insurance and banking products through all offices and branches of the Bank with some of the Group’s offices located within the Bank’s branches.  The Group’s principal operations are in Western New England, and it is expanding its services in the Company’s other regions.  The Group is focusing on the Bank’s distribution channels in order to broaden its retail and commercial customer base.  The Company will consider acquisitions of insurance agencies in support of its growth strategy.

 

PERSONNEL

 

At year-end 2014, the Company had 1,091 full time equivalent employees, including 1,039 full time employees and 104 part time employees..  Berkshire continues to develop its staffing, including staff for new branches and hires related to team development.  The Company has also developed staff with targeted skills to deepen the Company’s infrastructure.  The Company’s employees are not represented by a collective bargaining unit.

 

SUBSIDIARY ACTIVITIES

 

The Company wholly-owns two active consolidated subsidiaries: the Bank and Berkshire Insurance Group.  The Bank is a Massachusetts-chartered savings bank.  Berkshire Insurance Group is incorporated in Massachusetts.  Berkshire Bank owns consolidated subsidiaries operated as Massachusetts securities corporations.  The Company also owns all of the common stock of a Delaware statutory business trust, Berkshire Hills Capital Trust I. The capital trust is unconsolidated and its only material assets is a $15 million trust preferred security related to the junior subordinated debentures reported in the Company’s consolidated financial statements.  Additional information about the subsidiaries is contained in Exhibit 21 to this report.

 

SEGMENT REPORTING

 

The Company has two reportable operating segments, banking and insurance.  Banking includes the activities of the Bank and its subsidiaries, which provide commercial and retail banking services.  Insurance includes the activities of Berkshire Insurance Group, which provides commercial and consumer insurance services.  The only other consolidated financial activity of the Company is that of the Company’s role as parent of the Bank and Berkshire Insurance Group. For more information about the Company’s reportable operating segments, see the related note in the consolidated financial statements.

 

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Table of Contents

 

REGULATION AND SUPERVISION

 

General

 

The Company is a Delaware corporation and a bank holding company, within the meaning of the Bank Holding Company Act of 1956, as amended. As such, it is registered with, supervised by and required to comply with the rules and regulations of, the Federal Reserve Board. The Federal Reserve Board requires the Company to file various reports and also conducts examinations of the Company.  The Company must receive the approval of the Federal Reserve Board to engage in certain transactions, such as acquisitions of additional banks and savings associations. The Company was previously regulated as a savings and loan holding company. However, in July 2014, the Company became a bank holding company in connection with the Bank’s conversion to a Massachusetts trust company charter. As a result, the Company is now regulated as a bank holding company and has further elected to become a financial holding company. As a financial holding company, the Company may engage in activities that are financial in nature or incidental to a financial activity.

 

The Bank is a Massachusetts-chartered trust company and its deposits are insured up to applicable limits by the FDIC. The Bank was previously a Massachusetts-chartered savings bank and converted to a Massachusetts-chartered trust company in July 2014. The Bank is subject to extensive regulation by the Massachusetts Commissioner of Banks (the “Commissioner”) as its chartering agency, and by the FDIC, as its deposit insurer. The Bank is required to file reports with the Commissioner and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other depository institutions or branches of other institutions. The Commissioner and the FDIC conduct periodic examinations to test the Bank’s safety and soundness and compliance with various regulatory requirements. The regulatory structure gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the Commissioner, the Massachusetts legislature, the FDIC, the Federal Reserve Board or Congress, could have a material adverse impact on the Company, the Bank and their operations.

 

In January 2015, the Commonwealth of Massachusetts enacted “An Act Modernizing the Banking Laws and Enhancing the Competitiveness of State-Chartered Banks.”  Among other things, the legislation attempts to better synchronize Massachusetts laws with federal requirements in the same area, streamlines the process for an institution to engage in activities permissible for federally chartered and out of state institutions, consolidates corporate governance statutes and authorizes the Commissioner to establish a tiered supervisory system for Massachusetts chartered institutions based on factors such as asset size, capital level, balance sheet composition, examination rating, compliance and other factors deemed appropriate. The new provisions of Massachusetts banking law are scheduled to take effect on April 7, 2015.

 

Federal Legislation

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was enacted in 2010. The Dodd-Frank Act has significantly changed the bank regulatory structure and is affecting the lending, investment, trading and operating activities of depository institutions and their holding companies. The Dodd-Frank Act eliminated the Office of Thrift Supervision, the Company’s previous primary federal regulator, as of July 21, 2011.

 

Additionally, the Dodd-Frank Act created a new Consumer Financial Protection Bureau as an independent bureau of the Federal Reserve Board. The Consumer Financial Protection Bureau assumed responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations, a function previously assigned to prudential regulators, and has authority to impose new requirements. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. However, institutions of less than $10 billion in assets, such as the Bank, continue to be examined for compliance with consumer protection and fair lending laws and regulations by, and are subject to the primary enforcement authority of their prudential regulator rather than the Consumer Financial Protection Bureau.

 

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Table of Contents

 

The Consumer Financial Protection Bureau has finalized the rule implementing the “Ability to Repay” requirements of the Dodd-Frank Act.  The regulations generally require creditors to make a reasonable, good faith determination as to a borrower’s ability to repay most residential mortgage loans.  The final rule establishes a safe harbor for certain “Qualified Mortgages,” which contain certain features deemed less risky and omit certain other characteristics considered to enhance risk.  The Ability to Repay final rules became effective on January 10, 2014.

 

The Dodd-Frank Act also broadened the base for Federal Deposit Insurance Corporation assessments for deposit insurance, permanently increased the maximum amount of deposit insurance to $250,000 per depositor.  The Dodd-Frank Act increased shareholder influence over boards of directors by requiring companies to give shareholders a non-binding vote on executive compensation and so-called “golden parachute” payments.  The legislation directed the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to company executives, regardless of whether or not the company is publicly traded.  The Dodd-Frank Act also provided for originators of certain securitized loans to retain a percentage of the risk for transferred credits, directed the Federal Reserve Board to regulate pricing of certain debit card interchange fees, repealed restrictions on paying interest on checking accounts and contained a number of reforms related to mortgage origination.

 

Many of the provisions of the Dodd-Frank Act are subject to delayed effective dates and/or require the issuance of implementing regulations. The regulatory process is ongoing and the impact on operations cannot yet be fully assessed. However, there is a significant possibility that the Dodd-Frank Act will, at a minimum, result in increased regulatory burden, compliance costs and interest expense for the Company and the Bank.

 

Certain regulatory requirements applicable to the Company, including certain changes made by the Dodd-Frank Act, are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on the Company and is qualified in its entirety by reference to the actual laws and regulations.

 

Massachusetts Banking Laws and Supervision

 

General. As a Massachusetts-chartered depository institution, the Bank is subject to supervision, regulation and examination by the Commissioner and to various Massachusetts statutes and regulations which govern, among other things, investment powers, lending and deposit-taking activities, borrowings, maintenance of surplus and reserve accounts, distribution of earnings and payment of dividends. In addition, the Bank is subject to Massachusetts consumer protection and civil rights laws and regulations. The approval of the Commissioner is required for a Massachusetts-chartered institution to establish or close branches, merge with other financial institutions, issue stock and undertake certain other activities.

 

Massachusetts law and regulations generally allow Massachusetts institutions to engage in activities permissible for federally chartered banks or banks chartered by another state. The recent legislation establishes a 30 day notice procedure to the Commissioner in order to engage in such activities.  The legislation also authorizes Massachusetts institutions to engage in activities determined to be “financial in nature” or incidental or complementary to such a financial activity, subject to a 30 day notice to the Commissioner.

 

Dividends. A Massachusetts stock institution, such as the Bank, may declare cash dividends from net profits not more frequently than quarterly and non-cash dividends at any time. No dividends may be declared, credited or paid if the institution’s capital stock is impaired. A Massachusetts stock institution with outstanding preferred stock may not, without the prior approval of the Massachusetts Commissioner of Banks, declare dividends to the common stock without also declaring dividends to the preferred stock. The approval of the Commissioner is required if the total of all dividends declared in any calendar year exceeds the total of its net profits for that year combined with its retained net profits of the preceding two years, less any required transfer to surplus or a fund for the retirement of any preferred stock. Net profits for this purpose means the remainder of all earnings from current operations plus actual recoveries on loans and investments and other assets after deducting from the total thereof all current operating expenses, actual losses, accrued dividends on preferred stock, if any, and all federal and state taxes.

 

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Table of Contents

 

Loans to One Borrower Limitations. Massachusetts banking law grants broad lending authority. However, with certain limited exceptions, total obligations of one borrower to an institution may not exceed 20.0% of the total of the institution’s capital, which is defined under Massachusetts law as the sum of the institution’s capital stock, surplus account and undivided profits.

 

Loans to a Bank’s Insiders. Massachusetts banking laws prohibit any executive officer, director or trustee from borrowing from or otherwise becoming indebted to, their institution, except for any of the following loans or extensions of credit: (i) loans or extensions of credit, secured or unsecured, to an officer of the institution in an amount not exceeding $100,000; (ii) loans or extensions of credit intended or secured for educational purposes to an officer of the bank in an amount not exceeding $200,000; (iii) loans or extensions of credit secured by a mortgage on residential real estate to be occupied in whole or in part by the officer to whom the loan or extension of credit is made, in an amount not exceeding $750,000; and (iv) loans or extensions of credit to a director or trustee of the bank who is not also an officer of the institution in an amount permissible under the institution’s loan to one borrower limit.

 

The loans described above require approval of the majority of the members of the institution’s Board of Directors, excluding any member involved in the loan or extension of credit. No such loan or extension of credit may be granted with an interest rate or other terms that are preferential in comparison to loans granted to persons not affiliated with the institution.

 

The recent Massachusetts legislation provides that, beginning in April 2015, Massachusetts law incorporates federal regulations governing extensions of credit to insiders and separate Massachusetts requirements are repealed.

 

Investment Activities. In general, Massachusetts-chartered institutions may invest in preferred and common stock of any corporation organized under the laws of the United States or any state provided such investments do not involve control of any corporation and do not, in the aggregate, exceed 4.0% of the bank’s deposits.  Massachusetts-chartered institutions may also invest an amount equal to 1.0% of their deposits in stocks of Massachusetts corporations or companies with substantial employment in Massachusetts which have pledged to the Commissioner that such monies will be used for further development within the Commonwealth.  However, these powers are constrained by federal law.

 

Regulatory Enforcement Authority. Any Massachusetts-chartered institution that does not operate in accordance with the regulations, policies and directives of the Commissioner may be sanctioned for non-compliance, including seizure of the property and business of the institution and suspension or revocation of its charter. The Commissioner may, under certain circumstances, suspend or remove officers or directors who have violated the law, conducted the institution’s business in a manner which is unsafe, unsound or contrary to the depositors interests or been negligent in the performance of their duties. In addition, upon finding that an institution has engaged in an unfair or deceptive act or practice, the Commissioner may issue an order to cease and desist and impose a fine on the institution concerned. Finally, Massachusetts consumer protection and civil rights statutes applicable to the Bank permit private individual and class action lawsuits and provide for the rescission of consumer transactions, including loans, and the recovery of statutory and punitive damage and attorney’s fees in the case of certain violations of those statutes.

 

Massachusetts has other statutes or regulations that are similar to the federal provisions discussed below.

 

Federal Regulations

 

Capital Requirements. Under FDIC regulations, federally insured state-chartered banks that are not members of the Federal Reserve System (“state non-member banks”), such as the Bank, are required to comply with minimum leverage capital requirements. For an institution determined by the FDIC to not be anticipating or experiencing significant growth and to be in general a strong banking organization, rated composite 1 under the Uniform Financial Institutions Rating System established by the Federal Financial Institutions Examination Council, the minimum capital leverage requirement during 2014 was a ratio of Tier 1 capital to total average assets (as defined) of 3%. For all other institutions, the minimum leverage capital ratio was not less than 4%. Tier 1 capital is the sum of common stockholders’ equity, noncumulative perpetual preferred stock (including any related surplus) and minority investments in certain subsidiaries, less intangible assets (except for certain servicing rights and credit card relationships) and certain other items.

 

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Table of Contents

 

The Bank must also comply with the FDIC risk-based capital guidelines. The FDIC guidelines require state non-member banks to maintain certain levels of regulatory capital in relation to regulatory risk-weighted assets. Risk-based capital ratios are determined by allocating assets and specified off-balance sheet items to four risk-weighted categories ranging from 0% to 200%, with higher levels of capital being required for the categories perceived as representing greater risk.

 

During 2014, state non-member banks must maintain a minimum ratio of total capital to risk-weighted assets of at least 8%, of which at least one-half must be Tier 1 capital. Total capital consists of Tier 1 capital plus Tier 2 or supplementary capital items, which include allowances for loan losses in an amount of up to 1.25% of risk-weighted assets, cumulative preferred stock, a portion of the net unrealized gain on equity securities and other capital instruments.

 

In July 2013, the FDIC and the other federal bank regulatory agencies issued a final rule to revise their leverage and risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act.  Among other things, the rule established a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets); set the leverage ratio at a uniform 4% of total assets;  increased the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% of risk-weighted assets) ; and assigned a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property.  The final rule also required unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-out is exercised.  The rule limits a banking organization’s capital distributions and certain discretionary bonus payments to executive officers if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements.  The final rule became effective on January 1, 2015.  The “capital conservation buffer” is being phased in from January 1, 2016 to January 1, 2019, when the full capital conservation buffer will be effective.

 

As a bank holding company, the Company is also subject to regulatory capital requirements, as described in a subsequent section.

 

Interstate Banking and Branching. Federal law permits an institution, such as the Bank, to acquire another institution by merger in a state other than Massachusetts unless the other state has opted out.  Federal law, as amended by the Dodd-Frank Act, authorizes de novo branching into another state to the extent that the target state allows its state chartered banks to establish branches within its borders. The Bank operates branches in New York, Vermont, Connecticut and Tennessee, as well as Massachusetts. At its interstate branches, the Bank may conduct any activity authorized under Massachusetts law that is permissible either for an institution chartered in that state (subject to applicable federal restrictions) or a branch in that state of an out-of-state national bank. The New York State Superintendent of Banks, the Vermont Commissioner of Banking and Insurance, the Connecticut Commissioner of Banking and the Tennessee Commissioner of Financial Institution may exercise certain regulatory authority over the Bank’s branches in their respective states.

 

Prompt Corrective Regulatory Action. Federal law requires, among other things, that federal bank regulatory authorities take “prompt corrective action” with respect to banks that do not meet minimum capital requirements. For these purposes, the law establishes three categories of capital deficient institutions:  undercapitalized, significantly undercapitalized and critically undercapitalized.

 

During 2014, an institution was deemed to be “well capitalized” if it had a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, and a leverage ratio of 5% or greater. An institution was “adequately capitalized” if it had a total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater and generally a leverage ratio of 4% or greater. An institution was “undercapitalized” if it had a total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital ratio of less than 4%, or generally a leverage ratio of less than 4% (3% or less for institutions with the highest examination rating). An institution was deemed to be “significantly undercapitalized” if it had a total risk-based capital ratio

 

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of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, or a leverage ratio of less than 3%. An institution was considered to be “critically undercapitalized” if it had a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2%.

 

“Undercapitalized” banks must adhere to growth, capital distribution (including dividend) and other limitations and are required to submit a capital restoration plan. No institution may make a capital distribution, including payment as a dividend, if it would be “undercapitalized” after the payment. A bank’s compliance with such plans is required to be guaranteed by its parent holding company in an amount equal to the lesser of 5% of the institution’s total assets when deemed “undercapitalized” or the amount needed to comply with regulatory capital requirements. If an “undercapitalized” bank fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.” “Significantly undercapitalized” banks must comply with one or more of a number of additional restrictions, including but not limited to an order by the FDIC to sell sufficient voting stock to become “adequately capitalized”, requirements to reduce assets and cease receipt of deposits from correspondent banks or dismiss directors or officers, and restrictions on interest rates paid on deposits, compensation of executive officers and capital distributions by the parent holding company. “Critically undercapitalized” institutions must comply with additional sanctions including, subject to a narrow exception, the appointment of a receiver or conservator within 270 days after it obtains such status.

 

At December 31, 2014, the Bank met the criteria for being considered “well-capitalized” as defined in the prompt corrective action regulations.

 

In connection with the final capital rule described earlier, the federal banking agencies have adopted revisions to the prompt corrective action framework, which became effective on January 1, 2015.  Under the revised prompt corrective action requirements, insured depository institutions are required to meet the following in order to qualify as “well capitalized:”  (1) a common equity Tier 1 risk-based capital ratio of at least 6.5% (new standard); (2) a Tier 1 risk-based capital ratio of at least 8% (increased from 6%); (3) a total risk-based capital ratio of at least 10% (unchanged) and (4) a Tier 1 leverage ratio of 5% or greater (unchanged).

 

Transactions with Affiliates. Transactions between depository institutions and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. In a holding company context, at a minimum, the parent holding company of an institution and any companies which are controlled by such parent holding company are affiliates of the institution. Generally, Section 23A limits the extent to which the institution or its subsidiaries may engage in “covered transactions,” such as loans, with any one affiliate to 10% of such institution’s capital stock and surplus, and contains an aggregate limit on all such transactions with all affiliates to 20% of capital stock and surplus. Loans to affiliates and certain other specified transactions must comply with specified collateralization requirements. Section 23B requires that transactions with affiliates be on terms that are no less favorable to the institution or its subsidiary as similar transactions with non-affiliates.

 

Further, federal law restricts an institution with respect to loans to directors, executive officers, and principal stockholders (“insiders”). Loans to insiders and their related interests may not exceed, together with all other outstanding loans to such persons and affiliated entities, the institution’s total capital and surplus. Loans to insiders above specified amounts must receive the prior approval of the Board of Directors. Further, loans to insiders must be made on terms substantially the same as offered in comparable transactions to other persons, except that such insiders may receive preferential loans made under a benefit or compensation program that is widely available to the institution’s employees and does not give preference to the insider over the employees. Federal law places additional limitations on loans to executive officers.

 

Enforcement. The FDIC has extensive enforcement authority over insured institutions, including the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease and desist orders and remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and unsafe or unsound practices. The FDIC has authority under federal law to appoint a conservator or receiver for an insured institution under certain circumstances.

 

Insurance of Deposit Accounts. The Bank’s deposit accounts are insured by the deposit insurance fund of the FDIC up to applicable limits.  The FDIC insures deposits up to the standard maximum deposit insurance amount (“SMDIA”) of $250,000.  The deposit insurance limit was increased in response to the Dodd-Frank Act, which, among other provisions, made permanent the increase in the SMDIA from $100,000 to $250,000.  The Dodd-Frank Act provided

 

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for temporary unlimited coverage of certain noninterest bearing transaction accounts, but such unlimited coverage expired on December 31, 2012.

 

The FDIC has adopted a risk-based insurance assessment system. The FDIC assigns an institution to one of four risk categories based on the institution’s financial condition and supervisory ratings. An institution’s assessment rate depends on the capital category and supervisory category to which it is assigned and certain adjustments set forth in FDIC regulations.  Institutions deemed to present higher risk to the insurance fund pay higher assessments.  The overall assessment range, including prospective adjustments, is 2.5 to 45 basis points. Assessment rates are scheduled to decline as the FDIC fund reserve ratio improves. As required by the Dodd-Frank Act, FDIC assessments are now based on each institution’s total assets less Tier 1 capital, rather than deposits, as was previously the case.

 

FDIC insured institutions are also required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize a predecessor deposit insurance fund. These assessments will continue until the Financing Corporation bonds mature in 2017 through 2019. The assessment rate is adjusted quarterly to reflect changes in the assessment base of the fund.  For the quarter ended December 31, 2014, the Financing Corporation assessment amounted to 0.62 basis points of total assets less Tier 1 capital.

 

Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by a regulator. Management does not know of any practice, condition or violation that might lead to termination of FDIC deposit insurance.

 

The Dodd-Frank Act increased the minimum target federal deposit insurance fund ratio from 1.15% of estimated insured deposits to 1.35% of estimated insured deposits. The FDIC must seek to achieve the 1.35% ratio by September 30, 2020. Insured institutions with assets of $10 billion or more are supposed to fund the increase. The Dodd-Frank Act eliminated the 1.50% maximum fund ratio, instead leaving it to the discretion of the FDIC. The FDIC has exercised that discretion by establishing a long range fund ratio of 2.00%.

 

The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.

 

Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank system, which consists of 12 regional Federal Home Loan Banks that provide a central credit facility primarily for member institutions. The Bank, as a member, is required to acquire and hold shares of capital stock in the FHLBB.

 

The Federal Home Loan Banks are required to provide funds for certain purposes including contributing funds for affordable housing programs. These requirements, and general financial results, could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members.  Historically, the FHLBB has paid dividends to member banks based on money market rates.  These dividends were suspended for a time due to losses reported in 2008 and they remain at nominal levels.

 

Enforcement

 

The Federal Deposit Insurance Corporation has primary federal enforcement responsibility over state chartered banks. The Federal Deposit Insurance Corporation has authority to bring enforcement actions against such institutions and their “institution-related parties,” including officers, directors, certain shareholders, and attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the institution or receivership or conservatorship in certain circumstances. Potential civil money penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1.0 million per day.

 

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Holding Company Regulation

 

General. In July 2014, the Company’s changed status from that of a savings and loan holding company to that of a bank holding company through the Bank’s conversion from a Massachusetts-chartered savings bank to a Massachusetts-chartered trust company. By doing so, the previously applicable requirement that the Bank comply with the Qualified Thrift Lender Test, which required that a specified percentage of assets be in primarily residential mortgage-related investments, was eliminated.

 

The Company is now subject to examination, regulation, and periodic reporting as a bank holding company under the Bank Holding Company Act of 1956, as amended. The Company is required to obtain the prior approval of the Federal Reserve Board to acquire all, or substantially all, of the assets of any other bank or bank holding company. Prior Federal Reserve Board approval would be required for the Company to acquire direct or indirect ownership or control of any voting securities of any bank or bank holding company if, after such acquisition, it would, directly or indirectly, own or control more than 5% of any class of voting shares of the bank or bank holding company. In addition to the approval of the Federal Reserve Board, prior approval may also be necessary from other agencies having supervisory jurisdiction over the bank to be acquired before any bank acquisition can be completed.

 

A bank holding company is generally prohibited from engaging in non banking activities, or acquiring direct or indirect control of more than 5% of the voting securities of any company engaged in non-banking activities. One of the principal exceptions to this prohibition is for activities found by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the principal activities that the Federal Reserve Board has determined by regulation to be so closely related to banking are: (i) making or servicing loans; (ii) performing certain data processing services; (iii) providing discount brokerage services; (iv) acting as fiduciary, investment or financial advisor; (v) leasing personal or real property; (vi) making investments in corporations or projects designed primarily to promote community welfare; and (vii) acquiring a savings and loan association whose direct and indirect activities are limited to those permitted for bank holding companies.

 

The Gramm-Leach-Bliley Act of 1999 authorized a bank holding company that meets specified conditions, including being “well capitalized” and “well managed,” to opt to become a “financial holding company” and thereby engage in a broader array of financial activities than previously permitted. Such activities can include insurance underwriting and investment banking. The Company has elected to become a financial holding company.

 

The Company is subject to the Federal Reserve Board’s capital adequacy guidelines for bank holding companies (on a consolidated basis).  Such guidelines have historically been similar to, though less stringent than, those of the Federal Deposit Insurance Corporation for the depository institution subsidiaries.  The Dodd-Frank Act, however, required the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. Instruments such as cumulative preferred stock and trust preferred securities are no longer includable as Tier 1 capital, as was primarily the case with bank holding companies, subject to certain grandfathering rules.  The previously discussed final rule regarding regulatory capital requirements implements the Dodd-Frank Act as to bank holding company capital standards.  Consolidated regulatory capital requirements identical to those applicable to the subsidiary institutions apply to bank holding companies with greater than $500 million of assets, effective January 1, 2015.  As is the case with institutions themselves, the capital conservation buffer will be phased in between 2016 and 2019.

 

A bank holding company is generally required to give the Federal Reserve Board prior written notice of any purchase or redemption of then outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve Board may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, Federal Reserve Board order or directive, or any condition imposed by, or written agreement with, the Federal Reserve Board. There is an exception to this approval requirement for well-capitalized bank holding companies that meet certain other conditions.

 

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The Federal Reserve Board’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. The Dodd-Frank Act codified the source of strength doctrine.

 

The Federal Reserve Board has issued a policy statement regarding the payment of dividends and the repurchase of shares of common stock by bank holding companies.  In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Regulatory guidance provides for prior regulatory consultation with respect to dividends in certain circumstances such as where the company’s net income for the past four quarters, net of dividends’ previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. The guidance also provides for regulatory consultation prior to a holding company redeeming or repurchasing regulatory capital instruments when the holding company is experiencing financial weaknesses or redeeming or repurchasing common stock or perpetual preferred stock that would result in a net reduction as of the end of a quarter in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred. These regulatory policies could affect the ability of the Company to pay dividends, repurchase shares of its stock or otherwise engage in capital distributions.

 

The status of the Company as a registered bank holding company under the Bank Holding Company Act does not exempt it from certain federal and state laws and regulations applicable to corporations generally, including, without limitation, certain provisions of the federal securities laws.

 

Acquisition of the Company. Under the Change in Bank Control Act, no person may acquire control of a bank holding company such as the Company unless the Federal Reserve Board has been given 60 days’ prior written notice and has not issued a notice disapproving the proposed acquisition, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition.  Control, as defined under federal law, means ownership, control of or holding irrevocable proxies representing more than 25% of any class of voting stock, control in any manner of the election of a majority of the company’s directors, or a determination by the regulator that the acquiror has the power to direct, or directly or indirectly to exercise a controlling influence over, the management or policies of the institution.  Acquisition of more than 10% of any class of a bank holding company’s voting stock constitutes a rebuttable presumption of control under the regulations under certain circumstances including where, is the case with the Company, the issuer has registered securities under Section 12 of the Securities Exchange Act of 1934.

 

Massachusetts Holding Company Regulation. In addition to the federal holding company regulations, a bank holding company organized or doing business in Massachusetts must comply with regulations under Massachusetts law. Approval of the Massachusetts regulatory authorities would be required for the Company to acquire 25% or more of the voting stock of another depository institution. Similarly, prior regulatory approval would be necessary for any person or company to acquire 25% or more of the voting stock of the Company. The term “bank holding company,” for the purpose of Massachusetts law, is defined generally to include any company which, directly or indirectly, owns, controls or holds with power to vote more than 25% of the voting stock of each of two or more banking institutions, including commercial banks and state co-operative banks, savings banks and savings and loan association and national banks, federal savings banks and federal savings and loan associations. In general, a holding company controlling, directly or indirectly, only one banking institution will not be deemed to be a bank holding company for the purposes of Massachusetts law. Under Massachusetts law, the prior approval of the Board of Bank Incorporation is required before any of the following: any company becoming a bank holding company; any bank holding company acquiring direct or indirect ownership or control of more than 5% of the voting stock of, or all or substantially all of the assets of, a banking institution; or any bank holding company merging with another bank holding company. Although the Company is not a bank holding company for purposes of Massachusetts law, any future acquisition of ownership, control, or the power to vote 25% or more of the voting stock of another banking institution or bank holding company would cause it to become such.

 

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Legislation. The U.S. Congress, state lawmaking bodies and federal and state regulatory agencies continue to consider a number of wide-ranging and comprehensive proposals for altering the structure, regulation and competitive relationships of the nation’s financial institutions.  Any such legislation may impact the business of the Company and the Bank.

 

Other Regulations

 

Consumer Protection Laws. The Bank is subject to federal and state consumer protection statutes and regulations applicable to depository institutions including, but not limited to, the following:

 

·                  Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

·                  Home Mortgage Disclosure Act, requiring financial institutions to provide certain information about home mortgage and refinance loans;

·                  Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

·                  Fair Credit Reporting Act, governing the provision of consumer information to credit reporting agencies and the use of consumer information;

·                  Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and

·                  Electronic Funds Transfer Act, governing automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services.

 

The Bank also is subject to federal laws protecting the confidentiality of consumer financial records, and limiting the ability of the institution to share non-public personal information with third parties.

 

The Community Reinvestment Act (“CRA”) establishes a requirement for federal banking agencies that, in connection with examinations of depository institutions within their jurisdiction, the agencies evaluate the record of the depository institutions in meeting the credit needs of their local communities, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or new facility. Under the CRA, institutions are assigned a rating of “outstanding,” “satisfactory,” “needs to improve,” or “substantial non-compliance.” A less than “satisfactory” rating would result in the suspension of any growth of the Bank through acquisitions or opening de novo branches until the rating is improved. As of the most recent CRA examination by the FDIC, the Bank’s CRA rating was “satisfactory.”

 

Anti-Money Laundering Laws. The Bank is subject to extensive anti-money laundering provisions and requirements, which require the institution to have in place a comprehensive customer identification program and an anti-money laundering program and procedures. These laws and regulations also prohibit depository institutions from engaging in business with foreign shell banks; require depository institutions to have due diligence procedures and, in some cases, enhanced due diligence procedures for foreign correspondent and private banking accounts; and improve information sharing between depository institutions and the U.S. government. The Bank has established policies and procedures intended to comply with these provisions.

 

Taxation

 

The Company reports its income on a calendar year basis using the accrual method of accounting. This discussion of tax matters is only a summary and is not a comprehensive description of the tax rules applicable to the Company and its subsidiaries. Further discussion of income taxation is contained in the income taxes note to the consolidated financial statements.  The federal income tax laws apply to the Company in the same manner as to other corporations with some exceptions.  The Company may exclude from income 100% of dividends received from the Bank and from Berkshire Insurance Group as members of the same affiliated group of corporations.  The Company reports income on a calendar year basis to the Commonwealth of Massachusetts. Massachusetts tax law generally permits special tax treatment for a qualifying limited purpose “securities corporation.”  The Bank’s securities corporations all qualify for this treatment, and are taxed at a 1.3% rate on their gross income.

 

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ITEM 1A. RISK FACTORS

 

The risks set forth below, in addition to the other risks described in this Annual Report on Form 10-K, may adversely affect our business, financial condition and operating results. In addition to the risks set forth below and the other risks described in this annual report, there may also be additional risks and uncertainties that are not currently known to us or that we currently deem to be immaterial that could materially and adversely affect our business, financial condition or operating results. As a result, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods. Further, to the extent that any of the information contained in this Annual Report on Form 10-K constitutes forward-looking statements, the risk factors set forth below also are cautionary statements identifying important factors that could cause our actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of us.

 

Overall Business Risks

 

The Company’s Business May Be Adversely Affected by Conditions in the Financial Markets and Economic Conditions Generally and Locally. National and international markets continue to recover from the aftermath of the severe recession.  Numerous fiscal and monetary policy measures address the evolving conditions related to the uneven conditions of economic and financial recovery.  A slowing or failure of economic recovery in the U.S. and in the Company’s markets could adversely effect these challenging economic and market conditions, with potential risks and negative impacts on the us and others in the financial services industry.  A deterioration of business and economic conditions, particularly in our local markets, could adversely affect the credit quality of the Company’s loans, results of operations and financial condition.

 

Lending

 

Deterioration in the Housing Sector, Commercial Real Estate, and Related Markets May Adversely Affect Business and Financial Results.

 

Real estate lending is a major business activity for the Company.  Real estate market conditions affect the value and marketability of this real estate collateral, and they also affect the cash flows, liquidity, and net worth of many borrowers whose operations and finances depend on real estate market conditions.  Adverse conditions in our market areas could reduce our growth rate, affect the ability of our customers to repay their loans and generally affect our financial condition and results of operations.

 

The Company’s Emphasis on Commercial Lending May Expose the Company to Increased Lending Risks, Which Could Hurt Profits.

 

Berkshire plans to continue to emphasize the origination of commercial loans, which generally exposes us to a greater risk of nonpayment and loss because repayment of such loans often depends on the successful operations and income stream of the borrowers. Commercial loans are historically more sensitive to economic downturns.  Such sensitivity includes potentially higher default rates and possible reduction of collateral values. Commercial lending involves larger loan sizes and larger relationship exposures, which can have a greater impact on profits in the event of adverse loan performance.  The majority of the Company’s commercial loans is secured by real estate and subject to the previously discussed real estate risk factors.   Commercial lending sometimes involves construction or other development financing, which is dependent on the future success of new operations.  The Company’s commercial lending activities have extended across wider parts of its New England and New York markets into areas where the Company has less business experience.  The Company’s commercial lending includes asset based lending, which depends on the Company’s processes for monitoring and being able to liquidate collateral on which these loans rely.  The Company includes small business lending in its commercial loan disclosures.  The Company has expanded this lending function and re-engineered it small business loan origination process in order to accelerate growth.  Additionally, the Company has expanded its wholesale purchases and sales of loans and loan participations with other banks doing business in its markets, including participations in national credits.    Commercial loans may increase as a percentage of total loans, and commercial lending may continue to expose the company to increased risks.

 

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The Allowance for Loan Losses May Prove to be Insufficient to Absorb Losses in The Loan Portfolio.

 

Like all financial institutions, the Company maintains an allowance for loan losses which is our estimate of the probable losses that are inherent in the loan portfolio as of the financial statement date.  However, our allowance for loan losses may not be sufficient to cover actual loan losses, and future provisions for loan losses could materially and adversely affect our operating results.  The accounting measurements related to impairment and the loan loss allowance require significant estimates which are subject to uncertainty and changes relating to new information and changing circumstances.  Additionally, the allowance can only reflect those losses which are reasonably estimable, and there are constraints in our ability to estimate losses in this period of unusual economic and financial stress.  This is particularly relevant for our estimates of losses for pools of loans.  Accordingly, at any time, there may be probable losses inherent in the portfolio but which we are not reasonably able to estimate until additional information emerges which can form the basis for a reasonable estimate.

 

State and federal regulators, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to increase our allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease our allowance for loan losses by recognizing loan charge-offs, net of recoveries. Any such additional provisions for loan losses or charge-offs, as required by these regulatory agencies, could have a material adverse effect on our financial condition and results of operations.

 

Estimates Related to Accounting for Acquired Loans May Differ From Actual Results.

 

Under generally accepted principles for business combinations, there is no loan loss allowance recorded for acquired loans, which are recorded at net fair value on the acquisition date.   This net fair value generally includes embedded loss estimates for acquired loans with deteriorated credit quality.  These estimates are based on projections of expected cash flows for these problem loans, which in many cases rely on estimates deriving from the liquidation of collateral.  If the projections are inadequate, the fair value estimates may exceed the actual collectability of the balances, and this may result in the related loans being considered impaired, which would result in a reduction in interest income.  If fair value estimates differ from actual collectability, then tangible book value of the Company will have been recorded incorrectly at the time of the acquisition, and subsequent earnings will differ from original estimates.  Measures of tangible book value and earnings impacts of business combinations are frequently used in evaluating the merits and value of business combinations.  The Company has recorded significant income resulting from collections of acquired impaired loans which exceeded the fair value estimates originally established.  Additionally, accounting for acquired loans involves ongoing assessments of the timing and amount of expected loan collections.  Numerous assumptions and estimates are integral to purchased loan accounting, and actual results could be different from prior estimates.

 

New regulations could restrict the Company’s ability to originate and sell mortgage loans.

 

The CFPB has issued a rule designed to clarify for lenders how they can avoid monetary damages under the Dodd-Frank Act, which would hold lenders accountable for ensuring a borrower’s ability to repay a mortgage. Loans that meet this “qualified mortgage” definition will be presumed to have complied with the new ability-to-repay standard. Under the CFPB’s rule, a “qualified mortgage” loan must not contain certain specified features, including:

 

·                  excessive upfront points and fees (those exceeding 3% of the total loan amount, less “bona fide discount points” for prime loans);

 

·                  interest-only payments;

 

·                  negative-amortization; and

 

·                  terms longer than 30 years.

 

Also, to qualify as a “qualified mortgage,” a borrower’s total debt-to-income ratio may not exceed 43%. Lenders must also verify and document the income and financial resources relied upon to qualify the borrower for the loan and underwrite the loan based on a fully amortizing payment schedule and maximum interest rate during the first five years, taking into account all applicable taxes, insurance and assessments. The CFPB’s rule on qualified mortgages

 

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could limit our ability or desire to make certain types of loans or loans to certain borrowers, or could make it more expensive/and or time consuming to make these loans, which could limit our growth or profitability.

 

Operating

 

Expansion, Growth, and Acquisitions Could Negatively Impact Earnings If Not Successful.

 

The Company plans to achieve significant growth organically, by geographic expansion, through business line expansion, and through acquisitions. We have recently expanded into new geographic markets and anticipate that we will continue to expand into additional geographic markets as we grow as a regional bank.  The success of this expansion depends on our ability to continue to maintain and develop an infrastructure appropriate to support and integrate such growth. Also, our success depends on the acceptance by customers of us and our services in these new markets and, in the case of expansion through acquisitions, our success depends on many factors, including the long-term recruitment and retention of key personnel and acquired customer relationships. The profitability of our expansion strategy also depends on whether the income we generate in the new markets will offset the increased expenses of operating a larger entity with increased personnel, more branch locations and additional product offerings.  In 2013, revenues decreased in the second half of the year due to changes related to loans and operations acquired in the prior two years.  The Company has implemented certain expense restructuring activities, related in part to the rationalization of acquired operations.  Such activities expose us to risk that revenues may be affected or that changes in operations may result in inefficiencies or control deficiencies that could contribute to financial or market share losses.

 

Berkshire continues to identify and evaluate opportunities to expand through acquisition of banks, insurance agencies, and wealth management firms.  Some of these opportunities could result in further geographic expansion.  Merger and acquisition activities are subject to a number of risks, including lending, operating, and integration risks.  Growth through acquisition requires careful due diligence, evaluation of risks, and projections of future operations and financial conditions.  Actual results may differ from our expectations and could have a material adverse effect on our financial condition and results of operations.  Growth through acquisition also often involves the negotiation and execution of extensive merger agreements. Such agreements may give rise to litigation, constrain us in certain ways, or expose us to other risks beyond our normal operating risks.

 

The Company completed the purchase and integration of 20 branches in Central New York in 2014.  The amount of deposits acquired was significantly below the amount at the time of the purchase agreement.  Runoff abated after the purchase was completed, but it there is future attrition of deposit balances or difficulties in retaining acquired customer relationships, the expected benefits of this acquisition may not be realized.The Company’s recruitment of new executive and commercial lending management has in several cases brought in new management who previously worked at larger institutions.  These individuals have often served larger customers than the Company has historically serviced, and they have had the benefit of larger capital and administrative resources than are present in the Company’s current structure. The success of this recruitment may depend on the successful integration of these individuals into the Company and may expose the Company to lending and operating losses related to large new customers in newer markets.  The Company’s commercial banking strategy has particularly focused on taking market share from larger national institutions and in many cases these new accounts are larger than the Company’s historic accounts.  Additionally, the Company’s ability to service these accounts may in some cases involve arranging loan participations and syndications.  These activities can expose the Company to additional lending, administrative, and liquidity risks.  The Company also actively recruits in other business lines, including private banking and wealth management.  This activity can give the Company additional access to large customers in its markets in order to expand our business.  Such recruitment can affect the retention of new and old business, and can also be affected by competitive reactions and other relationship risks in retaining accounts.

 

Operations acquired in business combinations have frequently been subject to bank regulations prior to the merger date.  Related regulatory examinations may result in the identification of certain operating matters requiring remediation, undisclosed deficiencies related to regulatory compliance, deficiencies that arise as a result of integration of acquired operations and operating activities conducted by those operations subsequent to the merger date, or impacts on existing business operations which are being integrated with the acquired operations.  Any identified deficiencies related to regulatory compliance may result in changes that affect operating revenues and costs, including the scope or scale of business activities and/or potential future expansion initiatives.

 

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Competition From Financial Institutions and Other Financial Service Providers May Adversely Affect the Company’s Growth and Profitability.

 

Competition in the banking and financial services industry is intense.   We compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Larger banking institutions have substantially greater resources and lending limits and may offer certain services that we do not.  Local competitors with excess capital may accept lower returns on new business.  There is increased competition by out-of-market competitors through the internet.  Federal regulations and financial support programs may in some cases favor competitors or place us at an economic disadvantage.  Our profitability depends on our continued ability to successfully compete and grow profitably in our market areas. Competition among financial institutions has included competition for banking teams and talent which creates risk that revenues, earnings, or market share could be adversely affected by the loss of talent.

 

Market Changes May Adversely Affect Demand For The Company’s Services and Impact Revenue, Costs, and Earnings.

 

Channels for servicing the Company’s customers are evolving rapidly, with less reliance on traditional branch facilities, more use of online and mobile banking, and demand for universal bankers and other relationship managers who can service multiples product lines.  The Company has an ongoing process for evaluating the profitability of its branch system and other office and operational facilities.  The identification of unprofitable operations and facilities can lead to restructuring charges and introduce the risk of disruptions to revenues and customer relationships.  The Company competes with larger providers who are rapidly evolving their service channels and escalating the costs of evolving the service process.

 

The Company is Subject to Security and Operational Risks Relating to Our Use of Technology that Could Damage Our Reputation and Our Business.

 

Security breaches of confidential information in our internet banking activities could expose us to possible liability and damage our reputation. Any compromise of our data security could also deter customers from using our internet banking services. We rely on industry standard internet security systems to provide the security and authentication necessary to effect secure transmission of data. These precautions may not protect our security systems from compromises or breaches and could result in damage to our reputation and our business. We utilize third party core banking software and for some systems we have outsourced our data processing to a third party. If our third party providers encounter difficulties or if we have difficulty in communicating and/or transmitting with such third parties, it could significantly affect our ability to adequately process and account for customer transactions, which could significantly affect our business operations.  We utilize file encryption in designated internal systems and networks and are subject to certain state and federal regulations regarding how we manage data security.  Our enterprise governance risk and compliance function includes a framework of controls, policies and technologies to monitor and protect information from cyberattacks, mishandling, and loss, together with safeguards related to the confidentiality, integrity and availability of information. Natural disasters and disaster recovery risks could affect our operating systems, which could affect our reputation. Our business continuity program addresses crisis management, business impact, and data and systems recovery.  Potential problems with the management of technology security and operational risks may affect regulatory compliance, which could affect operating costs and expansion plans.

 

The Company faces cybersecurity risks, including denial of service attacks, hacking and identity theft that could result in the disclosure of confidential information, which could adversely affect the Company’s business or reputation and create significant legal and financial exposure.

 

The Company’s computer systems and network infrastructure are subject to security risks and could be susceptible to cyber-attacks, such as denial of service attacks, hacking, terrorist activities or identity theft. Financial services institutions and companies engaged in data processing have reported breaches in the security of their websites or other systems, some of which have involved sophisticated and targeted attacks intended to obtain unauthorized access to confidential information, destroy data, disable or degrade service, or sabotage systems, often through the introduction of computer viruses or malware, cyber-attacks and other means. Denial of service attacks have been launched against a number of large financial services institutions. As a growing regional bank, the Company anticipates that it may be

 

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subject to similar attacks in the future. Hacking and identity theft risks could cause serious reputational harm to the Company. Cyber threats are rapidly evolving and the Company may not be able to anticipate or prevent all such attacks. The Company may incur increasing costs in an effort to minimize these risks and could be held liable for any security breach or loss. Despite efforts to ensure the integrity of its systems, the Company will not be able to anticipate all security breaches of these types, and the Company may not be able to implement effective preventive measures against such security breaches. The techniques used by cyber criminals change frequently and can originate from a wide variety of sources, including outside groups such as external service providers, organized crime affiliates, terrorist organizations or hostile foreign governments. Those parties may also attempt to fraudulently induce employees, customers or other users of the Company’s systems to disclose sensitive information in order to gain access to its data or that of its clients. These risks may increase in the future as the Company continues to increase its mobile-payment and other internet-based product offerings and expands its internal usage of web-based products and applications. A successful penetration or circumvention of system security could cause serious negative consequences to the Company, including significant disruption of operations, misappropriation of confidential information of the Company or that of its customers, or damage to computers or systems of the Company or those of its customers and counterparties. A security breach could result in violations of applicable privacy and other laws, financial loss to the Company or to its customers, loss of confidence in the Company’s security measures, significant litigation exposure, and harm to the Company’s reputation, all of which could have a material adverse effect on the Company.

 

Financial and Operating Counterparties Expose the Company to Risks.

 

We have increased our use of derivative financial instruments, primarily interest rate swaps, which exposes us to financial and contractual risks with counterparty banks.  We maintain correspondent bank relationships, manage certain loan participations, engage in securities transactions, and engage in other activities with financial counterparties that are customary to our industry.  We also utilize services from major vendors of technology, telecommunications, and other essential operating services.   There is financial and operating risk in these relationships, which we seek to manage through internal controls and procedures, but there are no assurances that we will not experience loss or interruption of our business as a result of unforeseen events with these providers.  Our expanded mortgage lending and mortgage banking operations have also exposed us to more counterparty transactions including the use of third parties to participate in the management of interest rate risk and mortgage sales and hedging.  Financial and operational risks are inherent in these counterparty relationships.

 

The Company May Not Be Able to Attract and Retain Skilled People.

 

Our success depends, in large part, on our ability to attract new employees, retain and motivate our existing employees, and continue to compensate employees competitively. Competition for the best people in our industry can be intense and we may not be able to hire or retain appropriately qualified individuals. As a result of recent revenue declines and expense restructuring activities, the Company could experience changes in the retention of existing employees.

 

Controls and Procedures May Fail or Be Circumvented.

 

Management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.

 

Retail Lending Changes Expose the Company to Operating Risks.

 

Volatile conditions in mortgage markets have been reflected in changes in the Company’s mortgage operations.  The Company has expanded its recruitment and re-engineered its mortgage banking activities (including a systems conversion) and changed its management of this function.  Similarly, consumer indirect auto lending has varied between high growth and declines in a short amount of time.

 

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These changes expose us to operating risks and expose the Bank to the risk of loan losses, losses related to interest rate risk management, compliance, litigation, and other risks common in consumer lending operations.

 

Derivatives and Counterparty Risks Have Increased.

 

Berkshire could experience losses if there are failures in the controls or accounting for these activities or if there are performance failures by any of these new counterparties. The risk of loss is increased when interest rates change suddenly and if the intended hedging objectives are not achieved as a result of market or counterparty behaviors. The sudden change in interest rates in 2013 contributed to lower mortgage banking profitability in 2013.

 

Following the completion of the New York branch acquisition shortly after year-end 2013, all outstanding interest rate swaps related to Federal Home Loan Bank loans were terminated and new borrowings and interest rate swaps were entered into based on an analysis of the current interest rate profile and objectives.  These terminations in hedge management were due to changed circumstances and the Company’s ability to utilize its hedge accounting methods depends on its ability to forecast related economic and financial factors which could limit its ability to utilize these methods in the event of future unforeseen events.

 

Ongoing System Conversions Expose the Company to Operating and Financial Risks.

 

Following its core systems conversion in 2012, the Company has further converted companion accounting and banking systems.  These conversions also create increasing risks of maintaining systems interfaces.  The changes expose the Bank to new risks with new systems and new vendors.  The Bank has worked closely with third parties to manage the related operating and financial risks.  Potential problems with new systems could involve regulatory compliance risk, potentially resulting in higher operating costs or limitations on operating activities.  The new systems involve new costs with the new vendor, which could exceed expectations and impact profitability and future vendor relations.

 

Liquidity

 

Our Wholesale Funding Sources May Prove Insufficient to Replace Deposits at Maturity and Support Our Operations and Future Growth.

 

We must maintain sufficient funds to respond to the needs of depositors and borrowers. As a part of our liquidity management, we use a number of funding sources in addition to adjusted deposit growth and repayments and maturities of loans and investments.  These sources include Federal Home Loan Bank advances, proceeds from the sale of loans, and liquidity resources at the holding company. Most recently, the Company has expanded its use of brokered deposits both to support ongoing growth and to provide enhanced deposit insurance to support large dollar commercial relationships.   Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable costs. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our operating margins and profitability would be adversely affected.  Turbulence in the capital and credit markets may adversely affect our liquidity and financial condition and the willingness of certain counterparties and customers to do business with us.  The Company’s long term plan anticipates asset growth at a faster rate than deposit growth, which has resulted in increased reliance on wholesale or nontraditional funding sources.  If deposits in new markets do not remain at planned levels, this could increase the possible reliance on wholesale or nontraditional funding sources.

 

The Company Has Terminated Its Participation in the Massachusetts Depositors Insurance Fund Size Thresholds, Which May Result In Changes to the Company and the Bank’s Operations.

 

Due to ongoing growth, the Company exceeded certain Massachusetts Depositors Insurance Fund size thresholds.  Berkshire Bank chose to withdraw from participation in the Depositors Insurance Fund.  The Bank was required, under Massachusetts law, to convert from a Massachusetts savings bank to a Massachusetts trust company and, under federal law, the Company was required to convert from a savings and loan holding company to a bank holding company. Such a charter conversion and holding company change affected the overall powers and obligations of the Company and the Bank. None of these issues affected the Bank’s federal deposit insurance coverage by the FDIC the withdrawal from the DIF supplemental insurance program included a notice and transition time period for currently insured accounts

 

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which is extending into 2015.  Withdrawal from DIF could have negative impact to future deposit acquisition or retention.  The Company believes that related charter changes were accomplished in an orderly manner without significant impact to business operations.

 

Our Ability to Service Our Debt, Pay Dividends and Otherwise Pay Our Obligations as They Come Due Is Substantially Dependent on Capital Distributions from the Bank, and These Distributions Are Subject to Regulatory Limits and Other Restrictions.

 

A substantial source of our holding company income is the receipt of dividends from the Bank, from which we service our debt, pay our obligations, and pay shareholder dividends.   The availability of dividends from the Bank is limited by various statutes and regulations. It is possible, depending upon the financial condition of the Bank and other factors, that the applicable regulatory authorities could assert that payment of dividends or other types of payments are an unsafe or unsound practice. If the Bank is unable to pay dividends to us, we may not be able to service our debt, pay our obligations or pay dividends on our common stock. The inability to receive dividends from the Bank would adversely affect our business, financial condition, results of operations and prospects.

 

Interest Rates

 

Changes in Interest Rates Could Adversely Affect Results of Operations and Financial Condition.

 

Net interest income is our largest source of income.  Changes in interest rates can affect the level of net interest income. The Company’s interest rate sensitivity is discussed in more detail in Item 7A of this report.  The Company principally manages interest rate risk by managing its volume and mix of earning assets and funding liabilities. In a changing interest rate environment, the Company may not be able to manage this risk effectively. If the Company is unable to manage interest rate risk effectively, its business, financial condition and results of operations could be materially harmed.  Changes in interest rates can also affect the demand for the Company’s products and services, and the supply conditions in the U.S. financial and capital markets.  Changes in the level of interest rates may negatively affect the Company’s ability to originate real estate loans, the value of its assets and its ability to realize gains from the sale of our assets, all of which ultimately affect our earnings.

 

Securities Market Values

 

Declines in the Value of Certain Investment Securities Could Require Write-Downs, Which Would Reduce Our Earnings.

 

Unrealized losses on investment securities result from changes in credit spreads and liquidity issues in the marketplace, along with changes in the credit profile of individual securities issuers. The Company concluded that, as of year-end 2014, any unrealized losses are temporary in nature, and it has the intent and ability to hold these investments for a time necessary to recover its cost or stated maturity (at which time, full payment is expected). However, a continued decline in the value of these securities or other factors could result in an other-than-temporary impairment write-down which would reduce earnings. The Company has increased its investment in equity securities and non-investment grade debt securities which may exhibit more credit risk and price volatility.   Some of the Company’s securities are locally originated economic development bonds.  These securities could become impaired due to economic and real estate market conditions which also affect loan risk.  The Company has an investment in the stock of the Federal Home Loan Bank of Boston, which currently provides a modest dividend after a period when the dividend was suspended.  If the capitalization of a Federal Home Loan Bank, including the FHLBB, became substantially diminished it could result in a write-down which would reduce our earnings.  Future regulatory pronouncements could affect the securities portfolio and its carrying value.

 

Regulatory

 

Legislative and Regulatory Initiatives May Affect Business Activities and Increase Operating Costs.

 

The potential exists for additional federal or state laws and regulations regarding lending, funding practices, capital, and liquidity standards.  Bank regulatory agencies are expected to be more active in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement orders. In addition, new laws,

 

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regulations, and other regulatory changes may also increase our compliance costs and affect our business and operations.  Moreover, the FDIC sets the cost of our FDIC insurance premiums, which can affect our profitability.

 

The Company is required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. Regulatory capital requirements and their impact on the Company may change.  It may need to raise additional capital in the future to support operations and continued growth. Our ability to raise capital, if needed, will depend on conditions in the capital markets at that time, which are outside of our control, and on our financial performance. If we cannot raise additional capital when needed, it could affect operations and the execution of the strategic plan, which includes further expanding operations through internal growth and acquisitions.

 

The Dodd-Frank Act made extensive changes in the regulation of insured depository institutions.   In addition to eliminating the OTS and creating the Consumer Financial Protection Bureau, the Dodd-Frank Act, among other things, directs changes in the way that institutions are assessed for deposit insurance, mandates the imposition of consolidated capital requirements on savings and loan holding companies, requires originators of certain securitized loans to retain a percentage of the risk for the transferred loans, stipulates regulatory rate-setting for certain debit card interchange fees, repeals restrictions on the payment of interest on commercial demand deposits and contains a number of reforms related to mortgage originations.  The impact of many of the provisions of the Dodd-Frank Act is ongoing as further regulations are promulgated.  The Company expects that the Dodd-Frank Act will, at a minimum, result in increased regulatory burden, compliance costs and interest expense for the Company. New laws, regulations, and other regulatory changes, along with negative developments in the financial industry and the domestic and international credit markets, may significantly affect the markets in which the Company does business, the markets for and value of our loans and investments, and our ongoing operations, costs and profitability.  For more information, see “Regulation and Supervision” in Item 1 of this report.

 

New Federal Bank Capital Rules May Affect the Company’s Future Condition and Performance.

 

In July 2013, the Office of the Comptroller of the Currency (“OCC”), Board of Governors of the Federal Reserve System (“FRB”), and the Federal Deposit Insurance Corporation (“FDIC”) announced the adoption of new rules that revise and replace the agencies’ capital rules as these federal agencies move forward with implementing capital requirements in response to agreements reached by the Basel Committee on Banking Supervision (“Basel III”). Many of these rules became effective on January 1, 2015 and some of the rules are being implemented in a phased transition which will be completed in 2019.  The Company expects that these rules will make some investments in earning assets less attractive and that overall measures of capital adequacy will be reduced but will remain Well Capitalized.  The new capital rules phase in certain buffers which, if not maintained, could result in limitations on certain distributions to management and shareholders.  The Company expects that such buffers will be maintained.  The implementation of the new capital rules is extensive and some aspects of interpretation and guidance have been delayed until close to implementation dates, increasing the uncertainty related to capital planning.  The Company has a high focus on the ongoing assessment of these new capital rules as they become effective, including the impact on capital sources and capital returns.

 

Provisions of Our Certificate of Incorporation, Bylaws and Delaware Law, as Well as State and Federal Banking Regulations, Could Delay or Prevent a Takeover of Us by a Third Party.

 

Provisions in our certificate of incorporation and bylaws, the corporate law of the State of Delaware, and state and federal regulations could delay, defer or prevent a third party from acquiring us, despite the possible benefit to our stockholders, or otherwise adversely affect the price of our common stock. These provisions include: limitations on voting rights of beneficial owners of more than 10% of our common stock; supermajority voting requirements for certain business combinations; the election of directors to staggered terms of three years; and advance notice requirements for nominations for election to our Board of Directors and for proposing matters that stockholders may act on at stockholder meetings. In addition, we are subject to Delaware laws, including one that prohibits us from engaging in a business combination with any interested stockholder for a period of three years from the date the person became an interested stockholder unless certain conditions are met. These provisions may discourage potential takeover attempts, discourage bids for our common stock at a premium over market price or adversely affect the market price of, and the voting and other rights of the holders of, our common stock. These provisions could also discourage proxy

 

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contests and make it more difficult for you and other stockholders to elect directors other than the candidates nominated by our Board.

 

Goodwill and Other Intangible Assets

 

Acquisitions Have Resulted in Significant Goodwill, Which if it Becomes Impaired Would be Required to be Written Down, Resulting in a Negative Impact on Earnings.

 

The initial recording and subsequent impairment testing of goodwill and other intangible assets requires subjective judgments about the estimates of the fair value of assets acquired.   Factors that may significantly affect the estimates include specific industry or market sector conditions, changes in revenue growth trends, customer behavior, competitive forces, cost structures and changes in discount rates.  It is possible that future impairment testing could result in an impairment of the value of goodwill or intangible assets, or both. If we determine impairment exists at a given point in time, our earnings and the book value of the related intangible asset(s) will be reduced by the amount of the impairment. Notwithstanding the foregoing, the results of impairment testing on goodwill and adjusted deposit intangible assets have no impact on our tangible book value or regulatory capital levels.  These are non-GAAP financial measures. They are not a substitute for GAAP measures and should only be considered in conjunction with the Company’s GAAP financial information.

 

Trading of our Common Stock

 

The Trading History of The Company’s Common Stock Is Characterized By Low Trading Volume.  The Value of Your Investment May be Subject To Sudden Decreases Due To the Volatility of the Price of Our Common Stock.

 

The level of interest and trading in the Company’s stock depends on many factors beyond our control. The market price of our common stock may be highly volatile and subject to wide fluctuations in response to numerous factors, including, but not limited to, the factors discussed in other risk factors and the following: actual or anticipated fluctuations in operating results; changes in interest rates; changes in the legal or regulatory environment; press releases, announcements or publicity relating to the Company or its competitors or relating to trends in its industry; changes in expectations as to future financial performance, including financial estimates or recommendations by securities analysts and investors; future sales of our common stock; changes in economic conditions in our marketplace, general conditions in the U.S. economy, financial markets or the banking industry; and other developments affecting our competitors or us. These factors may adversely affect the trading price of our common stock, regardless of our actual operating performance, and could prevent stockholders from selling their common stock at a desirable price.

 

In the past, stockholders have brought securities class action litigation against a company following periods of volatility in the market price of their securities. We could be the target of similar litigation in the future, which could result in substantial costs and divert management’s attention and resources.

 

Pending Agreement to Acquire Hampden Bancorp

 

Legal Proceedings Commenced After the Announcement of the Merger May Delay Consummation of the Merger, Result in Increased Expenditures and Consume the Time and Attention of Our Executive Officers.

 

A complaint has been filed against Hampden, the Hampden board of directors and Berkshire, seeking class action status and asserting that Hampden and the Hampden board of directors violated their fiduciary duties to Hampden stockholders in connection with the proposed Merger. The complaint further alleged that Berkshire aided and abetted Hampden and the Hampden board of directors in their alleged breach of fiduciary duties. Berkshire is vigorously defending itself against these claims.  At this time, Berkshire is unable to predict an outcome, favorable or unfavorable, or to estimate the amount of any potential loss. Legal proceedings of this type are costly to defend and may consume the time and attention of our executive officers, as well as delay the consummation of the Merger.

 

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Failure to Complete the Merger Could Negatively Impact the Stock prices and Future Businesses and Financial results of Berkshire and Hampden.

 

If the merger is not completed, the ongoing businesses of Berkshire and Hampden may be adversely affected and Berkshire and Hampden will be subject to several risks, including the following:

 

·                  Berkshire and Hampden will be required to pay certain costs relating to the merger, whether or not the merger is completed, such as legal, accounting, financial advisor and printing fees;

 

·                  under the merger agreement, Hampden is subject to certain restrictions on the conduct of its business prior to completing the merger, which may adversely affect its ability to execute certain of its business strategies; and

 

·                  matters relating to the merger may require substantial commitments of time and resources by Berkshire and Hampden management, which could otherwise have been devoted to other opportunities that may have been beneficial to Berkshire and Hampden as independent companies, as the case may be.

 

In addition, if the merger is not completed, Berkshire and/or Hampden may experience negative reactions from the financial markets and from their respective customers and employees. Berkshire and/or Hampden also could be subject to litigation related to any failure to complete the merger or to enforcement proceedings commenced against Berkshire or Hampden to perform their respective obligations under the merger agreement. If the merger is not completed, Berkshire and Hampden cannot assure their shareholders that the risks described above will not materialize and will not materially affect the business, financial results and stock prices of Berkshire and/or Hampden.

 

The Company May be Unable to Successfully Integrate Hampden’s Operations or Otherwise Realize the Expected Benefits from the Merger, Which Would Adversely Affect the Company’s Results of Operations and Financial Condition.

 

The merger of Hampden with and into the Company involves the integration of two companies that have previously operated independently. The difficulties of combining the operations of the two companies include:

 

·                                          integrating personnel with diverse business backgrounds;

 

·                                          combining different corporate cultures; and

 

·                                          retaining key employees.

 

The process of integrating operations could cause an interruption of, or loss of momentum in, the activities of the business and the loss of key personnel. The integration of the two companies will require the experience and expertise of certain key employees of Hampden who are expected to be retained by the Company. The Company may not be successful in retaining these employees for the time period necessary to successfully integrate Hampden’s operations with those of the Company. The diversion of management’s attention and any delay or difficulty encountered in connection with the merger and the integration of the two companies’ operations could have an adverse effect on the business and results of operation of the Company following the merger.

 

The success of the merger will depend, in part, on the Company’s ability to realize the anticipated benefits and cost savings from combining the business of the Company with Hampden. If the Company is unable to successfully integrate Hampden, the anticipated benefits and cost savings of the merger may not be realized fully or may take longer to realize than expected. For example, the Company may fail to realize the anticipated increase in earning and cost savings anticipated to be derived from the acquisition. In addition, as with regard to any merger, a significant decline in asset valuations or cash flows may also cause the Company not to realize expected benefits.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2. PROPERTIES

 

The Company’s headquarters are located in owned and leased facilities located in Pittsfield, Massachusetts. The Company also owns or leases other facilities within its primary market areas: Berkshire County, Massachusetts;

 

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Pioneer Valley (Springfield area), Massachusetts; Southern Vermont; the Capital Region (Albany area), New York; Central New York; Northern Connecticut; and Central/Eastern Massachusetts. The Company has 91 full-service branches in Massachusetts, New York, Connecticut, and Vermont (including one branch in Tennessee following a bank acquisition.)

 

The Company also has 7 regional headquarters. The 7 regional locations are full-service commercial offices located in Pittsfield, Massachusetts; Springfield, Massachusetts; Albany, New York; Syracuse, New York; Hartford, Connecticut; Westborough, Massachusetts; and Burlington, Massachusetts. In addition, the Company has 5 residential mortgage lending locations in Central/Eastern, Massachusetts.

 

Berkshire Insurance Group operates from 12 locations in Western Massachusetts and Syracuse, New York in both standalone premises as well as in rented space located in the Bank’s premises.

 

In January 2014, Berkshire completed the acquisition of 20 New York branches, reaching more communities between Albany and Syracuse. As part of the acquisition, two branches were consolidated in Central New York.  The Company also opened a new office in Loudonville, New York in January 2014, as part of its ongoing organic expansion.  Additionally, in October 2014 the Bank opened a new branch banking office in the Westborough, Massachusetts facility which it had previously established as a regional commercial head quarters serving the Worcester and Central/Eastern Massachusetts markets.

 

Berkshire continues to expand its new retail branch design which eliminates traditional teller counters and provides an interactive customer service environment through “pod” stations which include automated cash handling technology.  In many cases, this branch design also includes a multimedia community room which is offered for use by nonprofit community groups.

 

Based on its pending merger agreement with Hampden Bancorp, the Bank expects to add an additional seven branch offices in the Springfield market in the second quarter of 2015.

 

ITEM 3. LEGAL PROCEEDINGS

 

At December 31, 2014, neither the Company nor the Bank was involved in any pending legal proceedings believed by management to be material to the Company’s financial condition or results of operations. Periodically, there have been various claims and lawsuits involving the Bank, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, claims involving the making and servicing of real property loans and other issues incident to the Bank’s business. However, neither the Company nor the Bank is a party to any pending legal proceedings that it believes, in the aggregate, would have a material adverse effect on the financial condition or operations of the Company.

 

Following the public announcement of the execution of the Agreement and Plan of Merger, dated November 3, 2014 (the “Merger Agreement”), by and among the Company and Hampden Bancorp, Inc. (“Hampden”), on or about February 11, 2015, Brian Levy, a purported shareholder of Hampden, filed a shareholder class action lawsuit in the Superior Court of the Commonwealth of Massachusetts for Hampden County against Hampden, the Directors of Hampden and the Company (the “Hampden shareholder litigation”).  The Hampden shareholder litigation purports to be brought on behalf of all of Hampden’s public stockholders and alleges that (i) the directors of Hampden breached their fiduciary duties to it’s stockholders by, among other things, failing to take steps necessary to obtain a fair and adequate price for Hampden’s common stock, (ii) Hampden and its directors failed to disclose material facts in its proxy solicitation materials for its shareholder vote to approve the transaction set forth in the Merger Agreement, and (iii) the Company knowingly aided and abetted Hampden’s directors’ breach of fiduciary duty.

 

Hampden, its Directors and the Company all deny and are vigorously defending each of the allegations asserted in the Hampden shareholder litigation.  Management of the Company believes the Hampden shareholder litigation will not have any material adverse effect on the financial condition or operations of the Company.

 

ITEM 4.  MINE SAFETY DISCLOSURES

 

Not Applicable.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

Market Information

 

The common shares of the Company trade on the New York Stock Exchange under the symbol “BHLB”. The following table sets forth the quarterly high and low sales price information and dividends declared per share of common stock in 2014 and 2013.

 

2014

 

High

 

Low

 

Dividends
Declared

 

First quarter

 

$

27.28

 

$

23.95

 

$

0.18

 

Second quarter

 

26.64

 

22.06

 

0.18

 

Third quarter

 

25.11

 

22.37

 

0.18

 

Fourth quarter

 

26.91

 

22.84

 

0.18

 

 

2013

 

 

 

 

 

 

 

First quarter

 

$

26.01

 

$

23.38

 

$

0.18

 

Second quarter

 

27.84

 

24.62

 

0.18

 

Third quarter

 

29.38

 

24.34

 

0.18

 

Fourth quarter

 

27.86

 

24.50

 

0.18

 

 

The Company had approximately 3,307 holders of record of common stock at March 9, 2015.

 

Dividends

 

The Company intends to pay regular cash dividends to common stockholders; however, there can be no assurance as to future dividends because they are dependent on the Company’s future earnings, capital requirements, financial condition, and regulatory environment.  Dividends from the Bank have been a source of cash used by the Company to pay its dividends, and these dividends from the Bank are dependent on the Bank’s future earnings, capital requirements, and financial condition.  Further information about dividend restrictions is provided in the Stockholders’ Equity note in the consolidated financial statements.

 

Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities

 

On September 28, 2012, the Company issued $75.0 million principal amount of fixed to floating rate unregistered subordinated notes through a private placement to institutional investors in accordance with Rule 506 of Regulation D.  The notes are due in 2027 and are redeemable at par by the Company during the final five years.  The notes bear interest at a fixed rate of 6.875% for the first ten years and convert to a variable rate of interest in the final five years.  The proceeds were used for Beacon merger consideration and other corporate purposes.  There have been no other sales of registered or unregistered securities within the last three years.

 

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Table of Contents

 

Purchases of Equity Securities by the Issuer and Affiliated Purchases

 

There were no purchases of equity securities during the fourth quarter of 2014 made by or on behalf of the Company or any “affiliated purchaser”, as defined by Section 240.10b-18(a)(3) of the Securities and Exchange Act of 1934, of shares of the Company’s common stock. On March 26, 2013, the Company authorized the purchase of up to 500 thousand shares, from time to time, subject to market conditions. The repurchase plan will continue until it is completed or terminated by the Board of Directors. The Company has no intentions to terminate this plan or to cease any potential future purchases. As of year-end 2014, there were 23 thousand shares that remain unpurchased under this plan.

 

 

 

 

 

 

 

Total number of shares

 

Maximum number of

 

 

 

 

 

 

 

purchased as part of

 

shares that may yet

 

 

 

Total number of

 

Average price

 

publicly announced

 

be purchased under

 

Period 

 

shares purchased

 

paid per share

 

plans or programs

 

the plans or programs

 

October 1-31, 2014

 

 

$

 

 

23,113

 

November 1-30, 2014

 

 

 

 

23,113

 

December 1-31, 2014