UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q


(Mark One)

[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2006

OR

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

For the transition period from __________________ to _________________

Commission File Number 0-51584

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)
 
(413) 443-5601
(Registrant’s telephone number, including area code)
 
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer [  ] Accelerated filer [X ] Non-accelerated filer [  ]
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)  Yes [  ] No [X] 

The Registrant had 8,631,220 shares of common stock, par value $0.01 per share, outstanding as of August 3, 2006.







BERKSHIRE HILLS BANCORP, INC.
FORM 10-Q

INDEX

 
   
Page
 
     
 
     
 
3
   
     
 
4
   
     
 
5
   
     
 
6
   
     
 
7
     
15
   
     
 
17
     
 
18
     
23
     
24
     
     
 
     
25
25
25
26
26
26
26
     
 
27






2


PART I. - FINANCIAL INFORMATION

ITEM 1.     CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


BERKSHIRE HILLS BANCORP, INC.
CONSOLIDATED BALANCE SHEETS


   
June 30,
 
December 31,
 
   
2006
 
2005
 
(In thousands, except share data)
         
Assets
             
Cash and cash equivalents
 
$
29,055
 
$
31,087
 
Securities available for sale, at fair value
   
353,322
   
390,876
 
Securities held to maturity, at amortized cost
   
42,524
   
29,908
 
Loans held for sale
   
-
   
2,093
 
Total loans
   
1,551,112
   
1,416,449
 
Less: Allowance for loan losses
   
(13,537
)
 
(13,001
)
Net loans
   
1,537,575
   
1,403,448
 
               
Premises and equipment, net
   
28,005
   
26,236
 
Accrued interest receivable
   
8,361
   
8,508
 
Goodwill
   
88,544
   
88,092
 
Other intangible assets
   
10,556
   
11,524
 
Bank-owned life insurance
   
19,402
   
19,002
 
Cash surrender value - other life insurance
   
10,418
   
11,503
 
Other assets
   
20,227
   
13,276
 
Total assets
 
$
2,147,989
 
$
2,035,553
 
               
Liabilities and Stockholders' Equity
             
Deposits
 
$
1,463,545
 
$
1,371,218
 
Borrowings
   
412,641
   
397,453
 
Junior subordinated debentures
   
15,464
   
15,464
 
Other liabilities
   
8,089
   
5,352
 
Total liabilities
   
1,899,739
   
1,789,487
 
               
Stockholders' equity:
             
Preferred stock ($.01 par value; 1,000,000 shares
             
authorized; none issued)
   
-
   
-
 
Common stock ($.01 par value; 26,000,000 shares authorized;
             
10,600,472 shares issued)
   
106
   
106
 
Additional paid-in capital
   
200,123
   
198,667
 
Unearned compensation
   
(2,409
)
 
(1,435
)
Retained earnings
   
105,033
   
99,429
 
Accumulated other comprehensive loss
   
(6,427
)
 
(2,239
)
Treasury stock, at cost (1,978,242 shares in 2006
             
and 2,060,604 in 2005)
   
(48,176
)
 
(48,462
)
Total stockholders' equity
   
248,250
   
246,066
 
               
Total liabilities and stockholders' equity
 
$
2,147,989
 
$
2,035,553
 
               
See accompanying notes to consolidated financial statements.

3


BERKSHIRE HILLS BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
 

   
Three Months Ended June 30,
 
Six Months Ended June 30,
 
(In thousands, except per share data)
 
2006
 
2005
 
2006
 
2005
 
Interest and dividend income
                         
Loans
 
$
24,017
 
$
15,226
 
$
46,373
 
$
27,142
 
Securities
   
4,180
   
4,100
   
8,877
   
8,210
 
Short-term investments
   
15
   
22
   
32
   
38
 
Total interest and dividend income
   
28,212
   
19,348
   
55,282
   
35,390
 
Interest expense
                         
Deposits
   
9,843
   
4,318
   
18,599
   
7,691
 
Borrowings
   
3,911
   
3,522
   
7,617
   
6,159
 
Total interest expense
   
13,754
   
7,840
   
26,216
   
13,850
 
                           
Net interest income
   
14,458
   
11,508
   
29,066
   
21,540
 
Provision for loan losses
   
600
   
300
   
890
   
793
 
Net interest income, after provision for loan losses
   
13,858
   
11,208
   
28,176
   
20,747
 
                           
Non-interest income
                         
Deposit fees
   
1,383
   
1,033
   
2,669
   
1,648
 
Wealth management fees
   
772
   
663
   
1,528
   
1,333
 
Insurance fees
   
581
   
175
   
1,489
   
207
 
Loan fees
   
125
   
198
   
351
   
372
 
Increase in cash surrender value of life insurance
   
247
   
200
   
540
   
403
 
Gain on sales of securities, net
   
529
   
1,388
   
1,026
   
1,817
 
Gain on sale of loans and securitized loans, net
   
-
   
162
   
-
   
751
 
Other
   
273
   
97
   
397
   
125
 
Total non-interest income
   
3,910
   
3,916
   
8,000
   
6,656
 
                           
Non-interest expense
                         
Salaries and benefits
   
5,758
   
4,485
   
11,411
   
8,820
 
Occupancy and equipment
   
1,822
   
1,212
   
3,753
   
2,352
 
Marketing and advertising
   
350
   
200
   
593
   
361
 
Data processing and telecommunications
   
813
   
635
   
1,697
   
1,127
 
Professional services
   
432
   
363
   
935
   
838
 
Foreclosed real estate and other loans, net
   
105
   
218
   
137
   
312
 
Amortization of intangible assets
   
478
   
156
   
956
   
186
 
Other recurring expense
   
1,495
   
1,162
   
2,995
   
1,972
 
Termination of Employee Stock Ownership Plan
   
-
   
8,667
   
-
   
8,667
 
Other non-recurring expense
   
385
   
963
   
385
   
963
 
Total non-interest expense
   
11,638
   
18,061
   
22,862
   
25,598
 
                           
Income (loss) from continuing operations before income taxes
   
6,130
   
(2,937
)
 
13,314
   
1,805
 
Income tax expense
   
1,888
   
1,671
   
4,254
   
3,161
 
Net income (loss) from continuing operations
   
4,242
   
(4,608
)
 
9,060
   
(1,356
)
                           
Income from discontinued operations before income taxes
   
359
   
-
   
359
   
-
 
Income tax expense
   
138
   
-
   
138
   
-
 
Net income from discontinued operations
   
221
   
-
   
221
   
-
 
                           
Net income (loss)
 
$
4,463
 
$
(4,608
)
$
9,281
 
$
(1,356
)
                           
Earnings (loss) per share
                         
Basic
 
$
0.52
 
$
(0.74
)
$
1.09
 
$
(0.23
)
Diluted
 
$
0.51
 
$
(0.74
)
$
1.06
 
$
(0.23
)
Average shares outstanding
                         
Basic
   
8,513
   
6,257
   
8,492
   
5,782
 
Diluted
   
8,760
   
6,257
   
8,758
   
5,782
 
 
See accompanying notes to consolidated financial statements.

4


BERKSHIRE HILLS BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY


   
Six Months Ended
 
   
June 30,
 
   
2006
 
2005
 
(In thousands)
         
           
Total stockholders' equity at beginning of period
 
$
246,066
 
$
131,736
 
               
Comprehensive income (loss):
             
Net income (loss)
   
9,281
   
(1,356
)
Change in net unrealized loss on securities available-for-sale,
             
net of reclassification adjustments and tax effects
   
(4,152
)
 
(2,146
)
Net loss on derivative instruments
   
(36
)
 
(8
)
Total comprehensive income (loss)
   
5,093
   
(3,510
)
               
Cash dividends declared ( $0.42 per share in 2006 and
             
$0.24 per share in 2005)
   
(3,613
)
 
(1,304
)
Treasury stock purchased/transferred
   
(2,279
)
 
(10,382
)
Exercise of stock options
   
1,655
   
914
 
Reissuance of treasury stock-other
   
1,608
   
905
 
Share-based compensation
   
120
   
-
 
Tax benefit from stock compensation
   
574
   
279
 
Change in unearned compensation
   
(974
)
 
380
 
Acquisition of Woronoco Bancorp, Inc.
   
-
   
111,915
 
Termination of Employee Stock Ownership Plan
   
-
   
13,564
 
               
               
Total stockholders' equity at end of period
 
$
248,250
 
$
244,497
 
               

See accompanying notes to consolidated financial statements.


5


BERKSHIRE HILLS BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

   
Six Months Ended June 30,
 
(In thousands)
 
2006
 
2005
 
Cash flows from operating activities:
             
Net income
 
$
9,281
 
$
(1,356
)
Adjustments to reconcile net income to net cash provided by
             
continuing operating activities :
             
Provision for loan losses
   
890
   
793
 
Depreciation, amortization, and deferrals, net
   
249
   
1,449
 
Share-based compensation and ESOP expense
   
756
   
8,789
 
Excess tax benefits from share-based payment arrangements
   
(574
)
 
(279
)
Increase in cash surrender value of bank-owned life insurance
   
(540
)
 
(403
)
Net gains on sales of securities and loans, net
   
(1,026
)
 
(2,568
)
Deferred income tax  (benefit) provision, net
   
(103
)
 
93
 
Net change in loans held for sale
   
2,093
   
(785
)
Net change in all other assets
   
(1,959
)
 
1,674
 
Net change in other liabilities
   
1,530
   
1,229
 
Net cash provided by continuing operating activities
   
10,597
   
8,636
 
Net cash provided by discontinued operating activities
   
359
   
-
 
Total net cash provided by operating activities
   
10,956
   
8,636
 
               
Cash flows from investing activities:
             
Sales of securities available for sale
   
17,243
   
122,755
 
Payments on securities available for sale
   
28,961
   
38,552
 
Purchases of securities available for sale
   
(14,209
)
 
(16,093
)
Payments on securities held to maturity
   
7,700
   
15,650
 
Purchases of securities held to maturity
   
(20,318
)
 
(8,633
)
Increase in loans, net
   
(135,803
)
 
(58,404
)
Capital expenditures
   
(3,617
)
 
(1,838
)
Proceeds from sale of fixed assets
   
370
   
-
 
Acquisition of Woronoco Bancorp, Inc. net of cash acquired
   
-
   
(21,316
)
Total net cash (used) provided by investing activities
   
(119,673
)
 
70,673
 
               
Cash flows from financing activities:
             
Net increase in deposits
   
92,285
   
17,279
 
Proceeds from Federal Home Loan Bank advances
   
177,014
   
387,512
 
Repayments of Federal Home Loan Bank advances
   
(161,766
)
 
(454,317
)
Treasury stock purchased
   
(2,279
)
 
(5,485
)
Proceeds from reissuance of treasury stock
   
3,263
   
1,819
 
Excess tax benefits from share-based payment arrangements
   
574
   
279
 
Cash dividends paid
   
(2,406
)
 
(1,304
)
Net cash provided (used) by financing activities
   
106,685
   
(54,217
)
               
Net change in cash and cash equivalents
   
(2,032
)
 
25,092
 
Cash and cash equivalents at beginning of period
   
31,087
   
17,902
 
Cash and cash equivalents at end of period
 
$
29,055
 
$
42,994
 
               
Supplemental cash flow information:
             
Interest paid on deposits
 
$
18,550
 
$
7,023
 
Interest paid on borrowed funds
   
7,765
   
5,503
 
Income taxes paid, net
   
1,239
   
2,952
 
Non-cash transfer of shares to treasury to pay-off ESOP loan
   
-
   
4,897
 
Fair value of non-cash assets acquired
   
-
   
827,780
 
Fair value of liabilities acquired
   
-
   
702,622
 
Fair value of common stock acquired
   
-
   
108,318
 
 
See accompanying notes to consolidated financial statements.
6


 

BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.      GENERAL

 
Basis of Presentation and Consolidation, and Use of Estimates
 
The consolidated financial statements include the accounts of Berkshire Hills Bancorp, Inc. ("Berkshire" or the "Company") and its wholly-owned subsidiaries including its principal wholly-owned subsidiary, Berkshire Bank (the "Bank"), but excluding its wholly-owned subsidiary Berkshire Hills Capital Trust I, which is accounted for using the equity method. The consolidated financial statements and notes thereto have been prepared in conformity with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. All significant intercompany transactions have been eliminated in consolidation. The results of operations for the three and six months ended June 30, 2006 are not necessarily indicative of the results which may be expected for the year as a whole or any other period.
 
The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, as of the date of the consolidated financial statements, and the reported amounts of revenues and expenses for the periods presented. Actual results could differ from those estimates. Material estimates that are susceptible to near-term changes include the determination of the allowance for loan losses and deferred tax accounts. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in Berkshire’s Annual Report on Form 10-K for the year ended December 31, 2005.
 
Business
 
Berkshire is a Delaware corporation and the holding company for Berkshire Bank, a state-chartered savings bank headquartered in Pittsfield, Massachusetts. The Company provides a variety of financial services to individuals, municipalities and businesses through its offices in Western Massachusetts and Northeastern New York. Its primary deposit products are checking accounts, NOW accounts, money market accounts, savings accounts, and time certificates of deposit accounts, and its primary lending products are residential and commercial mortgage loans, commercial loans, and automobile loans. The Company offers wealth management services including trust, financial planning, and investment services, as well as full-service insurance agency products.
 




 


7




BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

Earnings (loss) Per Common Share
 
Earnings (loss) per common share have been computed based on the following (average diluted shares outstanding are calculated using the treasury stock method):
 
   
Three Months Ended June 30,
 
Six Months Ended June 30,
 
   
2006
 
2005
 
2006
 
2005
 
(In thousands, except per share data)
                 
                   
Net income (loss)
 
$
4,463
 
$
(4,608
)
$
9,281
 
$
(1,356
)
                           
Average number of common shares outstanding
   
8,613
   
6,796
   
8,596
   
6,330
 
Adjustment for average unallocated SERP and ESOP shares
   
-
   
(407
)
 
-
   
(408
)
Less: average number of unvested stock award shares
   
(100
)
 
(132
)
 
(104
)
 
(140
)
Average number of basic shares outstanding
   
8,513
   
6,257
   
8,492
   
5,782
 
Plus: average number of unvested stock award shares
   
100
   
-
   
104
   
-
 
Plus: average number of dilutive shares based on stock options
   
147
   
-
   
162
   
-
 
Average number of diluted shares outstanding
   
8,760
   
6,257
   
8,758
   
5,782
 
                           
Basic earnings (loss) per share
 
$
0.52
 
$
(0.74
)
$
1.09
 
$
(0.23
)
Diluted earnings (loss) per share
 
$
0.51
 
$
(0.74
)
$
1.06
 
$
(0.23
)
                           
                           

Recent Accounting Pronouncements
 
On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment (Revised 2004)” (SFAS 123R). See Note 7 for further information on the Company’s share-based compensation plans.
 
In March 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 156, "Accounting for Servicing of Financial Assets" (SFAS 156). This statement amends SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities," with respect to the accounting for separately recognized servicing assets and servicing liabilities. Consistent with SFAS No. 140, SFAS 156 requires companies to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract. However, the statement permits a company to choose either the amortized cost method or fair value measurement method for each class of separately recognized servicing assets. This statement is effective as of the beginning of the company’s first fiscal year after September 15, 2006. The Company plans to adopt SFAS 156 at the beginning of 2007 and does not expect the adoption of this statement to have a material impact on its consolidated financial statements.
 
In June 2006, the FASB issued Financial Accounting Standards Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently analyzing the effects of FIN 48.
 




8




BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2.      SECURITIES

 
A summary of securities follows:
 

   
June 30, 2006  
 
   
Amortized
 
 Fair
 
   
Cost
 
 Value
 
(In thousands)
          
Securities Available for Sale
             
Debt securities:
             
U.S. Government agencies
 
$
59
 
$
54
 
Municipal bonds and obligations
   
63,903
   
62,658
 
Mortgage-backed securities
   
249,732
   
239,439
 
Other bonds and obligations
   
24,218
   
24,071
 
Total debt securities
   
337,912
   
326,222
 
               
Equity securities:
             
Federal Home Loan Bank stock
   
21,183
   
21,183
 
Other equity securities
   
3,918
   
5,917
 
Total equity securities
   
25,101
   
27,100
 
Total securities available for sale
   
363,013
   
353,322
 
               
Securities Held to Maturity
             
Municipal bonds and obligations
   
37,304
   
37,304
 
Mortgage-backed securities
   
5,220
   
5,030
 
Total securities held to maturity
   
42,524
   
42,334
 
               
Total securities
 
$
405,537
 
$
395,656
 
               
               
 
 
 December 31, 2005 
 
 
 
 Amortized 
   
Fair
 
 
 
 Cost 
   
Value
 
(In thousands)
             
Securities Available for Sale
             
Debt securities:
             
U.S. Government agencies
 
$
69
 
$
63
 
Municipal bonds and obligations
   
63,701
   
63,673
 
Mortgage-backed securities
   
264,705
   
258,504
 
Other bonds and obligations
   
24,356
   
24,703
 
Total debt securities
   
352,831
   
346,943
 
               
Equity securities:
             
Federal Home Loan Bank stock
   
36,717
   
36,717
 
Other equity securities
   
4,950
   
7,216
 
Total equity securities
   
41,667
   
43,933
 
Total securities available for sale
   
394,498
   
390,876
 
               
Securities Held to Maturity
             
Municipal bonds and obligations
   
23,851
   
23,851
 
Mortgage-backed securities
   
6,057
   
5,912
 
Total securities held to maturity
   
29,908
   
29,763
 
               
Total securities
 
$
424,406
 
$
420,639
 
               
 

9


BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

3.      LOANS

 
Loans consist of the following:
 
   
June 30, 2006
 
December 31, 2005
 
       
Percent
     
Percent
 
   
Balance
 
of total
 
Balance
 
of total
 
(Dollars in millions)
 
 
             
                   
Residential mortgages:
                         
1 - 4 family
 
$
535
   
34
 %
$
514
   
37
 %
Construction
   
34
   
2
   
35
   
2
 
Total residential mortgages
   
569
   
36
   
549
   
39
 
                           
Commercial mortgages:
                         
Construction
   
87
   
6
   
59
   
4
 
Single and multi-family
   
66
   
4
   
69
   
5
 
Other commercial real estate
   
322
   
21
   
283
   
20
 
Total commercial mortgages
   
475
   
31
   
411
   
29
 
                           
Commercial business loans
   
184
   
12
   
159
   
11
 
                           
Consumer loans:
                         
Auto
   
168
   
11
   
148
   
10
 
Home equity and other
   
155
   
10
   
149
   
11
 
Total consumer loans
   
323
   
21
   
297
   
21
 
                           
Total loans
 
$
1,551
   
100
 %
$
1,416
   
100
 %
                           

4.     LOAN LOSS ALLOWANCE AND NONACCRUAL LOANS

 
Activity in the allowance for loan losses is as follows:
 
   
Six Months Ended June 30,
 
   
2006
 
2005
 
(In thousands)
         
           
Balance at beginning of period
 
$
13,001
 
$
9,337
 
Provision for loan losses
   
890
   
793
 
Allowance attributed to acquired loans
   
-
   
3,321
 
Loans charged-off
   
(695
)
 
(719
)
Recoveries
   
341
   
312
 
               
Balance at end of period
 
$
13,537
 
$
13,044
 
               




10


BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The following is a summary of information pertaining to impaired and nonaccrual loans:

           
   
June 30, 2006
 
December 31, 2005
 
(In thousands)
         
           
Impaired loans with no valuation allowance
 
$
4,073
 
$
1,430
 
Impaired loans with a valuation allowance
   
348
   
484
 
Total impaired loans
 
$
4,421
 
$
1,914
 
               
Specific valuation allowance allocated to impaired loans
 
$
157
 
$
257
 
               
Total nonaccrual loans
 
$
772
 
$
1,186
 
               
Total loans past due ninety days or more and still accruing
 
$
20
 
$
110
 
               
               


 
5.     DEPOSITS

 
A summary of deposit balances, by type, is as follows:
 
   
June 30, 2006
 
December 31, 2005
 
       
Percent
     
Percent
 
   
Balance
 
of deposits
 
Balance
 
of deposits
 
(In millions)
                 
                   
Demand
 
$
188
   
13
 %
$
180
   
13
 %
NOW
   
137
   
9
   
149
   
11
 
Money market
   
274
   
19
   
245
   
18
 
Savings
   
207
   
14
   
222
   
16
 
Total non-maturity (core) deposits
   
806
   
55
   
796
   
58
 
                           
Time deposits less than 100 thousand
   
355
   
24
   
308
   
23
 
Time deposits 100 thousand or more
   
253
   
17
   
210
   
15
 
Brokered time deposits
   
50
   
4
   
57
   
4
 
Total time deposits
   
658
   
45
   
575
   
42
 
Total deposits
 
$
1,464
   
100
 %
$
1,371
   
100
 %
                           

 
6.     REGULATORY CAPITAL

 
The Bank’s actual and required capital ratios are as follows:
 
                 
FDIC Minimums
 
June 30, 2006
 
December 31, 2005
 
to be Well-Capitalized
                       
Total capital to risk weighted assets
 
10.5
%
   
11.1
%
   
10.0
%
                       
Tier 1 capital to risk weighted assets
 
9.6
     
10.2
     
6.0
 
                       
Tier 1 capital to average assets
 
7.9
     
7.8
     
5.0
 


11


BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

At each date shown, Berkshire Bank met the conditions to be classified as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios.
 
 
7.     SHARE-BASED COMPENSATION PLANS AND EMPLOYEE STOCK-OWNERSHIP PLAN

 
The Company has share-based compensation plans under which incentive and nonqualified stock options may be granted to certain employees and directors. The options are granted at an exercise price equal to the fair value of the underlying shares at the date of grant and have a contractual life of ten years. The options vest based on continued service with the Company in accordance with vesting periods which generally range from two to five years following the grant date. Restricted stock awards may also be granted under these compensation plans. The restricted stock awards generally have vesting periods ranging from two to five years, during which time the holder receives dividends and has full voting rights beginning on the grant date. Certain option and share awards provide for accelerated vesting if there is a change in control as defined in the compensation plans. The Company generally issues shares awarded under its share-based compensation plans from shares held in treasury. The Company’s share-based compensation plans are described more fully in Note 15 to the Company’s consolidated financial statements in its 2005 Form 10-K. The Company utilizes the Black-Scholes option pricing model to estimate the fair value of each option grant as of the date of the grant. Assumptions made in relation to prior grants have been previously disclosed in the Company’s prior filings.
 
The Company adopted Statement of Financial Accounting Standards No. 123R, Share-Based Payment (SFAS 123R), on January 1, 2006 using the “modified prospective” method. Under this method, awards that are granted, modified, or settled after December 31, 2005, are measured and accounted for in accordance with SFAS 123R. Also under this method, expense is recognized for awards that were granted prior to January 1, 2006 but vest after January 1, 2006, based on the fair value determined at the grant date under SFAS 123, Accounting for Stock-Based Compensation (SFAS 123). Prior to the adoption of SFAS 123R, the Company accounted for stock compensation under the intrinsic value method permitted by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) and related interpretations. Accordingly, the Company previously recognized no compensation cost for employee stock options that were granted with an exercise price equal to the market value of the underlying common stock on the date of grant.
 
As a result of applying the provisions of SFAS 123R during the three and six months ended June 30, 2006, the Company recognized additional stock-based compensation expense related to stock options of $36 thousand, or $31 thousand net of tax, and $120 thousand, or $101 thousand net of tax, respectively. The increase in stock-based compensation expense related to stock options, resulted in no change in both basic and diluted earnings per share during the three months ended June 30, 2006, and a $0.01 decrease in both basic and diluted earnings per share during the six months ended June 30, 2006. Cash flows from financing activities for the six months ended June 30, 2006 included $574 thousand in cash inflows from excess tax benefits related to stock compensation. Such cash flows were previously reported as operating activities.
 
 

 

12


 
A combined summary of activity in the Company’s stock award and stock option plans for the six months ended June 30, 2006 is presented in the following table:

 
           
Stock Options Outstanding
 
       
Non-vested
     
Weighted-
 
   
Shares
 
Stock
     
Average
 
   
Available
 
Awards
 
Number of
 
Exercise
 
   
for Grant
 
Outstanding
 
Shares
 
Price
 
Balance at December 31, 2005
   
307,592
   
112,752
   
790,984
 
$
19.79
 
                           
Granted
   
(47,600
)
 
47,600
   
-
   
-
 
Stock options exercised
   
-
   
-
   
(90,753
)
 
18.16
 
Shares vested
   
-
   
(62,720
)
 
-
   
-
 
Forfeited
   
5,100
   
(1,600
)
 
(3,500
)
 
22.30
 
Cancelled
   
-
   
-
   
-
   
-
 
                           
Balance at June 30, 2006
   
265,092
   
96,032
   
696,731
 
$
19.99
 
 
 
The total grant date fair value of unvested stock awards outstanding at December 31, 2005 was $2.73 million. For the six months ended June 30, 2006, there were 47,600 restricted stock awards granted.  These shares were valued at $33.78 per share, with a total grant date fair value of $1.61 million.  Stock awards vested during this period totaled 62,720 shares, with a total grant date fair value of $1.34 million.  At June 30, 2006, the total grant date fair value of unvested restricted stock awards was $2.94 million. Stock options vested during this period totaled 157,720 shares, with a total grant date fair value of $740 thousand. 
 
A summary of mid-year 2006 options outstanding is as follows:
 
   
Stock Options
 
   
Outstanding
 
Exercisable
 
           
Total number of shares
   
696,731
   
647,224
 
Weighted average exercise price
 
$
19.99
 
$
19.68
 
Aggregate intrinsic value (in thousands)
 
$
10,793
 
$
10,223
 
Weighted average remaining contractual term
   
5.8 years
   
5.7 years
 
               
 
 
Stock-based compensation expense totaled $336 thousand and $756 thousand during the three and six months ended June 30, 2006, respectively. Stock-based compensation expense is recognized ratably over the requisite service period for all awards. Unrecognized stock-based compensation expense related to stock options totaled $314 thousand at June 30, 2006. At such date, the weighted-average period over which this unrecognized expense is expected to be recognized was 1.7 years. Unrecognized stock-based compensation expense related to non-vested stock awards was $2.41 million at June 30, 2006. At such date, the weighted-average period over which this unrecognized expense was expected to be recognized was 2.1 years.
 
The following pro forma information presents net loss and loss per share for the three and six months ended June 30, 2005 as if the fair value method of SFAS 123R had been used to measure compensation cost for stock-based employee compensation expense.
 

13


 

   
Three Months Ended
 
Six Months Ended
 
(In thousands, except per share data)
 
June 30, 2005
 
June 30, 2005
 
Net loss as reported
 
$
(4,608
)
$
(1,356
)
               
Add: Stock-based employee compensation expense included
             
in reported net loss, net of related tax effects
   
237
   
461
 
               
Less: Total stock-based employee compensation expense
             
determined under fair value method for all awards, net of
             
related tax effects
   
(395
)
 
(769
)
Pro forma net loss
 
$
(4,766
)
$
(1,664
)
               
Loss per share:
             
Basic - as reported
 
$
(0.74
)
$
(0.23
)
Basic - pro forma
   
(0.76
)
 
(0.29
)
               
Diluted - as reported
   
(0.74
)
 
(0.23
)
Diluted - pro forma
   
(0.76
)
 
(0.29
)
               
 
 
During the six months ended June 30, 2006 and 2005, proceeds from stock option exercises totaled $1.66 million and $914 thousand, respectively. The total intrinsic value of these exercises was $1.39 million and $1.38 million in these periods, respectively. During the six months ended June 30, 2006 and 2005, 90,753 shares and 66,843 shares were issued in connection with stock option exercises, respectively. During the six months ended June 30, 2006 and 2005, all shares issued in connection with stock option exercises and stock awards were issued from available treasury stock.
 
The Bank had established an Employee Stock Ownership Plan, which was terminated by the Bank as of June 30, 2005. Total expense applicable to the termination of the plan was recorded in the amount of $8.67 million in the first six months of 2005. The effect on capital of this expense was offset by credits to unearned compensation and additional paid in capital in stockholders' equity. The Bank recorded an additional $168 thousand in expense related to the termination of the ESOP supplementary executive retirement plan. Total compensation expense applicable to the operation of the plan prior to its termination was $340 thousand in the first six months of 2005.
 
 

 

14



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

 
Management’s discussion and analysis of financial condition and results of operations is intended to assist in understanding the financial condition and results of operations of the Company. The following analysis discusses changes in the financial condition and results of operations at and for the three and six months ended June 30, 2006 and 2005, and should be read in conjunction with the Company’s consolidated financial statements and the notes thereto, appearing in Part I, Item 1 of this document. This discussion and analysis update should be read in conjunction with Management’s Discussion and Analysis included in the 2005 Annual Report on Form 10-K. In the following discussion, income statement comparisons are against the same period of the previous year and balance sheet comparisons are against the previous fiscal year-end, unless otherwise noted.
 
Forward-Looking Statements
 
This report contains forward-looking statements that are based on assumptions and may describe future plans, strategies and expectations of Berkshire Hills Bancorp, Inc. and Berkshire Bank. These forward-looking statements are generally identified by use of the words “believe,” “expect,” intend,” “anticipate,” “estimate,” “project,” or similar expressions. The Company and the Bank’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of Berkshire and its subsidiaries include, but are not limited to, changes in interest rates, national and regional economic conditions, legislative and regulatory changes, monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board, the quality and composition of the loan or investment portfolios, demand for loan products, deposit flows, competition, demand for financial services in the Bank’s market area, changes in real estate market values in the Bank’s market area, and changes in relevant accounting principles and guidelines. Additional factors that may affect our results are discussed in the Form 10-K and this Form 10-Q under Item 1A. Risk Factors. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on such statements. Except as required by applicable law or regulation, Berkshire does not undertake, and specifically disclaims any obligation to release publicly the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of the statements or to reflect the occurrence of anticipated or unanticipated events.
 
General
 
Berkshire Hills Bancorp, Inc. is the holding company for Berkshire Bank. Established in 1846, Berkshire Bank is one of Massachusetts' oldest and largest independent banks and the largest banking institution based in Western Massachusetts. The Bank is headquartered in Pittsfield, Massachusetts with branches serving communities throughout Western Massachusetts and Northeastern New York. The Bank is transitioning into a regional bank and positioning itself as the financial institution of choice in its retail and commercial markets, delivering exceptional customer service and a broad array of competitively priced deposit, loan, insurance, wealth management and trust services, and investment products.
 
Critical Accounting Policies
 
The Company’s significant accounting policies are described in Note 1 to the consolidated financial statements in the 2005 Form 10-K. Please see those policies in conjunction with this discussion. Critical accounting policies are those that contain significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. Management believes that the Company’s most critical accounting policies, which involve the most complex or subjective decisions or assessments, are as follows:
 
Allowance for Loan Losses. Arriving at an appropriate level of allowance for loan losses involves a high degree of judgment. The allowance for loan losses provides for probable losses based upon evaluations of known and inherent risks in the loan portfolio. Management uses historical information, as well as current economic data, to assess the adequacy of the allowance for loan losses as it is affected by changing economic conditions and various external factors, which may impact the portfolio in ways currently unforeseen. Although we believe that we use the appropriate information available to establish the allowance for loan losses, future additions to the allowance may be necessary if certain future events occur that cause actual results to differ from the assumptions used in making the

15


evaluation. For example, a downturn in the local economy could cause an increase in non-performing loans. Additionally, a decline in real estate values could cause some of our loans to become inadequately collateralized. In either case, this may require us to increase our provision for loan losses, which would negatively impact earnings. The allowance for loan losses discussion in Item 1 of the 2005 Form 10-K provides additional information about the allowance.

Income Taxes. Management considers accounting for income taxes as a critical accounting policy due to the subjective nature of certain estimates that are involved in the calculation and evaluation of the timing and recognition of resulting tax liabilities and assets. Management uses the asset and liability method of accounting for income taxes in which deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. Management must assess the realizability of the deferred tax asset and to the extent that management believes that recovery is not likely, a valuation allowance is established. Adjustments to increase or decrease the valuation allowance are generally charged or credited, respectively, to income tax expense.

Goodwill and Identifiable Intangible Assets. In conjunction with the acquisition of Woronoco Bancorp in 2005, goodwill was recorded as an intangible asset equal to the excess of the purchase price over the estimated fair value of the net assets acquired. Other intangible assets were recorded for the fair value of core deposits and non-compete agreements. The valuation techniques used by management to determine the carrying value of assets acquired in the acquisition and the estimated lives of identifiable intangible assets involve estimates for discount rates, projected future cash flows, and time period calculations, all of which are susceptible to change based on changes in economic conditions and other factors. Future events or changes in the estimates which were used to determine the carrying value of goodwill and identifiable intangible assets or which otherwise adversely affect their value or estimated lives could have a material adverse impact on future results of operations.

Impact of New Accounting Pronouncements
 
Please refer to the note on Recent Accounting Pronouncements in Note 1 to the financial statements of this report for a detailed discussion of new accounting pronouncements.
 

 

16


Selected Financial Data
 
The following summary data is based in part on the consolidated financial statements and accompanying notes, and other information appearing elsewhere in this Form 10-Q. Historical data is also based in part on, and should be read in conjunction with, the Company’s prior filings with the SEC. Data includes the impact of the acquisition of Woronoco Bancorp on June 1, 2005 and the termination of the Employee Stock Ownership Plan on June 30, 2005.
 
   
At or for the Three Months Ended
 
At or for the Six Months Ended
 
   
June 30,
 
June 30,
 
   
2006
 
2005
 
2006
 
2005
 
Per Share:
                         
Earnings (loss) - diluted
 
$
0.51
 
$
(0.74
)
$
1.06
 
$
(0.23
)
Dividends declared
   
0.28
   
0.12
   
0.42
   
0.24
 
Book value
   
28.79
   
28.45
   
28.79
   
28.45
 
Tangible book value
   
17.30
   
16.56
   
17.30
   
16.56
 
Common stock price:
                         
High
   
36.39
   
34.90
   
36.39
   
37.64
 
Low
   
32.77
   
30.97
   
32.37
   
30.97
 
Close
   
35.48
   
33.32
   
35.48
   
33.32
 
                           
Operating and Financial Ratios:
                         
Return (loss) on average assets
   
0.85
%
 
(1.19
)%
 
0.90
%
 
(0.20
)%
Return (loss) on average equity
   
7.00
   
(11.26
)
 
7.36
   
(1.88
)
Net interest margin
   
3.16
   
3.26
   
3.21
   
3.30
 
Stockholders' equity/total assets
   
11.56
   
11.80
   
11.56
   
11.80
 
Tangible stockholders' equity/tangible assets
   
7.28
   
7.25
   
7.28
   
7.25
 
                           
Annualized Year-To-Date Growth:
                         
Total loans
   
28
%   
262
%   
19
%   
142
%
Total deposits
   
4
   
216
   
14
   
109
 
                           
At Period End: (In millions)
                         
Total assets
 
$
2,148
 
$
2,067
 
$
2,148
 
$
2,067
 
Total loans
   
1,551
   
1,416
   
1,551
   
1,416
 
Other earning assets
   
397
   
445
   
397
   
445
 
Total intangible assets
   
99
   
102
   
99
   
102
  
Deposits
   
1,464
   
1,306
   
1,464
   
1,306
 
Borrowings and debentures
   
428
   
504
   
428
   
504
 
Stockholders' equity
   
248
   
244
   
248
   
244
 
                           
For the Period: (In thousands)
                         
Net interest income
 
$
14,458
 
$
11,508
 
$
29,066
 
$
21,540
 
Provision for loan losses
   
600
   
300
   
890
   
793
 
Non-interest income
   
3,910
   
3,916
   
8,000
   
6,656
 
Non-interest expense
   
11,638
   
18,061
   
22,862
   
25,598
 
Net income (loss)
   
4,463
   
(4,608
)
 
9,281
   
(1,356
)
                           
Asset Quality Ratios:
                         
Net charge-offs (annualized)/average loans
   
0.04
%
 
0.08
%
 
0.05
%
 
0.08
%
Loan loss allowance/total loans
   
0.87
   
0.92
   
0.87
   
0.92
 
Non-performing assets/total assets
   
0.04
   
0.08
   
0.04
   
0.08
 
______________________________________________
(1)   All operating ratios are based on average balance sheet amounts where applicable.
(2)   Tangible equity or book value is total stockholders' equity less goodwill and other intangible assets. Tangible assets are total assets less goodwill and other intangible assets.
(3)   No revenue was recorded in the second quarter of 2006 for the Federal Home Loan Bank dividend due to a change in the dividend declaration schedule.
(4)   Results for 2005 include non-cash charges totaling $8.7 million for the termination of the Employee Stock Ownership Plan and other non-recurring expenses consisting of merger and systems conversion charges related to the Woronoco acquisition.
 
 

17


Average Balances, Interest and Average Yields/Cost
 
The following table presents an analysis of average rates and yields on a fully taxable equivalent basis for the periods included.
 
   
Three Months Ended June 30,
 
 Six Months Ended June 30,
 
   
2006
 
2005
 
 2006
 
2005
 
   
Average
 
Yield/Rate
 
Average
 
Yield/Rate
 
 Average
 
Yield/Rate
 
Average
 
Yield/Rate
 
(Dollars in millions)
 
Balance
 
(FTE basis)
 
Balance
 
(FTE basis)
 
 Balance
 
(FTE basis)
 
Balance
 
(FTE basis)
 
Assets
                                                 
Loans
                                                 
Residential mortgages
 
$
561
   
5.19
%
$
353
   
5.04
%
$
558
   
5.14
%
$
297
   
5.07
%
Commercial mortgages
   
450
   
7.32
   
315
   
6.34
   
440
   
7.28
   
296
   
6.15
 
Commercial business loans
   
162
   
8.07
   
154
   
6.51
   
157
   
7.78
   
147
   
6.47
 
Consumer loans
   
313
   
6.74
   
225
   
5.87
   
305
   
6.68
   
204
   
5.77
 
Total loans
   
1,486
   
6.46
   
1,047
   
5.83
   
1,460
   
6.34
   
944
   
5.79
 
                                                   
Securities
   
408
   
4.59
   
394
   
4.40
   
414
   
4.75
   
395
   
4.41
 
Short-term investments
   
1
   
4.94
   
2
   
2.91
   
1
   
4.70
   
2
   
2.80
 
Total earning assets
   
1,895
   
6.07
   
1,443
   
5.44
   
1,875
   
6.03
   
1,341
   
5.38
 
Intangible assets
   
99
         
39
         
99
         
22
       
Other assets
   
95
         
82
         
92
         
75
       
Total assets
 
$
2,089
       
$
1,564
       
$
2,066
       
$
1,438
       
                                                   
Liabilities and stockholders' equity
                                                 
Deposits
                                                 
NOW
 
$
140
   
1.02
%
$
113
   
0.18
%
$
141
   
1.01
%
$
104
   
0.18
%
Money Market
   
284
   
3.36
   
183
   
1.98
   
277
   
3.24
   
171
   
1.82
 
Savings
   
208
   
0.78
   
192
   
1.03
   
213
   
0.77
   
178
   
1.02
 
Time
   
644
   
4.17
   
385
   
2.99
   
627
   
4.02
   
352
   
2.95
 
Total interest-bearing deposits
   
1,276
   
3.09
   
873
   
1.98
   
1,258
   
2.96
   
805
   
1.92
 
Borrowings and debentures
   
380
   
4.13
   
387
   
3.65
   
380
   
4.04
   
359
   
3.46
 
Total interest-bearing liabilities
   
1,656
   
3.33
   
1,260
   
2.50
   
1,638
   
3.23
   
1,164
   
2.40
 
Non-interest-bearing demand deposits
   
172
         
130
         
170
         
119
       
Other liabilities
   
6
         
9
         
6
         
7
       
Total liabilities
   
1,834
         
1,399
         
1,814
         
1,290
       
Stockholders' equity
   
255
         
165
         
252
         
148
       
Total liabilities and equity
 
$
2,089
       
$
1,564
       
$
2,066
       
$
1,438
       
                                                   
Interest rate spread
         
2.74
%
       
2.94
%
       
2.80
%
       
2.98
%
Net interest margin
         
3.16
%
       
3.26
%
       
3.21
%
       
3.30
%
                                                   
Supplementary Data
                                                 
Cost of funds
         
3.02
%
       
2.24
%
       
2.92
%