Form 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q


(Mark One)

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

For the quarterly period ended September 30, 2006

OR

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 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 ý No o

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 o Accelerated filer ý Non-accelerated filer o 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes o No ý 

The Registrant had 8,693,945 shares of common stock, par value $0.01 per share, outstanding as of November 2, 2006.



1




BERKSHIRE HILLS BANCORP, INC.
FORM 10-Q

INDEX

 
 
Page
 
     
 
     
 
3
     
 
4
 
   
 
5
 
   
 
6
 
 
 
 
7
     
16
 
   
 
18
     
 
19
     
27
     
28
     
 
 
   
29
     
29
     
33
     
34
     
34
     
34
     
34
     
 
35



 

2


BERKSHIRE HILLS BANCORP, INC.
CONSOLIDATED BALANCE SHEETS



   
September 30,
 
December 31,
 
   
2006
 
2005
 
(In thousands, except share data)
         
Assets
             
Cash and due from banks
 
$
25,371
 
$
30,977
 
Short-term investments
   
199
   
110
 
Total cash and cash equivalents
   
25,570
   
31,087
 
               
Due from broker
   
95,022
   
1,425
 
               
Securities available for sale, at fair value
   
251,859
   
390,876
 
Securities held to maturity, at amortized cost
   
39,957
   
29,908
 
               
Total loans
   
1,629,083
   
1,416,449
 
Less: Allowance for loan losses
   
(19,153
)
 
(13,001
)
Net loans
   
1,609,930
   
1,403,448
 
               
Premises and equipment, net
   
27,944
   
26,236
 
Accrued interest receivable
   
9,395
   
8,508
 
Goodwill
   
88,594
   
88,092
 
Other intangible assets
   
10,071
   
11,524
 
Bank-owned life insurance
   
19,602
   
19,002
 
Cash surrender value - other life insurance
   
10,445
   
11,503
 
Other assets
   
16,708
   
13,944
 
Total assets
 
$
2,205,097
 
$
2,035,553
 
               
Liabilities and Stockholders' Equity
             
Deposits
 
$
1,488,101
 
$
1,371,218
 
Borrowings
   
441,216
   
397,453
 
Junior subordinated debentures
   
15,464
   
15,464
 
Other liabilities
   
5,615
   
5,352
 
Total liabilities
   
1,950,396
   
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
   
200,160
   
198,667
 
Unearned compensation
   
(2,109
)
 
(1,435
)
Retained earnings
   
102,783
   
99,429
 
Accumulated other comprehensive income (loss)
   
782
   
(2,239
)
Treasury stock, at cost (1,911,131 shares in 2006
             
and 2,060,604 in 2005)
   
(47,021
)
 
(48,462
)
Total stockholders' equity
   
254,701
   
246,066
 
               
Total liabilities and stockholders' equity
 
$
2,205,097
 
$
2,035,553
 
               

See accompanying notes to consolidated financial statements.

 

3


BERKSHIRE HILLS BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
 

   
Three Months Ended
 
Nine Months Ended
 
   
September 30,
 
September 30,
 
(In thousands, except per share data)
 
2006
 
2005
 
2006
 
2005
 
Interest and dividend income
                         
Loans
 
$
26,388
 
$
21,149
 
$
72,761
 
$
48,282
 
Securities
   
4,985
   
4,628
   
13,862
   
12,839
 
Short-term investments
   
15
   
62
   
47
   
98
 
Total interest and dividend income
   
31,388
   
25,839
   
86,670
   
61,219
 
Interest expense
                         
Deposits
   
10,766
   
5,979
   
29,365
   
13,689
 
Borrowings
   
5,019
   
4,806
   
12,636
   
10,951
 
Total interest expense
   
15,785
   
10,785
   
42,001
   
24,640
 
                           
Net interest income
   
15,603
   
15,054
   
44,669
   
36,579
 
Provision for loan losses
   
6,185
   
204
   
7,075
   
998
 
Net interest income, after provision for loan losses
   
9,418
   
14,850
   
37,594
   
35,581
 
                           
Non-interest income
                         
Deposit fees
   
1,334
   
1,439
   
4,003
   
3,087
 
Wealth management fees
   
882
   
680
   
2,410
   
2,013
 
Insurance fees
   
623
   
472
   
2,112
   
679
 
Loan fees
   
209
   
179
   
560
   
560
 
Increase in cash surrender value of life insurance
   
227
   
245
   
767
   
648
 
(Loss) gain recognized on securities, net
   
(5,080
)
 
832
   
(4,054
)
 
2,649
 
Gain on sale of loans and securitized loans, net
   
-
   
22
   
-
   
773
 
Other
   
21
   
86
   
419
   
217
 
Total non-interest income
   
(1,784
)
 
3,955
   
6,217
   
10,626
 
                           
Non-interest expense
                         
Salaries and benefits
   
6,001
   
5,699
   
17,412
   
14,524
 
Occupancy and equipment
   
1,885
   
1,655
   
5,638
   
4,006
 
Marketing and advertising
   
403
   
372
   
996
   
732
 
Data processing and telecommunications
   
853
   
736
   
2,550
   
1,718
 
Professional services
   
376
   
590
   
1,311
   
1,376
 
Foreclosed real estate and other loans, net
   
58
   
241
   
195
   
557
 
Amortization of intangible assets
   
478
   
481
   
1,434
   
667
 
Other recurring non-interest expense
   
1,299
   
998
   
4,295
   
3,159
 
Termination of Employee Stock Ownership Plan
   
-
   
-
   
-
   
8,667
 
Other non-recurring expense
   
-
   
828
   
385
   
1,791
 
Total non-interest expense
   
11,353
   
11,600
   
34,216
   
37,197
 
                           
(Loss) income from continuing operations before income taxes
   
(3,719
)
 
7,205
   
9,595
   
9,010
 
Income tax (benefit) expense
   
(1,466
)
 
2,459
   
2,788
   
5,621
 
Net (loss) income from continuing operations
   
(2,253
)
 
4,746
   
6,807
   
3,389
 
                           
Income from discontinued operations before income taxes
   
217
   
-
   
576
   
-
 
Income tax expense
   
84
   
-
   
222
   
-
 
Net income from discontinued operations
   
133
   
-
   
354
   
-
 
Net (loss) income
 
$
(2,120
)
$
4,746
 
$
7,161
 
$
3,389
 
                           
(Loss) earnings per share
                         
Basic
 
$
(0.25
)
$
0.56
 
$
0.84
 
$
0.51
 
Diluted
 
$
(0.25
)
$
0.54
 
$
0.82
 
$
0.48
 
Average shares outstanding
                         
Basic
   
8,557
   
8,456
   
8,516
   
6,683
 
Diluted
   
8,557
   
8,856
   
8,775
   
7,061
 
                           
 
See accompanying notes to consolidated financial statements.

4


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


   
Nine Months Ended September 30,
 
   
2006
 
2005
 
(In thousands)
         
           
Total stockholders' equity at beginning of period
 
$
246,066
 
$
131,736
 
               
Comprehensive income (loss):
             
Net income
   
7,161
   
3,389
 
Change in net unrealized gain (loss) on securities available-for-sale,
             
net of reclassification adjustments and tax effects
   
3,042
   
(3,772
)
Net loss on derivative instruments
   
(21
)
 
(42
)
Total comprehensive income (loss)
   
10,182
   
(425
)
               
Cash dividends declared ( $0.42 per share in 2006 and
             
$0.38 per share in 2005)
   
(3,617
)
 
(2,508
)
Treasury stock purchased/transferred
   
(2,356
)
 
(11,893
)
Exercise of stock options
   
2,761
   
1,326
 
Reissuance of treasury stock-other
   
1,608
   
905
 
Share-based compensation
   
157
   
-
 
Tax benefit from stock compensation
   
574
   
279
 
Change in unearned compensation
   
(674
)
 
738
 
Acquisition of Woronoco Bancorp, Inc.
   
-
   
111,915
 
Termination of Employee Stock Ownership Plan
   
-
   
13,564
 
               
               
Total stockholders' equity at end of period
 
$
254,701
 
$
245,637
 
               
 
See accompanying notes to consolidated financial statements.


5


BERKSHIRE HILLS BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
 

   
Nine Months Ended September 30,
 
(In thousands)
 
2006
 
2005
 
Cash flows from operating activities:
             
Net income
 
$
7,161
 
$
3,389
 
Adjustments to reconcile net income to net cash provided by
             
continuing operating activities :
             
Provision for loan losses
   
7,075
   
998
 
Depreciation, amortization, and deferrals, net
   
639
   
3,203
 
Share-based compensation and ESOP expense
   
1,093
   
8,789
 
Excess tax benefits from share-based payment arrangements
   
(574
)
 
(279
)
Increase in cash surrender value of bank-owned life insurance
   
(767
)
 
(600
)
Net losses (gains) on sales of securities and loans, net
   
4,054
   
(3,422
)
Deferred income tax (benefit) provision, net
   
(1,653
)
 
1,129
 
Net change in loans held for sale
   
2,093
   
(799
)
Net change in all other assets
   
(4,539
)
 
4,570
 
Net change in other liabilities
   
263
   
(5,241
)
Net cash provided by continuing operating activities
   
14,845
   
11,737
 
Net cash provided by discontinued operating activities
   
576
   
-
 
Total net cash provided by operating activities
   
15,421
   
11,737
 
               
Cash flows from investing activities:
             
Sales of securities available for sale
   
20,671
   
126,653
 
Payments on securities available for sale
   
41,422
   
61,259
 
Purchases of securities available for sale
   
(14,351
)
 
(27,336
)
Payments on securities held to maturity
   
12,886
   
20,771
 
Purchases of securities held to maturity
   
(22,941
)
 
(17,801
)
Increase in loans, net
   
(214,323
)
 
(58,308
)
Capital expenditures
   
(4,288
)
 
(3,464
)
Proceeds from sale of loans
   
-
   
3,635
 
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
   
(180,554
)
 
84,093
 
               
Cash flows from financing activities:
             
Net increase in deposits
   
116,883
   
59,431
 
Proceeds from Federal Home Loan Bank advances
   
257,014
   
504,285
 
Repayments of Federal Home Loan Bank advances
   
(213,251
)
 
(654,406
)
Proceeds from junior subordinated debentures
   
-
   
15,464
 
Treasury stock purchased
   
(2,356
)
 
(6,996
)
Proceeds from reissuance of treasury stock
   
4,369
   
2,231
 
Excess tax benefits from share-based payment arrangements
   
574
   
279
 
Cash dividends paid
   
(3,617
)
 
(2,508
)
Net cash provided (used) by financing activities
   
159,616
   
(82,220
)
               
Net change in cash and cash equivalents
   
(5,517
)
 
13,610
 
Cash and cash equivalents at beginning of period
   
31,087
   
17,902
 
Cash and cash equivalents at end of period
 
$
25,570
 
$
31,512
 
               
Supplemental cash flow information:
             
Interest paid on deposits
 
$
29,343
 
$
12,933
 
Interest paid on borrowed funds
   
11,838
   
10,391
 
Income taxes paid, net
   
1,627
   
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 nine months ended September 30, 2006 are not necessarily indicative of the results which may be expected for the year as a whole.
 
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, deferred tax assets and liabilities, and the carrying value of goodwill and other intangible assets. 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, NOW, money market, savings, and time certificates of deposit accounts, and its primary lending products are residential mortgage, commercial mortgage, commercial business, and consumer 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 Per Common Share
 
Earnings per common share have been computed based on the following (average diluted shares outstanding are calculated using the treasury stock method):
 

   
Three Months Ended
 
Nine Months Ended
 
   
September 30,
 
September 30,
 
   
2006
 
2005
 
2006
 
2005
 
(In thousands, except per share data)
                 
                   
Net (loss) income
 
$
(2,120
)
$
4,746
 
$
7,161
 
$
3,389
 
                           
Average number of common shares outstanding
   
8,657
   
8,588
   
8,616
   
7,091
 
Adjustment for average unallocated SERP and ESOP shares
   
-
   
-
   
-
   
(271
)
Less: average number of unvested stock award shares
   
(100
)
 
(132
)
 
(100
)
 
(137
)
Average number of basic shares outstanding
   
8,557
   
8,456
   
8,516
   
6,683
 
Plus: average number of unvested stock award shares
   
-
   
132
   
100
   
137
 
Plus: average number of dilutive shares based on stock options
   
-
   
268
   
159
   
241
 
Average number of diluted shares outstanding
   
8,557
   
8,856
   
8,775
   
7,061
 
                           
Basic (loss) earnings per share
 
$
(0.25
)
$
0.56
 
$
0.84
 
$
0.51
 
Diluted (loss) earnings per share
 
$
(0.25
)
$
0.54
 
$
0.82
 
$
0.48
 
                           
 
Recent Accounting Pronouncements
 
On January 1, 2006, the Company adopted Statement of Financial Accounting Standards 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 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 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 a company’s first fiscal year after September 15, 2006. Earlier adoption is permitted as of the beginning of an entity's fiscal year, provided the entity has not yet issued financial statements, including interim financial statements. 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 September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, "Fair Value Measurements" (SFAS 157). This statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective for the Company on January 1, 2008 and is not expected to have a significant impact on the Company's 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 enterprises’ 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.

8


BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
 
FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently analyzing the effects of FIN 48.
 
On September 13, 2006, the Securities and Exchange Commission “SEC” issued Staff Accounting Bulletin No. 108 (“SAB 108”). SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB 108, Companies might evaluate the materiality of financial statement misstatements using either the income statement or balance sheet approach, with the income statement approach focusing on new misstatements added in the current year, and the balance sheet approach focusing on the cumulative amount of misstatement present in a company’s balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach, and not be corrected. SAB 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. SAB 108 will be applicable to all financial statements issued by the Company after November 15, 2006. The Company does not expect that SAB 108 will have a significant impact on the reported results of operations or financial condition.
 
On September 20, 2006, the FASB ratified EITF 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements” (EITF 06-4). This issue addresses accounting for split-dollar life insurance arrangements after the employer purchases a life insurance policy on the covered employee. This EITF states that an obligation arises as a result of a substantive agreement with an employee to provide future postretirement benefits. Under EITF 06-4, the obligation is not settled upon entering into an insurance arrangement. Since the obligation is not settled, a liability should be recognized in accordance with applicable authoritative guidance. EITF 06-4 is effective for fiscal years beginning after December 15, 2007. The adoption of EITF 06-4 is not expected to have a material effect on the Company’s financial statements.
 
Also on September 20, 2006, the FASB ratified EITF 06-5, “Accounting for Purchases of Life Insurance—Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance.” This issue addresses how an entity should determine the amount that could be realized under the insurance contract at the balance sheet date in applying FTB 85-4 and if the determination should be on an individual or group policy basis. EITF 06-5 is effective for fiscal years beginning after December 15, 2006. The adoption of EITF 06-5 is not expected to have a material effect on the Company’s financial statements.
 


 

9


BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2.    
SECURITIES
 
A summary of securities follows. The $1,849,000 loss on mortgage-backed securities held for sale was recorded in the income statement in the quarter ended September 30, 2006.
 
            
   
September 30, 2006  
 
            
   
Amortized
 
 Fair
 
   
Cost
 
 Value
 
(In thousands)
          
Securities Available for Sale
             
Debt securities:
             
U.S. Government agencies
 
$
-
 
$
-
 
Municipal bonds and obligations
   
63,846
   
64,417
 
Mortgage-backed securities, held for sale
   
73,862
   
72,012
 
Mortgage-backed securities, other
   
64,716
   
63,836
 
Other bonds and obligations
   
23,778
   
24,106
 
Total debt securities
   
226,202
   
224,371
 
               
Equity securities:
             
Federal Home Loan Bank stock
   
21,835
   
21,835
 
Other equity securities
   
4,495
   
5,653
 
Total equity securities
   
26,330
   
27,488
 
Total securities available for sale
   
252,532
   
251,859
 
               
Securities Held to Maturity
             
Municipal bonds and obligations
   
35,213
   
35,213
 
Mortgage-backed securities
   
4,744
   
4,529
 
Total securities held to maturity
   
39,957
   
39,742
 
               
Total securities
 
$
292,489
 
$
291,601
 
               
               
            
   
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
 
               

10


BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

3.    
LOANS
 
Loans consisted of the following:
 

   
September 30, 2006
 
December 31, 2005
 
       
Percent
     
Percent
 
   
Balance
 
of total
 
Balance
 
of total
 
(Dollars in millions)
                 
                   
Residential mortgages:
                         
1 - 4 family
 
$
553
   
34
%
$
514
   
37
%
Construction
 
 
32
   
2
   
35
   
2
 
Total residential mortgages
   
585
   
36
   
549
   
39
 
                           
Commercial mortgages:
                         
Construction
   
116
   
7
   
59
   
4
 
Single and multi-family
   
67
   
4
   
69
   
5
 
Other commercial real estate
   
334
   
21
   
283
   
20
 
Total commercial mortgages
   
517
   
32
   
411
   
29
 
                           
Commercial business loans
   
194
   
12
   
159
   
11
 
                           
Consumer loans:
                         
Auto
   
181
   
11
   
148
   
10
 
Home equity and other
   
152
   
9
   
149
   
11
 
Total consumer loans
   
333
   
20
   
297
   
21
 
                           
Total loans
 
$
1,629
   
100
%
$
1,416
   
100
%
                           


4.    
LOAN LOSS ALLOWANCE
 
Activity in the allowance for loan losses was as follows:
 

   
Nine Months Ended September 30,
 
           
   
2006
 
2005
 
(In thousands)
         
           
Balance at beginning of period
 
$
13,001
 
$
9,337
 
Provision for loan losses
   
7,075
   
998
 
Allowance attributed to acquired loans
   
-
   
3,321
 
Reclassification of commitment reserve to other liabilities
   
(425
)
 
-
 
Loans charged-off
   
(1,022
)
 
(1,003
)
Recoveries
   
524
   
470
 
               
Balance at end of period
 
$
19,153
 
$
13,123
 
               

In prior periods, the Company’s loan loss allowance included a reserve for credit losses related to off-balance sheet credit commitments. During the third quarter of 2006, the Company transferred this reserve to other liabilities in the statement of financial condition.
 

11


BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


5.    
DEPOSITS
 
A summary of deposit balances, by type, was as follows:
 
   
September 30, 2006
 
December 31, 2005
 
       
Percent
     
Percent
 
   
Balance
 
of deposits
 
Balance
 
of deposits
 
(In millions)
                 
                   
Demand
 
$
178
   
12
%
$
180
   
13
%
NOW
   
139
   
9
   
149
   
11
 
Money market
   
282
   
19
   
245
   
18
 
Savings
   
209
   
14
   
222
   
16
 
Total non-maturity (core) deposits
   
808
   
54
   
796
   
58
 
                           
Time deposits less than 100 thousand
   
364
   
24
   
308
   
23
 
Time deposits 100 thousand or more
   
269
   
18
   
210
   
15
 
Brokered time deposits
   
47
   
4
   
57
   
4
 
Total time deposits
   
680
   
46
   
575
   
42
 
Total deposits
 
$
1,488
   
100
%
$
1,371
   
100
%
                           
 
6.    
REGULATORY CAPITAL
 
The Bank’s actual and required capital ratios were as follows:
 
           
FDIC Minimums 
 
   
September 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
   
9.3
   
10.2
   
6.0
 
                     
Tier 1 capital to average assets
   
7.5
   
7.8
   
5.0
 
                     

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.


12


BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

7.    
SHARE-BASED COMPENSATION PLANS
 
The Company has share-based compensation plans under which incentive and nonqualified stock options may be granted periodically 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 date of the grant. 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. 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 consolidated financial statements in the 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 2005 Form 10-K and prior Forms 10-K.
 
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 unvested awards that were granted prior to January 1, 2006, based on the fair value determined at the grant date under SFAS No. 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 nine months ended September 30, 2006, the Company recognized additional stock-based compensation expense related to stock options of $37 thousand, or $32 thousand net of tax, and $157 thousand, or $134 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 September 30, 2006 and a $0.02 decrease in both basic and diluted earnings per share during the nine months ended September 30, 2006. Cash flows from financing activities for the nine months ended September 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.
 
A combined summary of activity in the Company’s stock award and stock option plans for the nine months ended September 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
   
-
   
-
   
(160,671
)
 
17.18
 
Shares vested
   
-
   
(62,720
)
 
-
   
-
 
Forfeited
   
5,100
   
(1,600
)
 
(3,500
)
 
22.30
 
Cancelled
   
-
   
-
   
-
   
-
 
                           
Balance at September 30, 2006
   
265,092
   
96,032
   
626,813
 
$
20.45
 
                           

13


BERKSHIRE HILLS BANCORP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
The total grant date fair value of unvested stock awards outstanding at December 31, 2005 was $2.73 million. For the nine months ended September 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 September 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 options outstanding at September 30, 2006 is as follows:
 

   
Stock Options
 
   
Outstanding
 
Exercisable
 
           
Total number of shares
   
626,813
   
577,306
 
Weighted average exercise price
 
$
20.45
 
$
20.14
 
Aggregate intrinsic value (in thousands)
 
$
9,493
 
$
8,921
 
Weighted average remaining contractual term
   
5.9
 years   
5.8
 years 
               
 
Stock-based compensation expense totaled $337 thousand and $1.09 million during the three and nine months ended September 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 $276 thousand at September 30, 2006. At such date, the weighted-average period over which this unrecognized expense is expected to be recognized was 1.4 years. Unrecognized stock-based compensation expense related to non-vested, non-option stock awards was $2.11 million at September 30, 2006. At such date, the weighted-average period over which this unrecognized expense was expected to be recognized was 1.8 years.
 
 The following pro forma information presents net income and earnings per share for the three and nine months ended September 30, 2005 as if the fair value method of SFAS 123R had been used to measure compensation cost for stock-based compensation expense.
 

   
Three Months Ended
 
Nine Months Ended
 
(In thousands, except per share data)
 
September 30, 2005
 
September 30, 2005
 
Net income as reported
 
$
4,746
 
$
3,389
 
               
Add: Stock-based employee compensation expense included
             
in reported net income, net of related tax effects
   
216
   
677
 
               
Less: Total stock-based employee compensation expense
             
determined under fair value method for all awards, net of
             
related tax effects
   
(324
)
 
(1,002
)
Pro forma net income
 
$
4,638
 
$
3,064
 
               
Income per share:
             
Basic - as reported
 
$
0.56
 
$
0.51
 
Basic - pro forma
   
0.55
   
0.46
 
               
Diluted - as reported
   
0.54
   
0.48
 
Diluted - pro forma
   
0.52
   
0.43
 
               
 
During the nine months ended September 30, 2006 and 2005, proceeds from stock option exercises totaled $2.76 million and $1.33 million, respectively. During these periods, 160,671 shares and 97,443 shares, respectively, were issued in connection with stock option exercises. During the nine months ended September 30, 2006 and 2005, all shares issued in connection with stock option exercises and non-vested, non-option stock awards were issued from available treasury stock.

14


 
The Bank maintained 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 supplemental 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.
 
 
 
 
 
 

15



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 nine months ended September 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. This document may include forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements, which are based on certain assumptions and describe future plans, strategies, and expectations of the Company, are generally identified by use of the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “seek,” “strive,” “try,” or future or conditional verbs such as “will,” “would,” “should,” “could,” “may,” or similar expressions. Although we believe that our plans, intentions and expectations, as reflected in these forward-looking statements are reasonable, we can give no assurance that these plans, intentions or expectations will be achieved or realized. Our ability to predict results or the actual effects of our plans and strategies are inherently uncertain. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained in this Form 10-Q. Important factors that could cause actual results to differ materially from our forward-looking statements are set forth under Item 1A. - “Risk Factors” in our most recent annual report on Form 10-K, in Part II, Item 1A. - “Risk Factors” in this Form 10-Q, and in other reports filed with the Securities and Exchange Commission. There are a number of factors, many of which are beyond our control, that could cause actual conditions, events, or results to differ significantly from those described in the forward-looking statements. These factors include, but are not limited to: general economic conditions, either nationally or locally in some or all of the areas in which we conduct our business; conditions in the securities markets or the banking industry; changes in interest rates and energy prices, which may affect our net income or future cash flows; changes in deposit flows, and in demand for deposit, loan, and investment products and other financial services in our local markets; changes in real estate values, which could impact the quality of the assets securing our loans; changes in the quality or composition of the loan or investment portfolios; changes in competitive pressures among financial institutions or from non-financial institutions; the ability to successfully integrate any assets, liabilities, customers, systems, and management personnel we may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames; our timely development of new and competitive products or services in a changing environment, and the acceptance of such products or services by our customers; the outcome of pending or threatened litigation or of other matters before regulatory agencies, whether currently existing or commencing in the future; changes in accounting principles, policies, practices, or guidelines; changes in legislation and regulation; operational issues and/or capital spending necessitated by the potential need to adapt to industry changes in information technology systems on which we are highly dependent; changes in the monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board; war or terrorist activities; and other economic, competitive, governmental, regulatory, and geopolitical factors affecting the Company’s operations, pricing, and services. Additionally, the timing and occurrence or non-occurrence of events may be subject to circumstances beyond our control. You should not place undue reliance on these 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.




16


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 is 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 reflective of 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 and other relevant information, 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 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 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. The Company increased its allowance from $13.5 million at June 30, 2006 to $19.2 million at September 30, 2006. For a further discussion of this increase, see the section on the Loan Loss Allowance in “Comparison of Financial Condition at September 30, 2006 and December 31, 2005” in this Form 10-Q.

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 in an amount 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-competition 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.

17


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.
 

   
At or for the Three Months Ended
 
At or for the Nine Months Ended
 
   
September 30,
 
September 30,
 
   
2006
 
2005
 
2006
 
2005
 
Per Share:
                         
(Loss) earnings - diluted
 
$
(0.25
)
$
0.54
 
$
0.82
 
$
0.48
 
Dividends declared
   
0.14
   
0.14
   
0.42
   
0.38
 
Book value
   
29.31
   
28.68
   
29.31
   
28.68
 
Common stock price:
                         
High
   
38.44
   
35.20
   
38.44
   
37.64
 
Low
   
33.46
   
31.90
   
32.37
   
30.97
 
Close
   
35.59
   
34.00
   
35.59
   
34.00
 
                           
Operating and Financial Ratios:
                         
(Loss) return on average assets
   
(0.37
)%
 
0.92
%
 
0.47
%
 
0.27
%
(Loss) return on average equity
   
(3.15
)
 
7.90
   
3.83
   
2.47
 
Net interest margin
   
3.22
   
3.31
   
3.22
   
3.31
 
Stockholders' equity/total assets
   
11.55
   
12.08
   
11.55
   
12.08
 
                           
Annualized Growth:
                         
Total loans
   
20
%
 
(1
)%
 
20
%
 
94
%
Total deposits
   
7
   
13
   
11
   
79
 
                           
At Period End: (In millions)
                         
Total assets
 
$
2,205
 
$
2,033
 
$
2,205
 
$
2,033
 
Total loans
   
1,629
   
1,412
   
1,629
   
1,412
 
Other earning assets
   
387
   
429
   
387
   
429
 
Total intangible assets
   
99
   
100
   
99
   
100
 
Deposits
   
1,488
   
1,348
   
1,488
   
1,348
 
Borrowings and debentures
   
457
   
436
   
457
   
436
 
Stockholders' equity
   
255
   
246
   
255
   
246
 
                           
For the Period: (In thousands)
                         
Net interest income
 
$
15,603
 
$
15,054
 
$
44,669
 
$
36,579
 
Provision for loan losses
   
6,185
   
204
   
7,075
   
998
 
Non-interest income
   
(1,784
)
 
3,955
   
6,217
   
10,626
 
Non-interest expense
   
11,353
   
11,600
   
34,216
   
37,197
 
Net (loss) income
   
(2,120
)
 
4,746
   
7,161
   
3,389
 
                           
Asset Quality Ratios:
                         
Net charge-offs (annualized)/average loans
   
0.04
%
 
0.04
%
 
0.04
%
 
0.06
%
Loan loss allowance/total loans
   
1.18
   
0.93
   
1.18
   
0.93
 
Non-performing assets/total assets
   
0.24
   
0.08
   
0.24
   
0.08
 
                           
(1) All operating ratios are annualized and based on average balance sheet amounts where applicable.
                           


 

18


Average Balances and Average Yields/Cost
The following table presents average balances and an analysis of average rates and yields on an annualized fully taxable equivalent basis for the periods included.
 

   
Three Months Ended September 30,
 
 Nine Months Ended September 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
 
$
576
   
5.24
%
$
561
   
5.06
%
$
564
   
5.17
%
$
385
   
5.06
%
Commercial mortgages
   
496
   
7.37
   
396
   
6.68
   
458
   
7.31
   
328
   
6.39
 
Commercial business loans
   
186
   
8.31
   
166
   
6.92
   
167
   
7.95
   
156
   
6.54
 
Consumer loans
   
328
   
6.94
   
300
   
5.93
   
313
   
6.76
   
237
   
5.84
 
Total loans
   
1,586
   
6.58
   
1,423
   
5.91
   
1,502
   
6.42
   
1,106
   
5.83
 
                                                   
Securities
   
399
   
5.55
   
436
   
4.69
   
402
   
5.03
   
411
   
4.50
 
Short-term investments
   
1
   
5.25
   
7
   
3.50
   
1
   
4.88
   
3
   
3.74
 
Total earning assets
   
1,986
   
6.38
   
1,866
   
5.60
   
1,905
   
6.15
   
1,520
   
5.48
 
Intangible assets
   
99
         
101
         
103
         
49
       
Other assets
   
98
         
98
         
93
         
84
       
Total assets
 
$
2,183
       
$
2,065
       
$
2,101
       
$
1,653
       
                                                   
Liabilities and stockholders' equity
                                                 
Deposits
                                                 
NOW
 
$
132
   
0.98
%
$
136
   
0.42
%
$
138
   
1.00
%
$
112
   
0.28
%
Money Market
   
283
   
3.51
   
241
   
2.07
   
279
   
3.33
   
196
   
1.91
 
Savings
   
213
   
1.02
   
240
   
0.86
   
213
   
0.85
   
198
   
0.96
 
Time
   
664
   
4.41
   
515
   
3.12
   
640
   
4.17
   
407
   
2.62
 
Total interest-bearing deposits
   
1,292
   
3.31
   
1,132
   
2.10
   
1,270
   
3.09
   
913
   
2.00
 
Borrowings and debentures
   
445
   
4.47
   
500
   
3.81
   
402
   
4.19
   
407
   
3.60
 
Total interest-bearing liabilities
   
1,737
   
3.60
   
1,632
   
2.62
   
1,672
   
3.35
   
1,320
   
2.50
 
Non-interest-bearing demand deposits
   
179
         
185
         
173
         
144
       
Other liabilities
   
8
         
6
         
6
         
6
       
Total liabilities
   
1,924
         
1,823
         
1,851
         
1,470
       
Stockholders' equity
   
259
         
242
         
250
         
183
       
Total liabilities and equity
 
$
2,183
       
$
2,065
       
$
2,101
       
$
1,653
       
                                                   
Interest rate spread
         
2.78
%
       
2.98
%
       
2.80
%
       
2.98
%
Net interest margin
         
3.22
%
       
3.31
%
       
3.22
%
       
3.31
%
                                                   
Supplementary Data
                                                 
Total deposits
 
1,471
        $ 
1,317