BERKSHIRE HILLS BANCORP INC - Annual Report: 2014 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

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

 

For the fiscal year ended: December 31, 2014

 

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

 

For the transition period from           to           

 

Commission File Number: 001-15781

 

 

BERKSHIRE HILLS BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

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

 

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

 

 

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

 

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

 

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

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o

 

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

 

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

 

 

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

 

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

 

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

 

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

 

 

Table of Contents

 

INDEX

 

PART I			4
ITEM 1.		BUSINESS	4
ITEM 1A.		RISK FACTORS	30
ITEM 1B.		UNRESOLVED STAFF COMMENTS	39
ITEM 2.		PROPERTIES	39
ITEM 3.		LEGAL PROCEEDINGS	40
ITEM 4.		MINE SAFETY DISCLOSURES	40
PART II			41
ITEM 5.		MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES	41
ITEM 6.		SELECTED FINANCIAL DATA	44
ITEM 7.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	49
ITEM 7A.		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	72
ITEM 8.		FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	75
ITEM 9.		CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	75
ITEM 9A.		CONTROLS AND PROCEDURES	75
ITEM 9B.		OTHER INFORMATION	76
PART III			77
ITEM 10.		DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE	77
ITEM 11.		EXECUTIVE COMPENSATION	78
ITEM 12.		SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS	78
ITEM 13.		CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE	79
ITEM 14.		PRINCIPAL ACCOUNTING FEES AND SERVICES	79
PART IV			80
ITEM 15.		EXHIBITS AND FINANCIAL STATEMENT SCHEDULES	80
SIGNATURES			82
TABLE INDEX
PART I			4
ITEM 1.			4
	ITEM 1 TABLE 1 — LOAN PORTFOLIO ANALYSIS		9
	ITEM 1 TABLE 2 — MATURITY AND SENSITIVITY OF LOAN PORTFOLIO		12
	ITEM 1 TABLE 3 — PROBLEM ASSETS AND ACCRUING TDR		14
	ITEM 1 TABLE 4 — ALLOWANCE FOR LOAN LOSS		15
	ITEM 1 TABLE 5 — ALLOCATION OF ALLOWANCE BY LOAN CATEGORY		16
	ITEM 1 TABLE 6 — AMORTIZED COST AND FAIR VALUE OF SECURITIES		17

 

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	ITEM 1 TABLE 7 — WEIGHTED AVERAGE YIELD ON SECURITIES	17
	ITEM 1 TABLE 8 — AVERAGE BALANCE AND WEIGHTED AVERAGE INTEREST RATES ON DEPOSITS	18
	ITEM 1 TABLE 9 — MATURITY OF DEPOSITS > $100,000	19
PART II		41
ITEM 6		44
	ITEM 6 TABLE 3 — AVERAGE BALANCES, INTEREST AND AVERAGE YIELD COSTS	46
	ITEM 6 TABLE 4 — RATE VOLUME ANALYSIS	47
ITEMS 7-7A.		72
	ITEM 7 — 7A TABLE 1 — CONTRACTUAL OBLIGATIONS	71
	ITEM 7 — 7A TABLE 2 — QUALITATIVE ASPECTS OF MARKET RISK	73

 

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PART I

 

ITEM 1. BUSINESS

 

FORWARD-LOOKING STATEMENTS

 

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

 

GENERAL

 

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

 

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The Company profiles itself as follows:

 

 

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

 

 

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

 

·                  Strong top and bottom line momentum

 

·                  Diversified revenue drivers and controlled expenses

 

·                  Well positioned footprint in attractive markets

 

·                  AMEB culture

 

·                  Solid internal capital generation supports growth

 

·                  Focused on long-term profitability goals and shareholder value

 

·                  Acquisition disciplines a strength in a consolidating market

 

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

 

 

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

 

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

 

The Bank serves the following regions:

 

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

 

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

 

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

 

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

 

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

 

 

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

 

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

 

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

 

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COMPANY WEBSITE AND AVAILABILITY OF SECURITIES AND EXCHANGE COMMISSION FILINGS

 

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

 

COMPETITION

 

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

 

LENDING ACTIVITIES

 

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

 

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

 

Item 1 - Table 1 - Loan Portfolio Analysis

 

		2014					2013					2012					2011					2010
					Percent					Percent					Percent					Percent					Percent
					of					of					of					of					of
(In millions)		Amount			Total		Amount			Total		Amount			Total		Amount			Total		Amount			Total
Residential mortgages		$	1,496.2		32	%	$	1,384.3		33	%	$	1,324.3		33	%	$	1,020.4		34	%	$	645.0		30	%
Commercial real estate		1,611.6			35		1,417.1			34		1,413.5			35		1,156.2			39		925.6			43
Commercial and industrial loans		804.4			17		687.3			16		600.1			15		410.3			14		286.1			13
Total commercial loans		2,416.0			52		2,104.4			50		2,013.6			50		1,566.5			53		1,211.7			56
Consumer		768.4			16		691.8			17		650.7			17		369.6			13		285.5			14
Total loans		$	4,680.6		100	%	$	4,180.5		100	%	$	3,988.6		100	%	$	2,956.5		100	%	$	2,142.2		100	%
Allowance for loan losses		(35.7		)			(33.3		)			(33.2		)			(32.4		)			(31.9		)
Net loans		$	4,645.0				$	4,147.2				$	3,955.4				$	2,924.1				$	2,110.3

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Contractual Maturity		One Year			More than One			More Than
(In thousands)		or Less			to Five Years			Five Years			Total
Construction mortgage loans:
Residential		$	16,356		$	11,706		$	—		$	28,062
Commercial		30,836			142,554			—			173,390
Commercial and industrial loans		228,415			402,979			172,972			804,366
Total		$	275,607		$	557,239		$	172,972		$	1,005,818

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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Item 1 - Table 3 - Problem Assets and Accruing TDR

 

(In thousands)		2014			2013			2012			2011			2010
Non-accruing loans:
Residential mortgages		$	3,908		$	7,868		$	7,466		$	7,010		$	2,173
Commercial real estate		12,878			13,739			12,617			14,280			9,488
Commercial and industrial loans		1,705			2,355			3,681			990			1,305
Consumer		3,214			3,493			1,748			1,954			746
Total non-performing loans		21,705			27,455			25,512			24,234			13,712
Real estate owned		2,049			2,758			1,929			1,900			3,386
Total non-performing assets		$	23,754		$	30,213		$	27,441		$	26,134		$	17,098
Troubled debt restructurings (accruing)		$	12,612		$	8,344		$	3,641		$	1,263		$	7,829
Accruing loans 90+ days past due		$	4,568		$	9,223		$	18,977		$	10,184		$	1,054
Total non-performing loans/total loans		0.46		%	0.66		%	0.64		%	0.82		%	0.64		%
Total non-performing assets/total assets		0.37		%	0.53		%	0.52		%	0.65		%	0.59		%

 

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

 

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

 

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

 

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

 

Item 1 - Table 4 - Allowance for Loan Loss

 

(In thousands)		2014			2013			2012			2011			2010
Balance at beginning of year		$	33,323		$	33,208		$	32,444		$	31,898		$	31,816
Charged-off loans:
Residential mortgages		2,596			2,426			2,647			1,322			409
Commercial real estate		5,684			5,026			4,229			4,046			6,403
Commercial and industrial loans		3,010			2,917			697			1,443			2,685
Consumer		2,563			2,467			1,877			885			1,188
Total charged-off loans		13,853			12,836			9,450			7,696			10,685
Recoveries on charged-off loans:
Residential mortgages		365			399			103			231			213
Commercial real estate		270			549			52			189			794
Commercial and industrial loans		228			211			96			109			1,094
Consumer		361			414			373			150			140
Total recoveries		1,224			1,573			624			679			2,241
Net loans charged-off		12,629			11,263			8,826			7,017			8,444
Allowance attributed to loans acquired by merger		—			—			—			—			—
Provision for loan losses		14,968			11,378			9,590			7,563			8,526
Transfer of commitment reserve		—			—			—			—			—
Balance at end of year		$	35,662		$	33,323		$	33,208		$	32,444		$	31,898
Ratios:
Net charge-offs/average loans		0.29		%	0.29		%	0.26		%	0.27		%	0.42		%
Recoveries/charged-off loans		8.84			12.25			6.60			8.82			20.97
Net loans charged-off/allowance for loan losses		35.41			33.80			26.58			21.63			26.47
Allowance for loan losses/total loans		0.76			0.80			0.83			1.10			1.49
Allowance for loan losses/non-accruing loans		164.30			121.37			130.17			133.88			232.63

 

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

 

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

 

		2014					2013					2012					2011					2010
					Percent of					Percent of					Percent of					Percent of					Percent of
					Amount Allocated					Amount Allocated					Amount Allocated					Amount Allocated					Amount Allocated
					to Total					to Total					to Total					to Total					to Total
		Amount			Loans in Each		Amount			Loans in Each		Amount			Loans in Each		Amount			Loans in Each		Amount			Loans in Each
(Dollars in thousands)		Allocated			Category		Allocated			Category		Allocated			Category		Allocated			Category		Allocated			Category
Residential mortgages		$	7,480		0.50	%	$	7,562		0.55	%	$	6,444		0.49	%	$	3,420		0.34	%	$	3,200		0.50	%
Commercial real estate		15,539			0.96		16,112			1.13		19,275			1.36		22,176			1.92		19,923			2.15
Commercial and industrial loans		6,322			0.79		5,770			0.85		5,707			0.95		4,566			1.11		6,498			2.27
Consumer		6,321			0.82		3,879			0.56		1,782			0.27		2,282			0.62		2,277			0.80
Total		$	35,662		0.76	%	$	33,323		0.80	%	$	33,208		0.83	%	$	32,444		1.10	%	$	31,898		1.49	%

 

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

 

		2014					2013					2012					2011					2010
					Percent of					Percent of					Percent of					Percent of					Percent of
					Loans in Each					Loans in Each					Loans in Each					Loans in Each					Loans in Each
					Category					Category					Category					Category					Category
(Dollars in thousands)		Amount Allocated			to Total Loans		Amount Allocated			to Total Loans		Amount Allocated			to Total Loans		Amount Allocated			to Total Loans		Amount Allocated			to Total Loans
Residential mortgages		$	7,480		31.97	%	$	7,562		33.11	%	$	6,444		33.20	%	$	3,420		34.51	%	$	3,200		30.11	%
Commercial real estate		15,539			34.43		16,112			41.26		19,275			35.44		22,176			39.11		19,923			43.21
Commercial and industrial loans		6,322			17.19		5,770			9.08		5,707			15.05		4,566			13.88		6,498			13.35
Consumer		6,321			16.41		3,879			16.55		1,782			16.31		2,282			12.50		2,277			13.33
Total		$	35,662		100.00	%	$	33,323		100.00	%	$	33,208		100.00	%	$	32,444		100.00	%	$	31,898		100.00	%

 

INVESTMENT SECURITIES ACTIVITIES

 

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

 

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

 

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

 

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

 

		2014						2013						2012
		Amortized			Fair			Amortized			Fair			Amortized			Fair
(In thousands)		Cost			Value			Cost			Value			Cost			Value
Securities available for sale
Municipal bonds and obligations		$	127,013		$	133,699		$	77,852		$	77,671		$	79,498		$	84,757
Mortgage-backed securities		824,865			829,652			610,326			601,429			318,245			321,685
Other bonds and obligations		74,953			73,525			61,123			58,975			35,241			34,436
Marketable equity securities		48,992			54,942			20,041			21,973			22,467			25,291
Total securities available for sale		$	1,075,823		$	1,091,818		$	769,342		$	760,048		$	455,451		$	466,169
Securities held to maturity
Municipal bonds and obligations		$	4,997		$	4,997		$	4,244		$	4,244		$	8,295		$	8,295
Mortgage-backed securities		70			74			73			75			76			83
Tax advantaged economic development bonds		37,948			39,594			40,260			41,101			41,678			43,137
Other bonds and obligations		332			332			344			344			975			975
Total securities held to maturity		$	43,347		$	44,997		$	44,921		$	45,764		$	51,024		$	52,490
Trading account security		$	12,554		$	14,909		$	13,096		$	14,840		$	13,610		$	16,893
Restricted equity securities		$	55,720		$	55,720		$	50,282		$	50,282		$	39,785		$	39,785

 

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

 

		2014						2013						2012
		Amortized			Fair			Amortized			Fair			Amortized			Fair
(In thousands)		Cost			Value			Cost			Value			Cost			Value
U.S. Treasuries,other Government agencies and corporations		$	873,927		$	884,668		$	630,442		$	623,478		$	340,789		$	347,058
Municipal bonds and obligations		182,513			193,199			135,451			137,855			143,080			153,082
Other bonds and obligations		131,004			129,577			111,749			109,601			76,001			75,197
Total Securites		$	1,187,444		$	1,207,444		$	877,642		$	870,934		$	559,870		$	575,337

 

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

 

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

 

Item 1 - Table 7 - Weighted Average Yield

 

							More than One					More than Five Years
		One Year or Less					Year to Five Years					to Ten Years					More than Ten Years					Total
					Weighted					Weighted					Weighted					Weighted					Weighted
		Amortized			Average		Amortized			Average		Amortized			Average		Amortized			Average		Amortized			Average
(In millions)		Cost			Yield		Cost			Yield		Cost			Yield		Cost			Yield		Cost			Yield
Municipal bonds and obligations		$	1.0		1.50	%	$	3.1		4.3	%	$	12.3		5.4	%	$	115.5		5.6	%	$	132.0		5.5	%
Mortgage-backed securities		—			—		4.6			4.3		5.4			2.0		814.9			2.5		824.9			2.5
Other bonds and obligations		—			—		15.4			4.9		48.5			1.2		49.4			4.6		113.2			3.2
Total		$	1.0		1.50	%	$	23.1		4.7	%	$	66.2		2.0	%	$	979.8		3.0	%	$	1,070.2		2.9	%

 

17