UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
For the fiscal year ended: December 31, 2019
For the transition period from to
Commission File Number: 001-15781
BERKSHIRE HILLS BANCORP, INC.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
(Address of principal executive offices) | (Zip Code) | |||
Registrant’s telephone number, including area code: (800 ) 773-5601 , ext. 133773
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of Exchange on which registered | ||||
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 ý
No o
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 ý
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 has submitted electronically 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 ý No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definition of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one)
x | Accelerated Filer | o | ||
Non-Accelerated Filer | o | Smaller Reporting Company | ||
Emerging Growth Company | ||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ý
The aggregate market value of the voting and non-voting common equity held by non-affiliates was approximately $1.4 billion, based upon the closing price of $31.39 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 February 25, 2020 was 50,200,155 .
DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Proxy Statement for the 2020 Annual Meeting of Shareholders are incorporated by reference in Part III of this Form 10-K.
INDEX
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TABLE INDEX | |||
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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, 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, Inc. (“Berkshire” or “the Company”) is headquartered in Boston, Massachusetts. Berkshire is a Delaware corporation and the holding company for Berkshire Bank (“the Bank”) and Berkshire Insurance Group, Inc.
The Bank has 130 full-service banking offices in its New England, New York, and Mid-Atlantic footprint. The Company offers a wide range of deposit, lending, insurance, and wealth management products to retail and commercial customers in its market areas.
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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. 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 held for investment 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 generally originates loans for investment except for residential mortgages, which are generally originated for sale on a servicing released basis. Additionally, the Bank also originates Small Business Administration ("SBA") 7A loans for sale to investors. The Bank also conducts wholesale purchases and sales of loans and loan participations generally with other banks doing business in its markets, including selected national banks.
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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 Note 7 - Loans of the Consolidated Financial Statements. In the fourth quarter of 2019, the Commercial Banking division reorganized itself into four vertical product categories delivered through a regional relationship management structure.
Item 1 - Table 1 - Loan Portfolio Analysis
2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||||||||||||||||||
Percent | Percent | Percent | Percent | Percent | |||||||||||||||||||||||||||||||
of | of | of | of | of | |||||||||||||||||||||||||||||||
(In millions) | Amount | Total | Amount | Total | Amount | Total | Amount | Total | Amount | Total | |||||||||||||||||||||||||
Commercial real estate | $ | 4,034 | 43 | % | $ | 3,400 | 38 | % | $ | 3,264 | 39 | % | $ | 2,617 | 40 | % | $ | 2,060 | 36 | % | |||||||||||||||
Commercial and industrial loans | 1,841 | 19 | 1,980 | 22 | 1,804 | 22 | 1,062 | 16 | 1,048 | 18 | |||||||||||||||||||||||||
Total commercial loans | 5,875 | 62 | 5,380 | 60 | 5,068 | 61 | 3,679 | 56 | 3,108 | 54 | |||||||||||||||||||||||||
Residential mortgages | 2,685 | 28 | 2,566 | 28 | 2,103 | 25 | 1,893 | 29 | 1,815 | 32 | |||||||||||||||||||||||||
Consumer | 943 | 10 | 1,097 | 12 | 1,128 | 14 | 978 | 15 | 802 | 14 | |||||||||||||||||||||||||
Total loans | $ | 9,503 | 100 | % | $ | 9,043 | 100 | % | $ | 8,299 | 100 | % | $ | 6,550 | 100 | % | $ | 5,725 | 100 | % | |||||||||||||||
Allowance for loan losses | (64 | ) | (61 | ) | (52 | ) | (44 | ) | (39 | ) | |||||||||||||||||||||||||
Net loans | $ | 9,439 | $ | 8,982 | $ | 8,247 | $ | 6,506 | $ | 5,686 | |||||||||||||||||||||||||
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. Commercial real estate loans are provided on owner-occupied properties and on investor-owned properties. The portfolio 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 10 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.
Commercial real estate loans are among the largest of the Bank’s loans, and may have higher credit risk and lending spreads. Because repayment is often dependent on the successful operation or management of the properties, repayment of commercial real estate loans may be affected by adverse conditions in the real estate market or the economy. The Bank seeks to manage these risks through its underwriting disciplines 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 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 are supported by full or partial 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.
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The Bank originates construction loans to developers and commercial borrowers in and around its markets. The maximum loan to value limits for construction loans follow Federal Deposit Insurance Corporation ("FDIC") supervisory limits, up to a maximum of 85 percent. 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 percent 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 ("C&I"). C&I loans are managed through the Bank’s commercial middle market banking organization. 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 can be committed or 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 percent 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. 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 to additionally mitigate credit risk. The Company considers these loans, together with its owner-occupied commercial real estate loans, as constituting the primary relationship based component of its commercial lending activities.
Asset Based Lending.The Asset Based Lending Group serves the commercial middle market in New England, as well as the Bank’s market in northeastern New York. In 2017, this group expanded into the Mid-Atlantic. The 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.
Small Business Banking. This group is also referred to as Business Banking, and handles most business relationships which are smaller than the middle market category. Additionally, some smaller business needs are handled through the Bank’s retail branch system. Berkshire Bank also owns 44 Business Capital, a dedicated SBA 7A program lending team based in the Philadelphia area. This team originates loans primarily in the Mid-Atlantic area. This team sells the guaranteed portions of these loans with servicing retained and the Bank retains the unguaranteed portions of the loans. The Bank is a preferred SBA lender and closely manages the servicing portfolio pursuant to SBA requirements. This team is the Bank’s largest source of commercial lending fee revenue, and it is targeting to further expand these operations to other markets. Berkshire Bank also owns Firestone Financial Corp. ("Firestone"), which is located in Needham, MA. Firestone originates loans secured by business-essential equipment through over 160 equipment distributors and manufacturers and directly via the end borrower in all 50 states. Key customer segments include the fitness, carnival, gaming, and entertainment industries.
Residential Mortgages. Through its mortgage banking operations, the Bank offers fixed-rate and adjustable-rate residential mortgage loans to individuals with maturities of up to 30 years that are fully amortizing with monthly loan payments. The majority of loans are originated for sale with rate lock commitments which are recorded as derivative financial instruments. Mortgages are generally underwritten according to U.S. government sponsored enterprise guidelines designated as “A” or “A-” and referred to as “conforming loans”. The Bank also originates jumbo loans above conforming loan amounts which generally are consistent with secondary market guidelines for
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these loans and are often held in portfolio. The Bank does not offer subprime mortgage lending programs. The Bank buys and sells seasoned mortgages primarily with smaller financial institutions operating in its markets.
The majority of the Bank’s secondary marketing is to U.S. secondary market investors on a servicing-released basis. The Bank also sells directly to government sponsored enterprises with servicing retained. Mortgage sales 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”), state housing agency programs, and other government sponsored mortgage programs.
The Bank does not offer interest-only or negative amortization mortgage loans. Adjustable rate mortgage loan interest rates may rise as interest rates rise, thereby increasing the potential for default. The Bank also originates construction loans which generally provide 15-month construction periods followed by a permanent mortgage loan, and follow the Bank’s normal mortgage underwriting guidelines. Mortgage banking also requires flexible and scalable operations due to the volatility of mortgage demand over time. Investor management is integral to maintaining the secondary market support that is required for these operations.
Most of the Bank’s mortgages are originated by commissioned mortgage lenders. With the First Choice Bank acquisition in December 2016, the Company acquired First Choice Loan Services Inc. ("First Choice Loan Services"), which operates its national mortgage banking business as a subsidiary of Berkshire Bank. This operation has a team of several hundred members originating mortgages in targeted markets in nine states, with headquarters in East Brunswick, N.J. First Choice Loan Services originates directly through its originators as well as online including a mortgage marketing partnership with Costco. In 2019, the Company decided to attempt to sell these national mortgage banking operations, which have been designated as held for sale and discontinued for financial statement presentation purposes. This decision reflects the Company’s heightened emphasis on community banking in its local markets.
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Consumer Loans. The Bank’s consumer loans are centrally underwritten and processed by its experienced consumer lending team based in Syracuse, New York. The Bank’s primary consumer lending activity in recent year has been indirect auto lending. In 2019, the Company decided to end the origination of indirect auto loans. This decision reflects the Company’s heightened emphasis on community banking in its local markets. The Bank’s other major consumer lending activity is prime home equity lending, following its conforming mortgage underwriting guidelines with more streamlined verifications and documentation. Most of these outstanding loans are prime based home equity lines with a maximum combined loan-to-value of 85 percent. 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.
Maturity and Sensitivity of Loan Portfolio. The following table shows contractual final maturities of selected loan categories at year-end 2019. The contractual maturities do not reflect premiums, discounts, deferred costs, or prepayments.
Item 1 - Table 2 - Loan Contractual Maturity - Scheduled Loan Amortizations are not included in the maturities presented.
Contractual Maturity | One Year | One to | More Than | |||||||||||||
(In thousands) | or Less | Five Years | Five Years | Total | ||||||||||||
Construction real estate loans: | ||||||||||||||||
Commercial | $ | 71,959 | $ | 178,578 | $ | 179,269 | $ | 429,806 | ||||||||
Residential | 2,415 | 321 | 5,383 | 8,119 | ||||||||||||
Commercial and industrial loans | 381,322 | 1,020,178 | 439,008 | 1,840,508 | ||||||||||||
Total | $ | 455,696 | $ | 1,199,077 | $ | 623,660 | $ | 2,278,433 | ||||||||
For the $1.8 billion of loans above which mature in more than one year, $0.5 billion of these loans are fixed-rate and $1.3 billion are variable rate.
Loan Administration.Lending activities are governed by a loan policy approved by the Board’s Risk Management and Capital 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 and Capital Committee and Management, under the leadership of the Chief Risk Officer. 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 and Capital Committee has established individual and combined loan limits and lending approval authorities. Management’s Executive Loan Committee is responsible for commercial loan approvals in accordance with these standards and procedures. Generally, pass rated secured commercial loans can be approved jointly up to $7 million by the regional lending manager and regional credit officer. Loans up to $15 million can be approved with the additional signature of the Chief Credit Officer. Loans in excess of this amount, and designated lower rated loans are approved by the Executive Loan Committee. These limits were expanded in 2016. The Bank tracks loan underwriting exceptions 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 individual and overall performance. The Bank purchases whole loans and participations in loans from banks headquartered in its market and from outside of its market. These loans are underwritten according to the Bank’s underwriting criteria and procedures and are generally serviced by the originating lender under terms of the applicable 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
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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 also sells residential mortgages and 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 60 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 pre-approvals 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 and Capital Committee. 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 non-owner occupied commercial real estate and 100% for construction loans. 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. Loan collections are managed by a combination of the related business units and the Bank’s special assets group, which focuses on larger, riskier collections and the recovery of purchased credit impaired loans.
Real estate obtained by the Bank as a result of loan collections, including foreclosures, 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 2019, if non-accruing loans had been current according to their original terms, amounted to $3.3 million. Included in the amount is $1.0 million related to troubled debt restructurings. The amount of interest income on those loans that was recognized in net income in 2019 was $1.6 million. Included in this amount is $157 thousand related to troubled debt restructurings. Interest income on accruing troubled debt restructurings totaled $817 thousand for 2019. The total carrying value of troubled debt restructurings was $19.3 million at year-end.
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The following table sets forth additional information on year-end problem assets. 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.
Item 1 - Table 3 - Problem Assets
(In thousands) | 2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||
Non-accruing loans: | ||||||||||||||||||||
Commercial real estate | $ | 20,119 | $ | 20,371 | $ | 7,267 | $ | 5,883 | $ | 4,882 | ||||||||||
Commercial and industrial loans | 11,373 | 6,003 | 7,311 | 7,523 | 8,259 | |||||||||||||||
Residential mortgages | 3,343 | 2,217 | 2,883 | 3,795 | 3,966 | |||||||||||||||
Consumer | 4,805 | 3,834 | 5,438 | 5,039 | 3,768 | |||||||||||||||
Total non-performing loans | 39,640 | 32,425 | 22,899 | 22,240 | 20,875 | |||||||||||||||
Real estate owned | — | — | — | 151 | 1,725 | |||||||||||||||
Repossessed assets | 858 | 1,209 | 1,147 | — | — | |||||||||||||||
Total non-performing assets | $ | 40,498 | $ | 33,634 | $ | 24,046 | $ | 22,391 | $ | 22,600 | ||||||||||
Total non-performing loans/total loans | 0.42 | % | 0.36 | % | 0.28 | % | 0.34 | % | 0.36 | % | ||||||||||
Total non-performing assets/total assets | 0.31 | % | 0.28 | % | 0.21 | % | 0.24 | % | 0.29 | % | ||||||||||
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 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 Note 8 - Loan Loss Allowance of 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 incurred 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 initially recorded 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 Note 1 - Summary of Significant Accounting Policies of 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
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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.
The following table presents an analysis of the allowance for loan losses for the five years indicated:
Item 1 - Table 4 - Allowance for Loan Loss
(In thousands) | 2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||
Balance at beginning of year | $ | 61,469 | $ | 51,834 | $ | 43,998 | $ | 39,308 | $ | 35,662 | ||||||||||
Charged-off loans: | ||||||||||||||||||||
Commercial real estate | 7,407 | 7,671 | 4,646 | 3,104 | 7,546 | |||||||||||||||
Commercial and industrial loans | 24,370 | 4,799 | 4,217 | 5,715 | 3,110 | |||||||||||||||
Residential mortgages | 898 | 1,248 | 1,603 | 2,865 | 1,857 | |||||||||||||||
Consumer | 3,879 | 4,293 | 4,118 | 2,342 | 2,175 | |||||||||||||||
Total charged-off loans | 36,554 | 18,011 | 14,584 | 14,026 | 14,688 | |||||||||||||||
Recoveries on charged-off loans: | ||||||||||||||||||||
Commercial real estate | 1,242 | 344 | 235 | 303 | 582 | |||||||||||||||
Commercial and industrial loans | 1,450 | 906 | 424 | 389 | 458 | |||||||||||||||
Residential mortgages | 173 | 165 | 313 | 304 | 205 | |||||||||||||||
Consumer | 376 | 780 | 423 | 358 | 363 | |||||||||||||||
Total recoveries | 3,241 | 2,195 | 1,395 | 1,354 | 1,608 | |||||||||||||||
Net loans charged-off | 33,313 | 15,816 | 13,189 | 12,672 | 13,080 | |||||||||||||||
Provision for loan losses | 35,419 | 25,451 | 21,025 | 17,362 | 16,726 | |||||||||||||||
Balance at end of year | $ | 63,575 | $ | 61,469 | $ | 51,834 | $ | 43,998 | $ | 39,308 | ||||||||||
Ratios: | ||||||||||||||||||||
Net charge-offs/average loans | 0.35 | % | 0.18 | % | 0.19 | % | 0.21 | % | 0.25 | % | ||||||||||
Recoveries/charged-off loans | 8.87 | 12.19 | 9.57 | 9.65 | 10.95 | |||||||||||||||
Net loans charged-off/allowance for loan losses | 52.40 | 25.73 | 25.44 | 28.80 | 33.28 | |||||||||||||||
Allowance for loan losses/total loans | 0.67 | 0.68 | 0.62 | 0.67 | 0.69 | |||||||||||||||
Allowance for loan losses/non-accruing loans | 160.38 | 189.57 | 226.36 | 197.83 | 188.30 | |||||||||||||||
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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.
Item 1 - Table 5A - Allocation of Allowance for Loan Loss by Category (as of year-end)
2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||||||||||||||||||
(Dollars in thousands) | Amount Allocated | Percent Allocated to Total Loans in Each Category | Amount Allocated | Percent Allocated to Total Loans in Each Category | Amount Allocated | Percent Allocated to Total Loans in Each Category | Amount Allocated | Percent Allocated to Total Loans in Each Category | Amount Allocated | Percent Allocated to Total Loans in Each Category | |||||||||||||||||||||||||
Commercial real estate | $ | 28,864 | 0.72 | % | $ | 24,885 | 0.73 | % | $ | 20,699 | 0.63 | % | $ | 18,801 | 0.72 | % | $ | 16,494 | 0.80 | % | |||||||||||||||
Commercial and industrial loans | 20,178 | 1.09 | % | 17,568 | 0.88 | % | 14,975 | 0.83 | % | 10,611 | 1.00 | % | 8,715 | 0.83 | % | ||||||||||||||||||||
Residential mortgages | 9,388 | 0.35 | % | 11,165 | 0.44 | % | 10,018 | 0.48 | % | 8,571 | 0.45 | % | 8,589 | 0.47 | % | ||||||||||||||||||||
Consumer | 5,145 | 0.55 | % | 7,851 | 0.72 | % | 6,142 | 0.54 | % | 6,015 | 0.61 | % | 5,510 | 0.69 | % | ||||||||||||||||||||
Total | $ | 63,575 | 0.67 | % | $ | 61,469 | 0.68 | % | $ | 51,834 | 0.62 | % | $ | 43,998 | 0.67 | % | $ | 39,308 | 0.69 | % | |||||||||||||||
Item 1 - Table 5B - Allocation of Allowance for Loan Loss (as of year-end)
2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||||||||||||||||||
(Dollars in thousands) | Amount Allocated | Percent of Loans in Each Category to Total Loans | Amount Allocated | Percent of Loans in Each Category to Total Loans | Amount Allocated | Percent of Loans in Each Category to Total Loans | Amount Allocated | Percent of Loans in Each Category to Total Loans | Amount Allocated | Percent of Loans in Each Category to Total Loans | |||||||||||||||||||||||||
Commercial real estate | $ | 28,864 | 42.45 | % | $ | 24,885 | 37.60 | % | $ | 20,699 | 39.33 | % | $ | 18,801 | 39.95 | % | $ | 16,494 | 41.96 | % | |||||||||||||||
Commercial and industrial loans | 20,178 | 19.37 | % | 17,568 | 21.90 | % | 14,975 | 21.74 | % | 10,611 | 16.22 | % | 8,715 | 22.10 | % | ||||||||||||||||||||
Residential mortgages | 9,388 | 28.26 | % | 11,165 | 28.37 | % | 10,018 | 25.34 | % | 8,571 | 28.90 | % | 8,589 | 21.91 | % | ||||||||||||||||||||
Consumer | 5,145 | 9.92 | % | 7,851 | 12.13 | % | 6,142 | 13.59 | % | 6,015 | 14.93 | % | 5,510 | 14.03 | % | ||||||||||||||||||||
Total | $ | 63,575 | 100.00 | % | $ | 61,469 | 100.00 | % | $ | 51,834 | 100.00 | % | $ | 43,998 | 100.00 | % | $ | 39,308 | 100.00 | % | |||||||||||||||
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INVESTMENT SECURITIES ACTIVITIES
The securities portfolio provides cash flow to protect the safety of customer deposits and as a potential source of liquidity. 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 Enterprise Risk Management/Asset-Liability Committee meets multiple times each quarter and reviews investment strategies. The Risk Management and Capital Committee of the Board of Directors 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, 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 2019. The municipal portfolio provides tax-advantaged yield, and the local economic development bonds were originated by the Company to area borrowers. The Company invests in investment grade corporate bonds and commercial mortgage-backed securities. Purchases of non-investment grade fixed-income securities have consisted primarily of capital instruments issued by local and regional financial institutions and a mutual fund investing in non-investment grade bonds of national corporate issuers and in community reinvestment projects. 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. Historically, the Company acquired equity securities in the Bank, which was allowed under its savings bank charter. As a result of the Bank's charter change in 2014, equity security purchases after that date have been conducted at the holding company level. The Bank 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 Company generally designates debt securities as available for sale, but sometimes designates longer-duration municipal securities as held to maturity based on its intent. This also allows the Company to more effectively manage the potential impact of longer-duration, fixed-rate securities on stockholders' equity in the event of rising interest rates. Based on a new accounting pronouncement effective in 2018, changes in fair value on equity securities are recorded to current period income, rather than to equity.
The following tables present the year-end amortized cost and fair value of the Company’s securities, by type of security, for the three years indicated.
Item 1 - Table 6A - Amortized Cost and Fair Value of Securities
2019 | 2018 | 2017 | ||||||||||||||||||||||
(In thousands) | Amortized Cost | Fair Value | Amortized Cost | Fair Value | Amortized Cost | Fair Value | ||||||||||||||||||
Securities available for sale | ||||||||||||||||||||||||
Municipal bonds and obligations | $ | 104,325 | $ | 110,138 | $ | 109,648 | $ | 111,207 | $ | 113,427 | $ | 118,233 | ||||||||||||
Mortgage-backed securities | 1,037,205 | 1,043,652 | 1,182,552 | 1,160,130 | 1,142,656 | 1,130,403 | ||||||||||||||||||
Other bonds and obligations | 155,809 | 157,765 | 129,073 | 128,310 | 131,167 | 132,278 | ||||||||||||||||||
Total securities available for sale | $ | 1,297,339 | $ | 1,311,555 | $ | 1,421,273 | $ | 1,399,647 | $ | 1,387,250 | $ | 1,380,914 | ||||||||||||
Securities held to maturity | ||||||||||||||||||||||||
Municipal bonds and obligations | $ | 252,936 | $ | 266,026 | $ | 264,524 | $ | 264,492 | $ | 270,310 | $ | 278,895 | ||||||||||||
Mortgage-backed securities | 86,291 | 89,191 | 89,273 | 88,442 | 92,115 | 92,242 | ||||||||||||||||||
Tax advantaged economic development bonds | 18,456 | 17,764 | 19,718 | 18,042 | 34,357 | 33,818 | ||||||||||||||||||
Other bonds and obligations | 296 | 296 | 248 | 248 | 321 | 321 | ||||||||||||||||||
Total securities held to maturity | $ | 357,979 | $ | 373,277 | $ | 373,763 | $ | 371,224 | $ | 397,103 | $ | 405,276 | ||||||||||||
Trading account security | $ | 9,390 | $ | 10,769 | $ | 10,090 | $ | 11,212 | $ | 10,755 | $ | 12,277 | ||||||||||||
Marketable equity securities | $ | 37,138 | $ | 41,556 | $ | 55,471 | $ | 56,638 | $ | 36,483 | $ | 45,185 | ||||||||||||
Restricted equity securities | $ | 48,019 | $ | 48,019 | $ | 77,344 | $ | 77,344 | $ | 63,085 | $ | 63,085 | ||||||||||||
Item 1 - Table 6B - Amortized Cost and Fair Value of Securities
2019 | 2018 | 2017 | ||||||||||||||||||||||
(In thousands) | Amortized Cost | Fair Value | Amortized Cost | Fair Value | Amortized Cost | Fair Value | ||||||||||||||||||
U.S. Treasuries, other Government agencies and corporations | $ | 1,160,634 | $ | 1,174,399 | $ | 1,327,296 | $ | 1,305,210 | $ | 1,271,254 | $ | 1,267,830 | ||||||||||||
Municipal bonds and obligations and tax advantaged securities | 385,107 | 404,697 | 403,980 | 404,953 | 428,849 | 443,223 | ||||||||||||||||||
Other | 204,124 | 206,080 | 206,665 | 205,902 | 194,573 | 195,684 | ||||||||||||||||||
Total Securities | $ | 1,749,865 | $ | 1,785,176 | $ | 1,937,941 | $ | 1,916,065 | $ | 1,894,676 | $ | 1,906,737 | ||||||||||||
The schedule includes available-for-sale and held-to-maturity securities, as well as the trading security, marketable equity securities, and restricted equity securities.
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The following table summarizes year-end 2019 amortized cost, weighted average yields, and contractual maturities of debt securities. Yields are shown on a fully taxable equivalent basis. 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. Yields include amortization and accretion of premiums and discounts.
Item 1 - Table 7 - Weighted Average Yield
One Year or Less | More than One Year to Five Years | More than Five Years to Ten Years | More than Ten Years | Total | ||||||||||||||||||||||||||||||
(In millions) | Amortized Cost | Weighted Average Yield | Amortized Cost | Weighted Average Yield | Amortized Cost | Weighted Average Yield | Amortized Cost | Weighted Average Yield | Amortized Cost | Weighted Average Yield | ||||||||||||||||||||||||
Municipal bonds and obligations | $ | 16.8 | 3.0 | % | $ | 14.8 | 4.0 | % | $ | 29.0 | 4.0 | % | $ | 296.7 | 5.0 | % | $ | 357.3 | 4.0 | % | ||||||||||||||
Mortgage-backed securities | 0.1 | 3.0 | % | 3.4 | 2.0 | % | 103.6 | 2.0 | % | 1,016.4 | 3.0 | % | 1,123.5 | 3.0 | % | |||||||||||||||||||
Other bonds and obligations | 20.0 | 1.0 | % | 19.8 | 5.0 | % | 51.6 | 5.0 | % | 83.1 | 4.0 | % | 174.5 | 4.0 | % | |||||||||||||||||||
Total | $ | 36.9 | 1.9 | % | $ | 38.0 | 4.3 | % | $ | 184.2 | 3.2 | % | $ | 1,396.2 | 3.5 | % | $ | 1,655.3 | 3.3 | % | ||||||||||||||
DEPOSIT ACTIVITIES AND OTHER SOURCES OF FUNDS
Deposits are the major source of funds for the Bank’s lending and investment activities. Deposit accounts are the primary product and service interaction with the Bank’s customers. The Bank serves personal, commercial, non-profit, and municipal deposit customers. Most of the Bank’s deposits are generated from the areas surrounding its branch offices. The Bank offers a wide variety of deposit accounts with a range of interest rates and terms. The Bank also periodically offers promotional interest rates and terms for limited periods of time. The Bank’s deposit accounts consist of demand deposits (non-interest-bearing checking), NOW (interest-bearing checking), regular savings, money market savings, and time certificates of deposit. The Bank emphasizes its transaction deposits – checking and NOW accounts – for personal accounts and checking accounts promoted to businesses. These accounts have the lowest marginal cost to the Bank and are also often a core account for a customer relationship. The Bank offers a courtesy overdraft program to improve customer service, and also provides debit cards and other electronic fee producing payment services to transaction account customers. The Bank offers targeted online deposit account opening capabilities for personal accounts. The Bank promotes remote deposit capture devices so that commercial accounts can make deposits from their place of business. Additionally, the Bank offers a variety of retirement deposit accounts to personal and business customers. Deposit related fees are a significant source of fee income to the Bank, including overdraft and interchange fees related to debit card usage. Deposit service fee income also includes other miscellaneous transactions and convenience services sold to customers through the branch system as part of an overall service relationship. The Bank offers compensating balance arrangements for larger business customers as an alternative to fees charged for checking account services. Berkshire’s Business Connection is a personal financial services benefit package designed for the employees of its business customers. In addition to providing service through its branches, Berkshire provides services to deposit customers through its private bankers, MyBankers, commercial/small business relationship managers, and call center representatives. Commercial cash management services are an important commercial service offered to commercial depositors and a fee income source to the bank. The Bank also operates a commercial payment processing business that serves regional and national payroll service bureau customers. Online banking and mobile banking functionality is increasingly important as a component of deposit account access and service delivery. The Bank is also gradually deploying its MyTeller video tellers to complement and extend its service capabilities in its branches.
The Company also is monitoring the development of payment services which are growing in their importance in the personal and commercial deposit markets. The Company has recruited experienced senior officers to enhance its offerings and market development for government banking and international services to support further development of commercial deposit sources.
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The Bank’s deposits are insured by the FDIC. The Bank utilizes brokered time deposits to broaden its funding base, augment its interest rate risk management vehicles, and to support loan growth. The Bank also offers brokered reciprocal money market arrangements to provide additional deposit protection to certain large commercial and institutional accounts. These balances are viewed as part of overall relationship balances with regional customers. Brokered deposits are sourced through selected Board approved brokers; these deposits are viewed as potentially more volatile than other deposits and are managed as a component of the Bank's liquidity policies.
The following table presents information concerning average balances and weighted average interest rates on the Bank’s interest-bearing deposit accounts for the years indicated.
Item 1 - Table 8 - Average Balance and Weighted Average Rates for Deposits
2019 | 2018 | 2017 | ||||||||||||||||||||||||||||
(In millions) | Average Balance | Percent of Total Average Deposits | Weighted Average Rate | Average Balance | Percent of Total Average Deposits | Weighted Average Rate | Average Balance | Percent of Total Average Deposits | Weighted Average Rate | |||||||||||||||||||||
Demand | $ | 1,745.2 | 18 | % | — | % | $ | 1,622.4 | 19 | % | — | % | $ | 1,296.4 | 18 | % | — | % | ||||||||||||
NOW and other | 1,053.9 | 11 | 0.6 | 824.7 | 9 | 0.5 | 591.0 | 8 | 0.3 | |||||||||||||||||||||
Money market | 2,542.6 | 26 | 1.2 | 2,432.2 | 28 | 0.9 | 1,935.8 | 27 | 0.6 | |||||||||||||||||||||
Savings | 798.2 | 8 | 0.2 | 740.8 | 9 | 0.2 | 680.1 | 10 | 0.1 | |||||||||||||||||||||
Time | 3,754.2 | 37 | 2.0 | 3,075.5 | 35 | 1.7 | 2,581.1 | 37 | 1.2 | |||||||||||||||||||||
Total | $ | 9,894.1 | 100 | % | 1.2 | % | $ | 8,695.6 | 100 | % | 0.9 | % | $ | 7,084.4 | 100 | % | 0.6 | % | ||||||||||||
At year-end 2019, the Bank had time deposit accounts in amounts of $100 thousand or more maturing as follows:
Item 1 - Table 9 - Maturity of Deposits > $100,000
Maturity Period | Amount | Weighted Average Rate | |||||
(In thousands) | |||||||
Three months or less | $ | 567,919 | 2.08 | % | |||
Over 3 months through 6 months | 619,804 | 2.26 | |||||
Over 6 months through 12 months | 914,560 | 2.19 | |||||
Over 12 months | 581,896 | 2.17 | |||||
Total | $ | 2,684,179 | 2.18 | % | |||
The Company also uses borrowings from the FHLBB as an additional source of funding, particularly for daily cash management and for funding longer duration assets. FHLBB advances also provide more pricing and option alternatives for particular asset/liability needs. The FHLBB functions as a central reserve bank providing credit for member institutions. As an FHLBB member, the Company is required to own capital stock of the organization. Borrowings from this institution are secured by a blanket lien on most of the Bank’s mortgage loans and mortgage-related securities, as well as certain other assets. Advances are made under several different credit programs with different lending standards, interest rates, and range of maturities.
The Company has a $15 million trust preferred obligation and a $7 million trust preferred obligation outstanding, as well as $74 million in senior subordinated notes. The Company’s common stock is listed on the New York Stock Exchange. Subject to certain limitations, the Company can also choose to issue common stock, preferred stock, subordinated debt, or senior debt in public stock offerings or private placements.
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DERIVATIVE FINANCIAL INSTRUMENTS
The Company offers interest rate swaps to commercial loan customers who wish to fix the interest rates on their loans, and the Company backs these swaps with offsetting swaps with national bank counterparties. With other lending institutions, the Company engages in risk participation agreements. These arrangements are structured similarly to its swaps with commercial borrowers, but a different bank is the lead underwriter. The Company gets paid a fee to take on the risk associated with having to make the lead bank whole on Berkshire’s portion of the pro-rated swap should the borrower default. These swaps are designated as economic hedges. Interest rate swaps that meet certain criteria to be viewed as conforming are required to be cleared through exchanges. The Bank has designated a national financial institution as its clearing agent.
The Company’s mortgage banking activities result in derivatives. Commitments to lend are provided on applications for residential mortgages intended for resale and are accounted for as non-hedging derivatives. The Company arranges offsetting forward sales commitments for most of these rate-locks with national bank counterparties, which are designated as economic hedges. Commitments on applications intended to be held for investment are not accounted for as derivative financial instruments. The Company has a policy for managing its derivative financial instruments, and the policy and program activity are overseen by the Risk Management and Capital Committee. Derivative financial instruments with counterparties which are not customers are limited to a select number of national financial institutions. Collateral may be required based on financial condition tests. The Company works with third-party firms which assist in marketing derivative transactions, executing transactions, and providing information for bookkeeping and accounting purposes.
The Company sometimes uses interest rate swap instruments for its own account to fix the interest rate on some of its borrowings, all of which have been designated as cash flow hedges. The Company also has begun offering forward foreign exchange derivatives to its commercial markets as part of its expanded international banking services. The Company expects to back these forwards with offsetting forwards with national bank counterparties. This activity would be targeted to support routine commercial needs of customers engaged in international trading activities and would only be offered for bank approved currencies and durations.
LIBOR BASED INSTRUMENTS
The Company’s floating-rate funding, certain hedging transactions and certain of the Company’s products, such as floating-rate loans and mortgages, determine the applicable interest rate or payment amount by reference to a benchmark rate, such as the London Interbank Offered Rate (“LIBOR”), or to an index, currency, basket or other financial metric. LIBOR and certain other benchmark rates are the subject of recent national, international, and other regulatory guidance and proposals for reform. In July 2017, the Chief Executive of the Financial Conduct Authority (“FCA”) announced that the FCA intends to stop persuading or compelling its panel banks to submit rates for the calculation of LIBOR after 2021.
The Company has approximately 1,050 commercial loans with a total balance of $2.8 billion with the contract interest rate tied to LIBOR. Additionally, the Company has approximately 500 interest rate swap contracts with a notional value of approximately $3.6 billion, including customer, dealer, and risk participation agreements. Many of these interest rate swap contracts are associated with the LIBOR based commercial loans.
The Company established an enterprise-wide LIBOR transition committee in 2019. The committee has assessed the on and off-balance sheet products that will be impacted with the LIBOR transition. The areas with the most impact are LIBOR based interest rate swaps and commercial loans that utilize LIBOR as the indexed rate. During 2019 revised LIBOR fallback language was added to all new Commercial loan contracts that contemplated the use of LIBOR as an index rate. An impact assessment is underway to identify further exposures, such as systems, processes, and models affected by the discontinuation of LIBOR. The Company continues to develop and execute plans to transition products associated with LIBOR to alternative reference rates.
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WEALTH MANAGEMENT SERVICES
The Company’s Wealth Management Group provides consultative investment management, trust administration, and financial planning to individuals, businesses, and institutions, with an emphasis on personal investment management. The Wealth Management Group has built a track record over more than a decade with its dedicated in-house investment management team. The Bank also provides a full line of investment products, financial planning, and brokerage services through BerkshireBanc Investment Services utilizing Commonwealth Financial Network as the broker/dealer. The Group’s principal operations are in Western New England and it is expanding services in the Company’s other regions. At year-end 2019, assets under management totaled $1.5 billion, primarily held in the Bank’s traditional wealth/trust platform and the remainder is managed through its investment services and financial advisory teams. The Bank is integrating with its growing private banking and MyBanker teams to further develop wealth management account generation.
INSURANCE
As an independent insurance agent, the Berkshire Insurance Group represents a carefully selected group of financially sound, reputable insurance companies offering attractive coverage at competitive prices. The Insurance Group offers a full line of personal and commercial property and casualty insurance. It also offers employee benefits insurance and a full line of personal life, health, and financial services insurance products. Berkshire Insurance Group operates a focused cross-sell program of insurance and banking products through all offices and branches of the Bank with some of the Group’s offices located within the Bank’s branches. The Group’s principal operations are in Western New England, and it is expanding its services in the Company’s other regions. The Group focuses on the Bank’s distribution channels in order to broaden its retail and commercial customer base. The Company may consider acquisitions of insurance agencies in support of its growth strategy.
PERSONNEL
Full-time equivalent staff in continuing operations totaled 1,550 positions at period-end, compared to 1,485 at year-end 2018. National mortgage banking operations designated as discontinued operations totaled 323 positions.
The Company’s employees are not represented by a collective bargaining unit. In 2018, the Bank’s president initiated a diversity and inclusion initiative as part of Berkshire’s expanded social responsibility focus. In 2018, the Company increased its hourly minimum wage to $15.00 and implemented the new Massachusetts equal pay law.
SUBSIDIARY ACTIVITIES
The Company wholly-owns two active consolidated subsidiaries: the Bank and Berkshire Insurance Group, Inc. The Bank operates as a commercial bank under a Massachusetts trust company charter. Berkshire Insurance Group is incorporated in Massachusetts. Berkshire Bank owns Firestone Financial, LLC which is a Massachusetts limited liability company, First Choice Loan Services Inc. which is a New Jersey corporation, as well as consolidated subsidiaries operated as Massachusetts securities corporations and other subsidiary entities. The Company designated the operations of First Choice Loan Services as held for sale in 2019. The Company also owns all of the common stock of Delaware statutory business trusts, Berkshire Hills Capital Trust I and SI Capital Trust II. The capital trusts are unconsolidated and their only material assets are trust preferred securities related to the junior subordinated debentures reported in the Company’s Consolidated Financial Statements. Additional information about the subsidiaries is contained in Exhibit 21 to this report.
REGULATION AND SUPERVISION
The Company is a Delaware corporation and a bank holding company that has elected financial holding company status within the meaning of the Bank Holding Company Act of 1956, as amended. As such, it is registered with, supervised by and required to comply with the rules and regulations of the Federal Reserve Board. The Federal Reserve Board requires the Company to file various reports and also conducts examinations of the Company. The Company must receive the approval of the Federal Reserve Board to engage in certain transactions, such as acquisitions of additional banks and savings associations.
The Bank is a Massachusetts-chartered trust company and its deposits are insured up to applicable limits by the FDIC. The Bank was previously a Massachusetts-chartered savings bank and converted to a Massachusetts-chartered trust company in July 2014. The Bank is subject to extensive regulation by the Massachusetts Commissioner of Banks (the “Commissioner”), as its chartering agency, and by the FDIC, as its deposit insurer. The
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Bank is required to file reports with the Commissioner and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other depository institutions or branches of other institutions. The Commissioner and the FDIC conduct periodic examinations to test the Bank’s safety and soundness and compliance with various regulatory requirements. The regulatory structure gives the regulatory authorities extensive discretion in connection with supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the Commissioner, the Massachusetts legislature, the FDIC, the Federal Reserve Board, or Congress, could have a material adverse impact on the Company, the Bank, and their operations.
Federal Legislation
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was enacted in 2010. The Dodd-Frank Act has significantly changed the bank regulatory structure and is affecting the lending, investment, trading and operating activities of depository institutions and their holding companies.
Many of the provisions of the Dodd-Frank Act were subject to delayed effective dates and/or the issuance of implementing regulations. The regulatory process is ongoing and the impact on operations cannot yet be fully assessed. However, the Dodd-Frank Act has, and is expected to continue to, at a minimum, result in increased regulatory burden, compliance costs and interest expense for the Company and the Bank.
Certain regulatory requirements applicable to the Company are referred to below. The description of statutory provisions and regulations applicable to financial institutions and their holding companies set forth in this Form 10-K does not purport to be a complete description of such statutes and regulations and their effects on the Company and is qualified in its entirety by reference to the actual laws and regulations.
Massachusetts Banking Laws and Supervision
General. As a Massachusetts-chartered depository institution, the Bank is subject to various Massachusetts statutes and regulations which govern, among other things, investment powers, lending and deposit-taking activities, borrowings, maintenance of surplus and reserve accounts, distribution of earnings and payment of dividends. In addition, the Bank is subject to Massachusetts consumer protection and civil rights laws and regulations. The approval of the Commissioner is required for a Massachusetts-chartered institution to establish or close branches, merge with other financial institutions, issue stock, and undertake certain other activities.
Massachusetts law and regulations generally allow Massachusetts institutions to engage in activities permissible for federally chartered banks or banks chartered by another state. There is a 30-day notice procedure to the Commissioner in order to engage in such activities. Massachusetts law also authorized Massachusetts institutions to engage in activities determined to be “financial in nature,” or incidental or complementary to such a financial activity, subject to a 30-day notice to the Commissioner.
Dividends. Under Massachusetts law, the Bank may declare cash dividends from net profits not more frequently than quarterly and non-cash dividends at any time. No dividends may be declared, credited, or paid if the institution’s capital stock is impaired. An institution with outstanding preferred stock may not, without the prior approval of the Commissioner, declare dividends to the common stock without also declaring dividends to the preferred stock. The approval of the Commissioner is generally required if the total of all dividends declared in any calendar year exceeds the total of its net profits for that year combined with its retained “net profits,” as defined, of the preceding two years.
Loans to One Borrower Limitations. Massachusetts banking law grants broad lending authority. However, with certain limited exceptions, total obligations of one borrower to an institution may not exceed 20.0% of the total of the institution’s capital, which is defined under Massachusetts law as the sum of the institution’s capital stock, surplus account and undivided profits.
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Investment Activities. In general, Massachusetts-chartered institutions may invest in preferred and common stock of any corporation organized under the laws of the United States or any state provided such investments do not involve control of any corporation and do not, in the aggregate, exceed 4.0% of the bank’s deposits. Massachusetts-chartered institutions may also invest an amount equal to 1.0% of their deposits in stocks of Massachusetts corporations or companies with substantial employment in Massachusetts which have pledged to the Commissioner that such monies will be used for further development within the Commonwealth. However, these powers are constrained by federal law, which generally limit the activities and equity investments of state banks to those permitted for national banks.
Regulatory Enforcement Authority. Any Massachusetts-chartered institution that does not operate in accordance with the regulations, policies, and directives of the Commissioner may be sanctioned for non-compliance, including seizure of the property and business of the institution and suspension or revocation of its charter. The Commissioner may, under certain circumstances, suspend or remove officers or directors who have violated the law, conducted the institution’s business in a manner which is unsafe, unsound or contrary to the depositors interests, or been negligent in the performance of their duties. In addition, upon finding that an institution has engaged in an unfair or deceptive act or practice, the Commissioner may issue an order to cease and desist and impose a fine on the institution concerned. Finally, Massachusetts consumer protection and civil rights statutes applicable to the Bank permit private individual and class action lawsuits and provide for the rescission of consumer transactions, including loans, and the recovery of statutory and punitive damage and attorney’s fees in the case of certain violations of those statutes.
Massachusetts has other statutes or regulations that are similar to the federal provisions discussed below.
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Federal Regulations
Capital Requirements. Federal regulations require FDIC insured depository institutions to meet several minimum capital standards: a common equity Tier 1 capital to risk-based assets ratio of 4.5%, a Tier 1 capital to risk-based assets ratio of 6.0%, a total capital to risk-based assets of 8.0%, and a 4.0% Tier 1 capital to total assets leverage ratio. The existing capital requirements were effective January 1, 2015 and are the result of a final rule implementing regulatory amendments based on recommendations of the Basel Committee on Banking Supervision and certain requirements of the Dodd-Frank Act.
Common equity Tier 1 capital is generally defined as common stockholders’ equity and retained earnings. Tier 1 capital is generally defined as common equity Tier 1 and additional Tier 1 capital. Additional Tier 1 capital includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus, meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock and subordinated debt. Also included in Tier 2 capital is the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out election regarding the treatment of accumulated other comprehensive income (“AOCI”), up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. The Bank chose the opt-out election. Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations, including adjustments for goodwill and other intangible assets.
In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, all assets, including certain off-balance sheet assets (e.g., recourse obligations, direct credit substitutes, residual interests) are multiplied by a risk weight factor assigned by the regulations based on the risks believed inherent in the type of asset. Higher levels of capital are required for asset categories believed to present greater risk. For example, a risk weight of 0% is assigned to cash and U.S. government securities, a risk weight of 50% is generally assigned to prudently underwritten first lien one to four-family residential mortgages, a risk weight of 100% is assigned to commercial and consumer loans, a risk weight of 150% is assigned to certain past due loans and a risk weight of between 0% and 600% is assigned to permissible equity interests, depending on certain specified factors.
In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions and certain discretionary bonus payments to management if the institution does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted asset above the amount necessary to meet its minimum risk-based capital requirements. The capital conservation buffer was phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increasing each year until fully implemented at 2.5% on January 1, 2019.
In assessing an institution’s capital adequacy, the FDIC takes into consideration not only these numeric factors, but qualitative factors as well, and has the authority to establish higher capital requirements for individual institutions where deemed necessary. As a bank holding company, the Company is also subject to regulatory capital requirements, as described in a subsequent section.
Interstate Banking and Branching. Federal law permits an institution, such as the Bank, to acquire another institution by merger in a state other than Massachusetts unless the other state has opted out. Federal law, as amended by the Dodd-Frank Act, authorizes de novo branching into another state to the extent that the target state allows its state-chartered banks to establish branches within its borders. The Bank currently operates branches in New York, Vermont, Connecticut, New Jersey, and Pennsylvania as well as Massachusetts. At its interstate branches, the Bank may conduct any activity authorized under Massachusetts law that is permissible either for an institution chartered in that state (subject to applicable federal restrictions) or a branch in that state of an out-of-state national bank. The New York State Superintendent of Banks, the Vermont Commissioner of Banking and Insurance, the Connecticut Commissioner of Banking, the New Jersey Commissioner of Banking and Insurance, the Pennsylvania Secretary of Banking and Securities, and the Director of the Rhode Island Department of Business Regulation may exercise certain regulatory authority over the Bank’s branches in their respective states.
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Prompt Corrective Regulatory Action. Federal law requires that federal bank regulatory authorities take “prompt corrective action” with respect to banks that do not meet minimum capital requirements. For this purpose, the law establishes three categories of capital deficient institutions: undercapitalized, significantly undercapitalized, and critically undercapitalized. The FDIC regulations implementing the prompt corrective action law were amended to incorporate the previously discussed increased regulatory capital standards that were effective January 1, 2015. An institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a leverage ratio of 5.0% or greater, and a common equity Tier 1 ratio of 6.5% or greater. An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, a leverage ratio of 4.0% or greater, and a common equity Tier 1 ratio of 4.5% or greater. An institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 6.0%, a leverage ratio of less than 4.0%, or a common equity Tier 1 ratio of less than 4.5%. An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 4.0%, a leverage ratio of less than 3.0%, or a common equity Tier 1 ratio of less than 3.0%. An institution is considered to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2.0%.
“Undercapitalized” banks must adhere to growth, capital distribution (including dividend), and other limitations and are required to submit a capital restoration plan. A bank’s compliance with such plans must be guaranteed by its holding company in an amount equal to the lesser of 5% of the institution’s total assets when deemed “undercapitalized” or the amount needed to comply with regulatory capital requirements. If an “undercapitalized” bank fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.” “Significantly undercapitalized” banks must comply with one or more of a number of additional restrictions, including but not limited to an order by the FDIC to sell sufficient voting stock to become “adequately capitalized,” requirements to reduce assets and cease receipt of deposits from correspondent banks or dismiss directors or officers, and restrictions on interest rates paid on deposits, compensation of executive officers, and capital distributions by the holding company. “Critically undercapitalized” institutions must comply with additional sanctions including, subject to a narrow exception, the appointment of a receiver or conservator within 270 days after it obtains such status.
At December 31, 2019, the Bank met the criteria for being considered “well capitalized” as defined in the prompt corrective action regulations.
Transactions with Affiliates and Loans to Insiders. Transactions between depository institutions and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act. In a holding company context, at a minimum, the parent holding company of an institution and any companies which are controlled by the holding company are affiliates of the institution. Generally, Section 23A limits the extent to which the institution or its subsidiaries may engage in “covered transactions,” such as loans, with any one affiliate to 10% of such institution’s capital stock and surplus. There is also an aggregate limit on all such transactions with all affiliates to 20% of capital stock and surplus. Loans to affiliates and certain other specified transactions must comply with specified collateralization requirements. Section 23B requires that transactions with affiliates be on terms that are no less favorable to the institution or its subsidiary as similar transactions with non-affiliates.
Federal law also restricts an institution with respect to loans to directors, executive officers, and principal stockholders (“insiders”). Loans to insiders and their related interests may not exceed, together with all other outstanding loans to such persons and affiliated entities, the institution’s total capital and surplus. Loans to insiders above specified amounts must receive the prior approval of the Board of Directors. Further, loans to insiders must be made on terms substantially the same as offered in comparable transactions to other persons, except that such insiders may receive preferential loans made under a benefit or compensation program that is widely available to the institution’s employees and does not give preference to the insider over the employees. Federal law places additional limitations on loans to executive officers. Massachusetts law previously had a separate law regarding insider transactions but that law was amended in 2015 to generally incorporate the federal restrictions.
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Insurance of Deposit Accounts. The Bank’s deposit accounts are insured by the Deposit Insurance Fund of the FDIC up to applicable limits. The FDIC insures deposits up to the standard maximum deposit insurance amount (“SMDIA”) of $250,000.
The FDIC charges insured depository institutions premiums to maintain the Deposit Insurance Fund. The Dodd-Frank Act required the FDIC to revise its procedures to base its assessments upon each insured institution’s total assets less tangible equity instead of deposits.
Under the FDIC’s risk-based assessment system, insured institutions are assessed based on perceived risk to the Deposit Insurance Fund with institutions deemed less risky pay lower FDIC assessments. Assessments for institutions with $10 billion or more of assets are primarily based on a scorecard approach by the FDIC, including factors such as examination ratings and modeling measuring the institution’s ability to withstand asset-related and funding-related stress and potential loss to the Deposit Insurance Fund should the bank fail. The assessment range (inclusive of possible adjustments specified by the regulations) for institutions with greater than $10 billion of total assets is 1.5 to 40 basis points. The Dodd-Frank Act required that banks of greater than $10 billion of assets bear the burden of raising the Deposit Insurance Fund reserve ratio from 1.15% to 1.35%. Such institutions were subject to an annual surcharge of 4.5 basis points of total assets exceeding $10 billion, effective July 1, 2016. The FDIC announced in November 2018 that the 1.35% reserve ratio had been reached so that the surcharges would cease. In 2019, the FDIC distributed premium rebates to the Company and other bank peers as a result of having collected excess premiums in earlier periods.
Insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by a regulator. Management does not know of any practice, condition or violation that might lead to termination of FDIC deposit insurance.
The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what insurance assessment rates will be in the future.
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank system, which consists of 12 regional Federal Home Loan Banks that provide a central credit facility primarily for member institutions. The Bank, as a member, is required to acquire and hold shares of capital stock in the FHLBB.
The Federal Home Loan Banks are required to provide funds for certain purposes including contributing funds for affordable housing programs. These requirements, and general financial results, could reduce the amount of dividends that the Federal Home Loan Banks pay to their members and result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. Historically, the FHLBB has paid dividends to member banks based on money market rates.
Enforcement
The FDIC has primary federal enforcement responsibility over state chartered banks that are not members of Federal Reserve System, which includes the Bank. The FDIC has authority to bring enforcement actions against such institutions and their “institution-related parties,” including officers, directors, certain shareholders, and attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the institution or receivership or conservatorship in certain circumstances. Potential civil money penalties cover a wide range of violations and actions, and range up to $25 thousand per day or, in extreme cases, as high as $1.0 million per day.
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Holding Company Regulation
General. The Company is subject to examination, regulation, and periodic reporting as a bank holding company under the Bank Holding Company Act of 1956, as amended. The Company is required to obtain the prior approval of the Federal Reserve Board to acquire all, or substantially all, of the assets of any other bank or bank holding company. Prior Federal Reserve Board approval would be required for the Company to acquire direct or indirect ownership or control of any voting securities of any bank or bank holding company if, after such acquisition, it would, directly or indirectly, own or control more than five percent of any class of voting shares of the bank or bank holding company.
A bank holding company is generally prohibited from engaging in non-banking activities, or acquiring direct or indirect control of more than five percent of the voting securities of any company engaged in non-banking activities. The Federal Reserve Board has allowed by regulation some exceptions based on activities closely related to banking including: (i) making or servicing loans; (ii) performing certain data processing services; (iii) providing discount brokerage services; (iv) acting as fiduciary, investment or financial advisor; and (v) acquiring a savings and loan association whose direct and indirect activities are limited to those permitted for bank holding companies.
The Gramm-Leach-Bliley Act of 1999 authorized a bank holding company that meets specified conditions, including being “well capitalized” and “well managed” as defined in the regulations, to opt to become a “financial holding company” and thereby engage in a broader array of financial activities. Such activities can include insurance and investment banking. The Company has elected to become a financial holding company.
The Company is subject to the Federal Reserve Board’s capital adequacy requirements for bank holding companies. The Dodd-Frank Act required the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. The previously discussed final rule regarding regulatory capital requirements implemented the Dodd-Frank Act as to bank holding company capital standards. Consolidated regulatory capital requirements identical to those applicable to the Bank applied to the Company, effective January 1, 2015. As is the case with institutions themselves, the capital conservation buffer was phased in beginning in 2016 and was fully effective on January 1, 2019.
Federal Reserve Board policy requires that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. The Dodd-Frank Act codified the source of strength doctrine.
The Federal Reserve Board has issued a policy statement regarding the payment of dividends and the repurchase of shares of common stock by bank holding companies. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Regulatory guidance provides for prior regulatory consultation with respect to dividends in certain circumstances such as where the company’s net income for the past four quarters, net of dividends’ previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized.
Federal regulations require a bank holding company to give the Federal Reserve Board prior written notice of any repurchase or redemption of then outstanding equity securities if the gross consideration for the repurchase or redemption, when combined with the net consideration paid for all such repurchases or redemptions during the preceding 12 months, is equal to 10% or more of the company’s consolidated net worth. The Federal Reserve Board may disapprove such a purchase or redemption under certain circumstances. There is an exception to this approval requirement for well-capitalized bank holding companies that meet certain other conditions. Federal Reserve policy provides for regulatory consultation prior to a holding company redeeming or repurchasing regulatory capital
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instruments under specified circumstances regardless of the applicability of the previously referenced notification requirement.
These regulatory policies could affect the ability of the Company to pay dividends, repurchase shares of its stock, or otherwise engage in capital distributions.
The status of the Company as a registered bank holding company under the Bank Holding Company Act does not exempt it from certain federal and state laws and regulations applicable to corporations generally, including, without limitation, certain provisions of the federal securities laws.
Acquisition of the Company. Under the Change in Bank Control Act, no person may acquire control of a bank holding company such as the Company unless the Federal Reserve Board has been given 60 days’ prior written notice and has not issued a notice disapproving the proposed acquisition, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition. Control, as defined for this purpose, means ownership, control of or holding irrevocable proxies representing more than 25% of any class of voting stock, control in any manner of the election of a majority of the company’s directors, or a determination by the regulator that the acquirer has the power to direct, or directly or indirectly to exercise a controlling influence over, the management or policies of the institution. Acquisition of more than 10% of any class of a bank holding company’s voting stock constitutes a rebuttable presumption of control under the regulations under certain circumstances including where, is the case with the Company, the issuer has registered securities under Section 12 of the Securities Exchange Act of 1934.
Massachusetts Holding Company Regulation. In addition to the federal holding company regulations, a bank holding company organized or doing business in Massachusetts must comply with requirements under Massachusetts law. Approval of the Massachusetts regulatory authorities is generally required for the Company to acquire 25 percent or more of the voting stock of another depository institution. Similarly, prior regulatory approval would be necessary for any person or company to acquire 25 percent or more of the voting stock of the Company.
Mergers and Acquisitions
The Company and the Bank have authority to engage, and have engaged, in acquisitions of other depository institutions. Such transactions are subject to a variety of conditions including, but not limited to, required stockholder approvals and the receipt of all necessary regulatory approvals. Necessary regulatory approvals include those required by the federal Bank Holding Company Act and/or Bank Merger Act, Massachusetts law and, if the target institution is located in a state other than Massachusetts, the law of that state. When considering merger applications, the federal regulators must evaluate such factors as the financial and managerial resources and future prospects of the parties, the convenience and needs of the communities to be served (including performance of the parties under the Community Reinvestment Act), competitive factors, any risk to the stability of the United States banking or financial system and the effectiveness of the institutions involved in combating money laundering activities. Both the Bank Holding Company Act and the Bank Merger Act provide for a waiting period of 15 to 30 days following approval by the federal banking regulator within which the United States Department of Justice may file objections to the merger under the federal antitrust laws. Massachusetts law requires the Commissioner (or Board of Bank Incorporation in certain cases) to consider such factors as whether competition among banking institutions will be unreasonably affected and whether public convenience and advantage will be promoted (including whether the merger will result in net new benefits).
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Other Regulations
Consumer Protection Laws. The Bank is subject to federal and state consumer protection statutes and regulations applicable to depository institutions. These include the Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers; Home Mortgage Disclosure Act, requiring financial institutions to provide certain information about home mortgage and refinance loans; the Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit; the Fair Credit Reporting Act, governing the provision of consumer information to credit reporting agencies and the use of consumer information; the Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and the Electronic Funds Transfer Act, governing automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services. Since the Bank has exceeded $10 billion of consolidated assets, compliance with such federal consumer protection statutes and regulations is examined for and enforced by the Consumer Finance Protection Bureau rather than the FDIC.
The Bank also is subject to Massachusetts and federal laws protecting the confidentiality of consumer financial records, and limiting the ability of the institution to share non-public personal information with third parties.
The Community Reinvestment Act (“CRA”) establishes a requirement for federal banking agencies that, in connection with examinations of depository institutions within their jurisdiction, the agencies evaluate the record of the depository institutions in meeting the credit needs of their local communities, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. These factors are also considered in evaluating mergers, acquisitions and applications to open a branch or new facility. Under the CRA, institutions are assigned a rating of “outstanding,” “satisfactory,” “needs to improve,” or “substantial non-compliance.” A less than “satisfactory” rating would result in the suspension of any growth of the Bank through acquisitions or opening de novo branches until the rating is improved. As of the most recent CRA examination by the FDIC, the Bank’s CRA rating was “satisfactory.”
Anti-Money Laundering Laws. The Bank is subject to extensive anti-money laundering provisions and requirements, which require the institution to have in place a comprehensive customer identification program and an anti-money laundering program and procedures. These laws and regulations also prohibit depository institutions from engaging in business with foreign shell banks; require depository institutions to have due diligence procedures and, in some cases, enhanced due diligence procedures for foreign correspondent and private banking accounts; and improve information sharing between depository institutions and the U.S. government. The Bank has established policies and procedures intended to comply with these provisions.
Taxation
The Company reports its income on a calendar year basis using the accrual method of accounting. This discussion of tax matters is only a summary and is not a comprehensive description of the tax rules applicable to the Company and its subsidiaries. Further discussion of income taxation is contained in Note 16 - Income Taxes of the Consolidated Financial Statements. The federal income tax laws apply to the Company in the same manner as to other corporations with some exceptions. The Company may exclude from income 100 percent of dividends received from the Bank and from Berkshire Insurance Group as members of the same affiliated group of corporations. The Company reports income on a calendar year basis to the Commonwealth of Massachusetts. Massachusetts tax law generally permits special tax treatment for a qualifying limited purpose “securities corporation.” The Bank’s securities corporations all qualify for this treatment, and are taxed at a 1.3% rate on their gross income.
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ITEM 1A. RISK FACTORS
The risks set forth below, in addition to the other risks described in this Annual Report on Form 10-K, may adversely affect the Company's business, financial condition, and operating results. In addition to the risks set forth below and the other risks described in this annual report, there may be additional risks and uncertainties that are not currently known to the Company or that the Company currently deems to be immaterial that could materially and adversely affect the Company's business, financial condition or operating results. As a result, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods. Further, to the extent that any of the information contained in this Annual Report on Form 10-K constitutes forward-looking statements, the risk factors set forth below also are cautionary statements identifying important factors that could cause actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of the Company.
Lending
Deterioration in the Housing Sector, Commercial Real Estate, and Related Markets May Adversely Affect Business and Financial Results.
Real estate lending is a major business activity for the Company. Real estate market conditions affect the value and marketability of real estate collateral, and they also affect the cash flows, liquidity, and net worth of many borrowers whose operations and finances depend on real estate market conditions. Adverse conditions in the Company's market areas could reduce growth rates, affect the ability of our customers to repay their loans, and generally affect the Company's financial condition and results of operations. Potential increases in interest rates could increase capitalization rates which could adversely affect commercial property appraisals and collateral value.
The Company’s Emphasis on Commercial Lending May Expose the Company to Increased Lending Risks, Which Could Hurt Profits.
The Company emphasizes commercial lending, which generally exposes the Company to a greater risk of nonpayment and loss because repayment of such loans often depends on the successful operations and income stream of the borrowers. Commercial loans are historically more susceptible to delinquency, default, and loss during economic downturns. Commercial lending involves larger loan sizes and larger relationship exposures, with greater potential impact on profits in the event of adverse loan performance. The majority of the Company’s commercial loans are secured by real estate and subject to the previously discussed real estate risk factors, as well as risks specific to individual properties and property types. Geographic expansion may result in new risks not identified by the Company or which it is unfamiliar with monitoring or resolving. Recent expansion has been focused on the Greater Boston market, where the Bank may be financing projects with larger loan amounts and where the Bank has less experience than in its traditional market areas and where competition may result in different lending structures.
In 2019, the Company wrote-off the $16 million balance of a secured commercial loan in circumstances involving alleged borrower fraud. Commercial lending activities pose higher risk of fraud, as in this situation. This asset was a participating interest in a commercial loan managed by another financial institution. Such participating interests involve risks related to counterparty performance, as further described in a later risk factor. In the case of this loan, the Company has filed legal claims against the lead lender in pursuit of the recovery of some of the loss recorded by the Company. The outcome of such legal proceedings is subject to uncertainty and the Company has not recognized any such potential recoveries in its financial records.
The Company is Subject to a Variety of Risks in Connection With Any Sale of Loans it May Conduct.
In connection with the Company’s sale of one or more loan portfolios, it may make certain representations and warranties to the purchaser concerning the loans sold and the procedures under which those loans have been originated and serviced. If any of these representations and warranties are invalid, the Company may be required to indemnify the purchaser for any related losses, or it may be required to repurchase part or all of the affected loans, which may be impaired. The Company may also be required to repurchase loans as a result of borrower fraud or in the event of early payment default by the borrower on a loan it has sold. The Company’s ability to maintain seller/servicer relationships with government agencies and government backed entities may be jeopardized in the event of the emergence of one or more of the above risks. Demand for the Company’s loans in the secondary markets could also be affected by these risks, which could lead to a reduction in related business activities.
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The Company may be required to reduce the value of any loans it marks as held for sale, which could adversely affect its results of operations. As a result of the Company’s strategic initiatives in 2019, the Company sold certain loan pools which were previously held for investment and conducted sales with buyers who it had not previously transacted with.
The Company is Exposed to Risk of Environmental Liability When It Takes Title to Property.
In the course of its business, the Company may foreclose on and take title to real estate. As a result, the Company could be subject to environmental liabilities with respect to these properties for property damage, personal injury, investigation and clean-up costs. The costs associated with investigation or remediation activities could be substantial. The Company may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property.
Operating
The Company’s Initiatives Resulting From Its Strategic Review May Not Be Successful.
In 2019, the Company initiated actions as a result of is strategic review of lines of business, balance sheet structure, efficiency, and stock repurchases. These actions are intended to produce more profitable and sustainable operations. These initiatives depend on conditions in the Company’s operating environment and involve significant changes in resource allocation and staffing. If operating conditions change or unanticipated consequences are experienced, the Company’s market position and operating results could be negatively impacted.
Discontinuing National Mortgage Banking Operations Exposes the Company to Additional Costs.
The FCLS national mortgage banking operations have been designated as discontinued and are held for sale. These operations involve a significant number of personnel and generate large volumes of loans and secondary market transactions and are the Company’s largest source of fee income. Prospects for the sale of these operations depend on market conditions and expectations of potential buyers. The structuring of a sale or other arrangements to complete the discontinuation of these operations may require additional expenses or have the impact of impairing the operations or revenue generating potential of the business. The Company could incur losses from discontinuing the operations or based on pricing available from buyers in this market. Such impacts may not be fully recognized until a sale or other disposition is completed.
Expansion, Growth, and Acquisitions Could Negatively Impact Earnings If Not Successful.
Successful expansion depends on the maintenance and development of an adequate infrastructure. Success also depends on customer acceptance and the long-term recruitment and retention of key personnel and acquired customer relationships. Profitability depends on whether the income generated will offset the increased operating expenses. The Company implemented certain expense restructuring activities, related in part to the rationalization of acquired operations. Changes in operations may result in inefficiencies or control deficiencies.
Merger and acquisition activities are subject to a number of risks, including lending, operating, and integration risks. Such growth requires careful due diligence, evaluation of risks, and projections of future operations and financial conditions. Adverse developments could have a material adverse effect on the Company's financial condition and results of operations. Acquisitions often involve extensive merger agreements, which may lead to litigation risks or operating constraints.
The Company has recruited executive and business line management to support its growth and expansion, and it has absorbed management of acquired operations. This involves retention risks, operating risks, and financial risks. Such recruitment can affect the retention of new and old business, and can also be affected by competitive reactions and other relationship risks in retaining accounts.
Regulatory examinations may identify matters requiring attention. Deficiencies related to regulatory compliance may result in changes that affect operating revenues and costs, including the scope or scale of business activities and/or potential future expansion initiatives. The Company may also face additional acquisition approval requirements, and growth plans could be slowed if expected approvals are not obtained.
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Competition From Financial Institutions and Other Financial Service Providers May Adversely Affect the Company’s Growth and Profitability.
Competition in the banking and financial services industry is intense. Larger banking institutions have substantially greater resources and lending limits and may offer certain services not offered by the Company. Local competitors with excess capital may accept lower returns on new business. There is increased competition by out-of-market competitors through the internet and mobile technology. Federal regulations and financial support programs may in some cases favor competitors. Competition includes competition for banking teams and talent. Competition creates risk that revenues, earnings, or market share could be adversely affected by the loss of talent.
Market Changes May Adversely Affect Demand For The Company’s Services and Impact Revenue, Costs, and Earnings.
Channels for servicing the Company’s customers are evolving rapidly, with less reliance on traditional branch facilities, more use of online and mobile banking, and demand for universal bankers and other relationship managers who can service multiple product lines. The Company has an ongoing process for evaluating the profitability of its branch system and other office and operational facilities. The identification of unprofitable operations and facilities can lead to restructuring charges and introduce the risk of disruptions to revenues and customer relationships. The Company competes with larger providers who are rapidly evolving their service channels and escalating the costs of evolving the service process.
The Company anticipates accelerating changes in market behaviors such that there is increased preference for providers with social purpose missions and community service initiatives, particularly to the underbanked. The Company’s strategic vision of building a 21st century community bank with a goal of purpose driven performance for all stakeholders is intended to future-proof the Company accelerated changes in market behaviors. The Company faces risk that these behaviors may change in a manner different from its expectations, which could affect future revenue, earnings, and recovery of investments in its strategic model.
The Company is Subject to Security and Operational Risks Relating to the Use of Technology that Could Damage the Company's Reputation and Business.
Security breaches of confidential information in our technology platforms could expose the Company to possible liability and damage its reputation. Any compromise of data security could also deter customers from using the Company's services. The Company relies on industry standard internet security and authentication systems to effect secure transmission of data. These precautions may not protect the Company's security systems from compromises or breaches and could result in damage to its reputation and business. The Company utilizes third party core banking software, in addition to other outsourced data processing. If third party providers encounter difficulties or if the Company has difficulty in communicating and/or transmitting with such third parties, it could significantly affect its ability to adequately process and account for customer transactions, which could significantly affect its business operations. The Company interfaces with electronic payments systems which are subject to security and operational risks. The Company utilizes file encryption in designated internal systems and networks and is subject to certain state and federal regulations regarding how the Company manages data security. The Company's enterprise governance risk and compliance function includes a framework of controls, policies and technologies to monitor and protect information from cyberattacks, mishandling, and loss, together with safeguards related to the confidentiality, integrity, and availability of information. Natural disasters and disaster recovery risks could affect its operating systems, which could affect its reputation. The Company's business continuity program addresses crisis management, business impact, and data and systems recovery. Potential problems with the management of technology security and operational risks may affect regulatory compliance, which could affect operating costs and expansion plans.
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The Company Faces Cybersecurity Risks, Including Denial of Service Attacks, Hacking and Identity Theft that Could Result in the Disclosure of Confidential Information or the Creation of Unauthorized Transactions, Which Could Adversely Affect the Company’s Business or Reputation and Create Significant Legal and Financial Exposure.
The Company’s computer systems and network infrastructure are subject to security risks and could be susceptible to cyber-attacks, such as denial of service attacks, hacking, terrorist activities or identity theft. Financial services institutions and companies engaged in data processing have reported breaches in the security of their websites or other systems, some of which have involved sophisticated and targeted attacks intended to obtain unauthorized access to confidential information, destroy data, steal financial assets, disable or degrade service, or sabotage systems, often through the introduction of computer viruses or malware, cyber-attacks and other means. Denial of service attacks have been launched against a number of large financial services institutions. As a growing regional bank, the Company may be subject to similar attacks in the future. Hacking and identity theft risks could cause serious reputational harm and possible financial loss to the Company. Cyber threats are rapidly evolving and the Company may not be able to anticipate or prevent all such attacks.
The Company may incur increasing costs in an effort to minimize these risks and could be held liable for any security breach or loss. Despite efforts to ensure the integrity of its systems, the Company will not be able to anticipate all security breaches of these types, and the Company may not be able to implement effective preventive measures against such security breaches. The techniques used by cyber criminals change frequently and can originate from a wide variety of sources, including outside groups such as external service providers, organized crime affiliates, terrorist organizations or hostile foreign governments. Those parties may also attempt to fraudulently induce employees, customers or other users of the Company’s systems to disclose sensitive information in order to gain access to its data or that of its clients or to conduct unauthorized financial transactions.
These risks may increase in the future as the Company continues to increase its mobile-payment and other internet-based product offerings and expands its internal usage of web-based products and applications. A successful penetration or circumvention of system security could cause serious negative consequences to the Company, including significant disruption of operations, misappropriation of confidential information of the Company or that of its customers, or damage to computers or systems of the Company or those of its customers and counterparties. A security breach could result in violations of applicable privacy and other laws, financial loss to the Company or to its customers, loss of confidence in the Company’s security measures, significant litigation exposure, and harm to the Company’s reputation, all of which could have a material adverse effect on the Company.
The Company is Subject to Regulatory Environment Changes Regarding Privacy and Data Protection and Could have a Material Impact on our Results of Operations.
The growth and expansion of the company into a variety of new fields may potentially involve new regulatory issues/requirements such as the EU General Data Protection Regulation (GDPR) or the California Consumer Privacy Act (CCPA). The potential costs of compliance with or imposed by new/existing regulations and policies that are applicable to us may affect the use of our products and services and could have a material adverse impact on our results of operations.
Financial and Operating Counterparties Expose the Company to Risks.
The Company's use of derivative financial instruments exposes us to financial and contractual risks with counterparties. The Company maintains correspondent bank relationships, manage certain loan participations, engage in securities and funding transactions, and undergo other activities with financial counterparties that are customary to its industry. The Company also utilizes services from major vendors of technology, telecommunications, and other essential operating services. There is financial and operating risk in these relationships, which the Company seeks to manage through internal controls and procedures, but there are no assurances that the Company will not experience loss or interruption of its business as a result of unforeseen events with these providers. The Company's mortgage banking operations have also exposed us to more counterparty transactions including the use of third parties to participate in the management of interest rate risk and mortgage sales and hedging. Financial and operational risks are inherent in these counterparty relationships. The Company could experience losses if there are failures in the controls or accounting, including those related to derivatives activities or if there are performance failures by any counterparties. The risk of loss is increased when interest rates
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change suddenly and if the intended hedging objectives are not achieved as a result of market or counterparty behaviors.
Changes in Executive Management Could Affect Operations.
Changes in executive and senior management could introduce control risks in the oversight of operating activities and in the planning and execution of strategic objectives, which could adversely affect the operations of the Bank.
The Company May Not Be Able to Attract and Retain Skilled People.
The Company's success depends, in large part, on its ability to attract new employees, retain and motivate its existing employees, and continue to compensate employees competitively. Competition for the best people can be intense and the Company may not be able to hire or retain appropriately qualified individuals. As a result of restructuring activities, the Company could experience challenges in the retention of existing employees.
Controls and Procedures May Fail or Be Circumvented.
Management regularly reviews and updates the Company’s internal controls, disclosure requirements and practices, and corporate governance policies and procedures. Any system of controls, however well designed and operated, can only provide reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations, and financial condition.
The Company’s Business is Reliant on Outside Vendors.
The Company’s business is highly dependent on the use of certain outside vendors for its day-to-day operations. The Company’s operations are exposed to risk that a vendor may not perform in accordance with established performance standards required in its agreements for any number of reasons including a change in their senior management, their financial condition, their product line or mix and how they support existing customers, or a simple change in their strategic focus. While the Company has comprehensive policies and procedures in place to mitigate risk at all phases of vendor management from selection, to performance monitoring and renewals, the failure of a vendor to perform in accordance with contractual agreements could be disruptive to its business, which could have a material adverse effect on its financial condition and results of operations.
Development of New Products and Services May Impose Additional Costs on the Company and May Expose It to Increased Operational Risk.
The Company’s financial performance depends, in part, on its ability to develop and market new and innovative services and to adopt or develop new technologies that differentiate its products or provide cost efficiencies, while avoiding increased related expenses. This dependency is exacerbated in the current “FinTech” environment, where financial institutions are investing significantly in evaluating new technologies, such as “Blockchain,” and developing potentially industry-changing new products, services and industry standards. The introduction of new products and services can entail significant time and resources, including regulatory approvals. Substantial risks and uncertainties are associated with the introduction of new products and services, including technical and control requirements that may need to be developed and implemented, rapid technological change in the industry, the Company’s ability to access technical and other information from its clients, the significant and ongoing investments required to bring new products and services to market in a timely manner at competitive prices and the preparation of marketing, sales and other materials that fully and accurately describe the product or service and its underlying risks. The Company’s failure to manage these risks and uncertainties also exposes it to enhanced risk of operational lapses which may result in the recognition of financial statement liabilities. Regulatory and internal control requirements, capital requirements, competitive alternatives, vendor relationships and shifting market preferences may also determine if such initiatives can be brought to market in a manner that is timely and attractive to the Company’s clients. Products and services relying on internet and mobile technologies may expose the Company to fraud and cybersecurity risks. Failure to successfully manage these risks in the development and implementation of new products or services could have a material adverse effect on the Company’s business and reputation, as well as on its consolidated results of operations and financial condition.
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The forecasted discontinuation of LIBOR and the emergence of one or more alternative benchmark indices to replace LIBOR could adversely impact the Company’s business and results of operations.
The Company’s floating-rate funding, certain hedging transactions and certain of the Company’s products, such as floating-rate loans and mortgages, determine the applicable interest rate or payment amount by reference to a benchmark rate, such as the London Interbank Offered Rate (“LIBOR”), or to an index, currency, basket or other financial metric. LIBOR and certain other benchmark rates are the subject of recent national, international, and other regulatory guidance and proposals for reform. In July 2017, the Chief Executive of the Financial Conduct Authority (“FCA”) announced that the FCA intends to stop persuading or compelling its panel banks to submit rates for the calculation of LIBOR after 2021. Consequently, at this time, it is not possible to predict whether and to what extent panel banks will continue to provide submissions for the calculation of LIBOR, such that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. Similarly, it is not possible to predict whether and for how long LIBOR will continue to be viewed as an acceptable market benchmark, what new or existing benchmark rate or rates may become accepted alternatives to LIBOR, or what the effect of any such changes in industry views or alternatives may be on the markets for LIBOR-linked financial instruments.
Regulators and various financial industry groups have sponsored or formed committees (e.g., the Federal Reserve-sponsored Alternative Reference Rates Committee) to, among other things, facilitate the identification of an alternative benchmark index to replace LIBOR, and publish consultations on recommended practices for transitioning away from LIBOR, including (i) the utilization of recommended fallback language for LIBOR-linked financial instruments, and (ii) development of alternative pricing methodologies for recommended alternative benchmarks such as the Secured Overnight Financing Rate (“SOFR”). SOFR is a measure of the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-based repurchase transactions. At this time, it is still not possible to predict whether these recommendations and proposals will be broadly accepted in the market, whether they will continue to evolve, and what the effect of their implementation may be on the markets for floating-rate financial instruments.
The discontinuation of LIBOR or changes in market perceptions of the acceptability of LIBOR as a benchmark could result in changes to the Company’s risk exposures (for example, if the anticipated discontinuation of LIBOR adversely affects the availability or cost of floating-rate funding and, therefore, the Company’s exposure to fluctuations in interest rates) or otherwise result in losses on a product or having to pay more or receive less on securities that the Company has issued or owns. A substantial portion of the Company’s on- and off-balance sheet financial instruments (many of which have terms that extend beyond 2021) are indexed to LIBOR, including interest rate swap agreements and other contracts used for hedging and trading account purposes, loans to commercial customers and consumers (including mortgage loans and other loans), and long-term borrowings. In addition, such uncertainty could result in pricing volatility and increased capital requirements, loss of market share in certain products, adverse tax or accounting impacts, and compliance, legal and operational costs and risks.
The Company established a LIBOR transition task force committee in 2018, which reports to the Enterprise Risk Management and Asset/Liability Committee. The task force has assessed the on- and off-balance sheet products that will be impacted with the LIBOR transition. The areas with the most impact are LIBOR based interest rate swaps and commercial loans that utilize LIBOR as the indexed rate. During 2019, revised LIBOR fallback language was added to all new Commercial loan contracts that contemplated the transition of LIBOR as an index rate. An impact assessment is underway to identify further exposures, such as systems, processes, and models affected by the discontinuation of LIBOR. The Company continues to develop and execute plans to transition products associated with LIBOR to alternative reference rates.
Acts of terrorism, severe weather, natural disasters, pandemics, public health issues and other external events could impact our ability to conduct business.
Our business is subject to risk from external events that could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue, and/or cause us to incur additional expenses. For example, financial institutions have been, and continue to be, targets of terrorist threats aimed at compromising their operating and communication systems. The metropolitan Boston area remains a central target for potential acts of terrorism, including cyber terrorism, which could affect not only our operations but those of our customers. Additionally, there
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could be sudden increases in electrical, telecommunications or other major physical infrastructure outages, natural disasters, the emergence of widespread health emergencies or pandemics, events arising from local or larger scale political or social matters, including terrorist acts, and cyber attacks. Events such as these may become more common in the future and could cause significant damage, such as disrupt power and communication services, impact the stability of our facilities and result in additional expenses, impair the ability of our borrowers to repay their loans, reduce the value of collateral securing the repayment of our loans, which could result in the loss of revenue. While we have established and regularly test disaster recovery procedures, the occurrence of any such event could have a material adverse effect on our business, operations and financial condition.
Liquidity
The Company's Wholesale Funding Sources May Prove Insufficient to Replace Deposits at Maturity and Support Operations and Future Growth.
The Company must maintain sufficient funds to respond to the needs of depositors and borrowers. As a part of its liquidity management, the Company uses a number of funding sources in addition to deposit growth and cash flows from loans and investments. These sources include Federal Home Loan Bank advances, proceeds from the sale of loans, and liquidity resources at the holding company. The Company uses brokered deposits both to support ongoing growth and to provide enhanced deposit insurance to support large dollar commercial relationships. The Company's financial flexibility will be severely constrained if the Company is unable to maintain access to wholesale funding or if adequate financing is not available to accommodate future growth at acceptable costs. Turbulence in the capital and credit markets may adversely affect liquidity and financial condition and the willingness of certain counterparties and customers to do business with the Company.
The Company's Ability to Service Our Debt, Pay Dividends, and Otherwise Pay Obligations as They Come Due Is Substantially Dependent on Capital Distributions from the Bank, and These Distributions Are Subject to Regulatory Limits and Other Restrictions. The Company’s Stock Repurchase Program is also Dependent on These Distributions.
A substantial source of holding company income is the receipt of dividends from the Bank, from which the Company services debt, pay obligations, and pay shareholder dividends. The availability of dividends from the Bank is limited by various statutes and regulations. It is possible, depending upon the financial condition of the Bank and other factors, that the applicable regulatory authorities could assert that payment of dividends or other types of payments are an unsafe or unsound practice. If the Bank is unable to pay dividends, the Company may not be able to service debt, pay debt obligations, or pay dividends on its common stock.
The Company’s strategic initiative to liquidate less strategic assets and to use proceeds to repurchase excess capital also depend on dividend distributions from the Bank which are Subject to Regulatory Limits and Other Restrictions. The Company’s ability to achieve targeted strategic benefits from this initiative may be compromised if Capital Distributions from the Bank are restricted or prohibited.
Secondary Mortgage Market Conditions Could Have a Material Impact on the Company’s Financial Condition and Results of Operations.
In addition to being affected by interest rates, the secondary mortgage markets are also subject to investor demand for residential mortgage loans and increased investor yield requirements for these loans. These conditions may fluctuate or worsen in the future. As a result, a prolonged period of secondary market illiquidity may reduce the Company’s loan production volumes and operating results.
Secondary markets are significantly affected by Fannie Mae, Freddie Mac and Ginnie Mae (collectively, the “Agencies”) for loan purchases that meet their conforming loan requirements. These agencies could limit purchases of conforming loans due to capital constraints, a change in the criteria for conforming loans or other factors. Proposals to reform mortgage finance could affect the role of the Agencies and the market for conforming loans which comprise the majority of the Company’s mortgage lending and related originations income.
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Interest Rates
Market Interest Rate Conditions Could Adversely Affect Results of Operations and Financial Condition.
Net interest income is the Company's largest source of income. Changes in interest rates can affect the level of net interest income and other elements of net income. The Company’s interest rate sensitivity is discussed in more detail in Item 7A of this report and is the primary market risk to its condition and operations. Changes in interest rates can also affect the demand for the Company’s products and services, and the supply conditions in the U.S. financial and capital markets. Changes in the level of interest rates may negatively affect the Company’s ability to originate real estate loans, the value of its assets and its ability to realize gains from the sale of assets, all of which ultimately affect earnings.
Securities Market Values
Declines in the Value of Certain Investment Securities Could Require Write-Downs, Which Would Reduce Earnings.
Declines in the value of investment securities due to market conditions and/or issuer impairment could result in losses that can reduce capital and earnings. The Company’s investment in equity securities and non-investment grade debt securities present heightened credit and price risks. Under new accounting standards, equity gains and losses are recorded to current period operating results. The Company has an investment in the stock of the Federal Home Loan Bank of Boston ("FHLBB") which could result in write-down in the event of impairment.
Taxation
Changes in Tax Preference Items May Affect Results of Operations.
Higher tax expense due to planned or unplanned changes in tax preference items may result in lower profitability. Quarterly results may vary significantly from annual results.
Regulatory
Legislative and Regulatory Initiatives May Affect Business Activities and Increase Operating Costs.
New federal or state laws and regulations could affect lending, funding practices, capital, and liquidity standards. New laws, regulations, and other regulatory changes may also increase compliance costs and affect business and operations. Moreover, the FDIC sets the cost of FDIC insurance premiums, which can affect profitability.
Regulatory capital requirements and their impact on the Company may change. The Company may need to raise additional capital in the future to support operations and continued growth. The Company's ability to raise capital, if needed, will depend on its condition and performance, and on market conditions.
New laws, regulations, and other regulatory changes, along with negative developments in the financial industry and the domestic and international credit markets, may significantly affect the markets in which the Company does business, the markets for and value of its loans and investments, and ongoing operations, costs and profitability. For more information, see “Regulation and Supervision” in Item 1 of this report.
In 2017, the Company crossed the $10 billion asset threshold established by the Dodd-Frank Act. The Company and the Bank are now subject to closer supervision by their primary regulators and, as to compliance with consumer protection laws and regulations, the Consumer Financial Protection Bureau. The Company and the Bank are subject to capital stress testing expectations which require significant resources and infrastructure. If the Company’s compliance with the enhanced supervision and requirements is insufficient, there can be significant negative consequences for its operations, profitability, and ability to further pursue its strategic growth plan.
Provisions of the Company's Certificate of Incorporation, Bylaws, and Delaware Law, as Well as State and Federal Banking Regulations, Could Delay or Prevent a Takeover of Us by a Third Party.
Provisions in the Company's certificate of incorporation and bylaws, the corporate law of the State of Delaware, and state and federal regulations could delay, defer or prevent a third party from acquiring us, despite the possible benefit stockholders, or otherwise adversely affect the price of its common stock. These provisions include: limitations on voting rights of beneficial owners of more than 10 percent of common stock; supermajority voting requirements for certain business combinations; the election of directors to terms of one year; and advance notice requirements for nominations for election to the Company's Board of Directors and for proposing matters that
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stockholders may act on at stockholder meetings. In addition, the Company is subject to Delaware laws, including one that prohibits engaging in a business combination with any interested stockholder for a period of three years from the date the person became an interested stockholder unless certain conditions are met. These provisions may discourage potential takeover attempts, discourage bids for the Company's common stock at a premium over market price or adversely affect the market price of, and the voting and other rights of the holders of, its common stock. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect directors other than the candidates nominated by the Board.
Significant Accounting Estimates May Not Be Realized in Accordance with Recorded Estimates.
Unexpected Changes May Adversely Affect Condition or Performance.
The Company’s significant accounting policies are described in Note 1 - Summary of Significant Accounting Policies of the Consolidated Financial Statements in Item 8 of this report. The SEC defines “critical accounting policies” as those that require application of management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in future periods. The Company’s critical accounting policies are further discussed in Item 7 of this report. If actual events and results do not conform to critical estimates, there could be a material impact on financial condition, operating performance, and execution of the strategic plan.
If the Company Determines Goodwill or Other Intangible Assets to be Impaired, the Company’s Financial Condition and Results Would Be Negatively Affected.
When the Company completes a business combination, a portion of the purchase price of the acquisition is allocated to goodwill and other identifiable intangible assets. The amount of the purchase price which is allocated to goodwill and other intangible assets is determined by the excess of the purchase price over the net identifiable assets acquired. At least annually (or more frequently if indicators arise), the Company evaluates goodwill for impairment by comparing the fair value of its reporting entities against the carrying value. If the Company determines goodwill or other intangible assets are impaired, the Company will be required to write down these assets. Any write-down would have a negative effect on the Consolidated Financial Statements.
A New Accounting Standard Will Require the Company to Increase Its Allowance For Loan Losses and May Have a Material Adverse Effect on Its Financial Condition and Results of Operations.
The Financial Accounting Standards Board has adopted a new accounting standard that will be effective for the Company for its 2020 fiscal year. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses. This standard is also applicable to other financial assets carried at amortized cost. This will change the current method of providing allowances for loan losses that are probable, which may require the Company to increase its allowance for loan losses, and to greatly increase the types of data it would need to collect and review to determine the appropriate level of the allowance for loan losses. Any increase in the Company’s allowance for loan losses or expenses incurred to determine the appropriate level of the allowance for loan losses may have a material adverse effect on its financial condition and operating results.
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Mergers and Acquisitions
Acquisitions May Disrupt the Company’s Business and Dilute Stockholder Value.
Future mergers or acquisitions involving cash, debt, or equity securities may occur from time to time. Acquiring other banks, businesses, or branches may have an adverse effect on the Company’s financial results and may involve various other risks commonly associated with acquisitions, including, among other things:
• | difficulty in estimating the value of the target company |
• | payment of a premium over book and market values that may dilute the Company’s tangible book value and earnings per share in the short and long term; |
• | exposure to unknown or contingent liabilities, or asset quality problems, of the target company; |
• | unexpected regulatory responses to merger related applications |
• | larger than anticipated merger-related expenses; |
• | difficulty and expense of integrating the operations and personnel of the target company, and retaining key employees and customers; |
• | inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits; and |
• | potential diversion of Company management’s time and attention. |
• | potential litigation could lead to additional expenses or prevent the completion of a merger agreement, which could result in the loss of the benefits which are targeted to offset merger costs. |
If the Company is unable to successfully integrate an acquired company, the anticipated benefits may not be realized fully or may take longer to realize than expected. A significant decline in asset valuations or cash flows may also prevent the attainment of targeted results. Additional discussion about the risk of acquisitions is included above in the discussion of Operating Risk.
Trading of the Company's Common Stock
The Trading History of the Company’s Common Stock is Characterized By Low Trading Volume. The Value of Shareholder Investments May be Subject to Sudden Decreases Due to the Volatility of the Price of the Common Stock.
The level of interest and trading in the Company’s stock depends on many factors beyond the Company's control. The market price of the Company's common stock may be highly volatile and subject to wide fluctuations in response to numerous factors, including, but not limited to, the factors discussed in other risk factors and the following: actual or anticipated fluctuations in operating results; changes in interest rates; changes in the legal or regulatory environment; press releases, announcements or publicity relating to the Company or its competitors or relating to trends in its industry; changes in expectations as to future financial performance, including financial estimates or recommendations by securities analysts and investors; future sales of its common stock; changes in economic conditions in the marketplace, general conditions in the U.S. economy, financial markets or the banking industry; and other developments. These factors may adversely affect the trading price of the Company's common stock, regardless of actual operating performance, and could prevent stockholders from selling their common stock at a desirable price.
In the past, stockholders have brought securities class action litigation against a company following periods of volatility in the market price of their securities. The Company could be the target of similar litigation in the future, which could result in substantial costs and divert management’s attention and resources.
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ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
The Company's headquarters are located at 60 State Street in leased property in Boston, MA. The Bank's headquarters are located in owned and leased facilities located in Pittsfield, MA. The Company also owns or leases other facilities within its primary market areas: Greater Boston (including Worcester, MA); Berkshire County, Massachusetts; Pioneer Valley (Springfield area), Massachusetts; Southern Vermont; the Capital Region (Albany area), New York; Central New York; Central and Eastern Connecticut; Southern Rhode Island; and Princeton area, New Jersey. As of December 31, 2019, the Company had 130 full-service branches in Massachusetts, New York, Connecticut, Vermont, Central New Jersey, and Eastern Pennsylvania.
The Company also has regional locations which are full-service commercial offices located in Boston, MA.; Pittsfield, MA.; Springfield, MA.; Albany, N.Y.; East Syracuse, N.Y.; Hartford, CT.; Willimantic, CT. Worcester, MA.; Burlington, MA.; and Lawrenceville, N.J. In addition, the Company has eight lending locations in Central/Eastern, Massachusetts. The Bank's wholly-owned subsidiary, Firestone Financial, LLC, is headquartered in the Boston metro area. First Choice Loan Services Inc., is headquartered in East Brunswick, N.J. and is a wholly-owned subsidiary of the Bank. As a national mortgage lender, the Company operates mortgage lending offices in targeted U.S. markets. These national mortgage banking operations were designated as held for sale in 2019 and are classified as discontinued operations in the financial statements.
Berkshire Insurance Group Inc. operates from 12 locations in Western Massachusetts and East Syracuse, N.Y. in both stand-alone premises as well as in rented space located in the Bank’s premises.
Berkshire continues to enhance its new retail branch design which eliminates traditional teller counters and provides an interactive customer service environment through “pod” stations which include automated cash handling technology. In many cases, this branch design also includes a multimedia community room which is offered for use by nonprofit community groups. The Company has begun introducing MyTeller automated remote teller stations at new offices and targeted existing offices.
The Bank has made its workplace more flexible as certain designated functions are approved for telecommuting arrangements. As a result of its merger and efficiency initiatives, the Bank has excess facilities space in various locations which in some cases is owned or subject to lease. The Bank is considering alternative uses of excess office space in support of its strategies to provide community benefit. The Bank has also introduced Reevx Labs community workspaces targeted to increase the Bank’s presence and service to underbanked urban communities. The first such workspace was opened shortly after year-end, and the Company has plans to open other such workspaces in targeted areas in the future.
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ITEM 3. LEGAL PROCEEDINGS
As of December 31, 2019, neither the Company nor the Bank was involved in any pending adverse legal proceedings believed by management to be material to the Company’s financial condition or results of operations. Periodically, there have been various claims and lawsuits involving the Bank, such as claims to enforce liens, condemnation proceedings on properties in which the Bank holds security interests, claims involving the making and servicing of real property loans, and other issues incident to the Bank’s business. A summary of certain legal matters involving unsettled litigation or pertaining to pending transactions are as follows:
On April 28, 2016, the Company and the Bank were served with a complaint filed in the United States District Court, District of Massachusetts, Springfield Division. The complaint was filed by an individual Berkshire Bank depositor, who claims to have filed the complaint on behalf of a purported class of Berkshire Bank depositors, and alleges violations of the Electronic Funds Transfer Act and certain regulations thereunder, among other matters. On July 15, 2016, the complaint was amended to add purported claims under the Massachusetts Consumer Protection Act. On January 4, 2019, the Parties reached an agreement in principle to settle the matter on a class-wide basis. Among other terms, the agreement in principle provides that the Company will pay a total of $3.0 million in exchange for the dismissal with prejudice and release of all claims that have been or could have been asserted in the lawsuit on behalf of the Plaintiff and the Settlement Class Members. On April 11, 2019, the Plaintiff filed the Parties’ fully-executed Settlement Agreement and Release (the “Settlement”) with the Court together with her unopposed motion for preliminary approval of class action settlement. On July 24, 2019, the Court granted preliminary approval of the Settlement, and issued an Order that notice of the Settlement be given to all Settlement Class Members. The Company paid $1.0 million on July 26, 2019, as required under the Settlement to offset certain anticipated administrative costs and expenses. The Company had an accrual of $2.0 million as of December 31, 2019, in anticipation of the completion of the Settlement. On February 14, 2020, the Court issued an order granting final approval of the Settlement and entered a final judgment dismissing the case with prejudice. The Company anticipates that the Settlement will be completed sometime during the first six months of 2020.
On January 29, 2018, the Bank was served with an amended complaint filed nominally against the Company in the Business Litigation Session of the Massachusetts Superior Court sitting in Suffolk County. The amended complaint was filed by two residuary beneficiaries of an estate planning trust that was administered by the Bank as successor trustee following the death of the trust donor, and alleges the Bank breached its fiduciary duty and violated the Massachusetts Consumer Protection Act in the course of performing its duties as trustee. The complaint seeks compensatory, statutory, and punitive damages. The Company and the Bank deny the allegations contained in the complaint and are vigorously defending this lawsuit. Discovery is complete in the case, and in January 2020 the Bank filed a motion for summary judgment seeking dismissal of the case on statute of limitations grounds. It is expected that this motion will be heard by the court during the first quarter of 2020.
On February 9, 2019, the Company received notice of a lawsuit filed in the United States District Court for the District of Connecticut by a purported SI Financial Group, Inc. (“SI Financial”) shareholder. On June 26, 2019, the Company received notice of a verified consolidated amended complaint in this action, which was filed after consolidation and elimination of two additional suits filed in the same Court by other former shareholders of SI Financial. The lawsuit purports to be filed as a putative class action lawsuit against SI Financial, the individual former members of the SI Financial board of directors, and the Company, in connection with the Company’s announced intention to acquire and merge with SI Financial. The Plaintiff, on behalf of himself and similarly situated SI Financial shareholders, generally alleges that the registration statement filed with the SEC on February 4, 2019 contains materially misleading omissions or misrepresentations in violation of Section 14(a) and Section 20(a) of the Exchange Act, and Rule 14a-9 promulgated thereunder, and that the individual Defendants breached their fiduciary duty to SI Financial shareholders and were unjustly enriched by the subject merger transaction. The Plaintiff seeks injunctive relief, unspecified damages, and an award of attorneys’ fees and expenses. Of note, SI Financial merged with and into the Company on May 17, 2019, and ceased to have any further independent legal existence at that time. The Company and the individual Defendants deny the allegations contained in the verified consolidated amended complaint and intend to vigorously defend this lawsuit. On July 26, 2019, the Company and the individual Defendants jointly filed a motion to dismiss all claims in this litigation, which is still pending before the court. There are no other active cases proceeding against the Company or the individual Defendants in regard to the SI Financial merger.
On February 4, 2020, the Bank filed a complaint in the New York State Supreme Court for the County of Albany against Pioneer Bank (“Pioneer”) seeking damages of approximately $16.0 million. The complaint alleges that Pioneer is liable to the Bank for a credit loss of approximately $16.0 million suffered by the Bank in the third quarter of 2019 as a result of Pioneer’s breach of loan participation agreements in which it served as the lead bank, as well as constructive fraud, fraudulent concealment and/or negligent misrepresentation. Pioneer has not yet responded to the Bank’s complaint. The Company wrote down the underlying credit loss in its entirety in the third quarter of 2019 and has not accrued for any anticipated recovery at this time.
ITEM 4. MINE SAFETY DISCLOSURES
Not Applicable.
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PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
The common shares of the Company trade on the New York Stock Exchange under the symbol “BHLB”. The following table sets forth the quarterly high and low sales price information and dividends declared per share of common stock in 2019 and 2018.
2019 | High | Low | Dividends Declared | |||||||||
First quarter | $ | 31.81 | $ | 26.02 | $ | 0.23 | ||||||
Second quarter | 31.60 | 27.35 | 0.23 | |||||||||
Third quarter | 33.33 | 28.20 | 0.23 | |||||||||
Fourth quarter | 33.72 | 27.99 | 0.23 | |||||||||
2018 | ||||||||||||
First quarter | $ | 40.10 | $ | 35.80 | $ | 0.22 | ||||||
Second quarter | 44.10 | 37.05 | 0.22 | |||||||||
Third quarter | 44.25 | 40.00 | 0.22 | |||||||||
Fourth quarter | 41.49 | 25.77 | 0.22 | |||||||||
The Company had approximately 4,205 holders of record of common stock at February 25, 2020.
Dividends
The Company intends to pay regular cash dividends to common and preferred shareholders; however, there is no assurance as to future dividends because they are dependent on the Company’s future earnings, capital requirements, financial condition, and regulatory environment. Dividends from the Bank have been a source of cash used by the Company to pay its dividends, and these dividends from the Bank are dependent on the Bank’s future earnings, capital requirements, and financial condition. Further information about dividend restrictions is disclosed in Note 20 - Shareholders’ Equity and Earnings per Common Share of the Consolidated Financial Statements.
Recent Sales of Unregistered Securities; Use of Proceeds from Registered Securities
The Company occasionally issues unregistered shares of common stock to vendors or as consideration in contracts for the purchase of assets, services, or operations. The Company issued 1,936 shares in 2019 and 23,877 shares in 2018. Subsequent to December 31, 2019, 260,700 preferred shares were converted to 521,400 unregistered shares of common stock from treasury shares.
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Purchases of Equity Securities by the Issuer and Affiliated Purchases
In April 2019, the Company announced that its Board of Directors authorized a new stock repurchase program,
pursuant to which the Company may repurchase up to 2.4 million shares of the Company's common stock. The new
repurchase program replaced the Company's unused 500 thousand share repurchase authorization. The timing of the purchases depends on certain factors, including but not limited to, market conditions and prices, available funds, and alternative uses of capital. The stock repurchase program may be carried out through open-market purchases, block trades, negotiated private transactions, or pursuant to a trading plan adopted in accordance with Rule 10b5-1 under the Securities Exchange Act of 1934. Repurchased shares are recorded as treasury shares. As of December 31, 2019, 1.7 million shares had been purchased under this program, which terminates on March 31, 2020.
Period | Total number of shares purchased | Average price paid per share | Total number of shares purchased as part of publicly announced plans or programs | Maximum number of shares that may yet be purchased under the plans or programs | |||||||||
October 1-31, 2019 | 408,600 | $ | 29.59 | 408,600 | 1,081,400 | ||||||||
November 1-30, 2019 | 210,000 | $ | 31.96 | 210,000 | 871,400 | ||||||||
December 1-31, 2019 | 197,028 | $ | 32.46 | 197,028 | 674,372 | ||||||||
Total | 815,628 | $ | 31.26 | 815,628 | 674,372 | ||||||||
Common Stock Performance Graph
The performance graph compares the Company’s cumulative shareholder return on its common stock over the last five years to the cumulative return of the NYSE Composite Index and the PHLX KBW Regional Bank Index. Total shareholder return is measured by dividing total dividends (assuming dividend reinvestment) for the measurement period plus share price change for a period by the share price at the beginning of the measurement period. The Company’s cumulative shareholder return over a five-year period is based on an initial investment of $100 on December 31, 2014.
Information used on the graph and table was obtained from a third party provider, a source believed to be reliable, but the Company is not responsible for any errors or omissions in such information.
40
Period Ending | ||||||||||||||||||
Index | 12/31/14 | 12/31/15 | 12/31/16 | 12/31/17 | 12/31/18 | 12/31/19 | ||||||||||||
Berkshire Hills Bancorp, Inc. | 100.00 | 112.18 | 146.26 | 148.66 | 112.12 | 140.93 | ||||||||||||
NYSE Composite Index | 100.00 | 96.03 | 107.62 | 127.96 | 116.72 | 146.76 | ||||||||||||
PHLX KBW Regional Banking Index | 100.00 | 105.99 | 147.46 | 150.13 | 123.87 | 153.43 | ||||||||||||
In accordance with the rules of the SEC, this section captioned “Common Stock Performance Graph,” shall not be incorporated by reference into any of our future filings made under the Securities Exchange Act of 1934 or the Securities Act of 1933. The Common Stock Performance Graph, including its accompanying table and footnotes, is not deemed to be soliciting material or to be filed under the Exchange Act or the Securities Act.
41
ITEM 6. SELECTED FINANCIAL DATA
The following summary data is based in part on the Consolidated Financial Statements and accompanying notes, and other schedules appearing elsewhere in this Form 10-K. Historical data is also based in part on, and should be read in conjunction with, prior filings with the SEC.
At or For the Years Ended December 31, | ||||||||||||||||||||
(In thousands, except per share data) | 2019 | 2018 | 2017 | 2016 | 2015 | |||||||||||||||
Per Common Share Data: | ||||||||||||||||||||
Net earnings, diluted - continuing operations | $ | 2.05 | $ | 2.36 | $ | 1.24 | $ | 1.88 | $ | 1.73 | ||||||||||
Net (loss)/earnings, diluted - discontinued operations | (0.08 | ) | (0.07 | ) | 0.15 | — | — | |||||||||||||
Net earnings, diluted | $ | 1.97 | $ | 2.29 | $ | 1.39 | $ | 1.88 | $ | 1.73 | ||||||||||
Total book value per common share | 34.65 | 33.30 | 32.14 | 30.65 | 28.64 | |||||||||||||||
Dividends | 0.92 | 0.88 | 0.84 | 0.80 | 0.76 | |||||||||||||||
Common stock price: | ||||||||||||||||||||
High | 33.72 | 44.25 | 40.00 | 37.35 | 30.40 | |||||||||||||||
Low | 26.02 | 25.77 | 32.85 | 24.71 | 24.32 | |||||||||||||||
Close | 32.88 | 26.97 | 36.60 | 36.85 | 29.11 | |||||||||||||||
Performance Ratios: (1) | ||||||||||||||||||||
Return on assets | 0.75 | % | 0.90 | % | 0.56 | % | 0.74 | % | 0.68 | % | ||||||||||
Return on equity | 5.75 | 6.84 | 4.45 | 6.44 | 6.14 | |||||||||||||||
Net interest margin, fully taxable equivalent (FTE) (2) | 3.17 | 3.40 | 3.40 | 3.31 | 3.34 | |||||||||||||||
Fee income/Net interest and fee income | 23.86 | 23.36 | 29.41 | 22.80 | 21.18 | |||||||||||||||
Growth Ratios: | ||||||||||||||||||||
Total commercial loans | 9.19 | % | 6.17 | % | 37.79 | % | 18.39 | % | 28.65 | % | ||||||||||
Total loans | 5.08 | 8.96 | 26.71 | 14.41 | 22.32 | |||||||||||||||
Total deposits | 15.07 | 2.66 | 32.13 | 18.48 | 20.08 | |||||||||||||||
Total net revenues, (compared to prior year) | 4.53 | 11.59 | 41.05 | 11.18 | 18.40 | |||||||||||||||
Earnings per share, (compared to prior year) | (13.97 | ) | 64.75 | (26.06 | ) | 8.62 | 27.21 | |||||||||||||
Selected Financial Data: | ||||||||||||||||||||
Total assets | $ | 13,215,970 | $ | 12,212,231 | $ | 11,570,751 | $ | 9,162,542 | $ | 7,831,086 | ||||||||||
Total earning assets | 11,916,007 | 11,140,307 | 10,509,163 | 8,340,287 | 7,140,387 | |||||||||||||||
Securities | 1,769,878 | 1,918,604 | 1,898,564 | 1,628,246 | 1,371,316 | |||||||||||||||
Total loans | 9,502,428 | 9,043,253 | 8,299,338 | 6,549,787 | 5,725,236 | |||||||||||||||
Allowance for loan losses | (63,575 | ) | (61,469 | ) | (51,834 | ) | (43,998 | ) | (39,308 | ) | ||||||||||
Total intangible assets | 599,377 | 551,743 | 557,583 | 422,551 | 334,607 | |||||||||||||||
Total deposits | 10,335,977 | 8,982,381 | 8,749,530 | 6,622,092 | 5,589,135 | |||||||||||||||
Total borrowings | 827,550 | 1,517,816 | 1,137,075 | 1,313,997 | 1,263,318 | |||||||||||||||
Total shareholders’ equity | 1,758,564 | 1,552,918 | 1,496,264 | 1,093,298 | 887,189 | |||||||||||||||
42
At or For the Years Ended December 31, | ||||||||||||||||||||
2019 | 2018 | 2017 | 2016 | 2015 | ||||||||||||||||
Selected Operating Data: | ||||||||||||||||||||
Total interest and dividend income | $ | 509,513 | $ | 465,894 | $ | 355,076 | $ | 280,439 | $ | 247,030 | ||||||||||
Total interest expense | 144,255 | 109,694 | 64,113 | 48,172 | 33,181 | |||||||||||||||
Net interest income | 365,258 | 356,200 | 290,963 | 232,267 | 213,849 | |||||||||||||||
Fee income | 76,824 | 74,026 | 71,356 | 68,606 | 57,480 | |||||||||||||||
All other non-interest income (loss) | 7,178 | 298 | 2,888 | (2,755 | ) | (3,192 | ) | |||||||||||||
Total net revenue | 449,260 | 430,524 | 365,207 | 298,118 | 268,137 | |||||||||||||||
Provision for loan losses | 35,419 | 25,451 | 21,025 | 17,362 | 16,726 | |||||||||||||||
Total non-interest expense | 289,857 | 266,893 | 252,978 | 203,302 | 196,829 | |||||||||||||||
Income from continuing operations before income taxes | 123,984 | 138,180 | 91,204 | 77,454 | 54,582 | |||||||||||||||
Income tax expense from continuing operations | 22,463 | 28,961 | 42,088 | 18,784 | 5,064 | |||||||||||||||
Net income from continuing operations | 101,521 | 109,219 | 49,116 | 58,670 | 49,518 | |||||||||||||||
(Loss)/income from discontinued operations before income taxes | (5,539 | ) | (4,767 | ) | 8,545 | — | — | |||||||||||||
Income tax (benefit)/expense from discontinued operations | (1,468 | ) | (1,313 | ) | 2,414 | — | — | |||||||||||||
Net (loss) from discontinued operations | (4,071 | ) | (3,454 | ) | 6,131 | — | — | |||||||||||||
Net income | $ | 97,450 | $ | 105,765 | $ | 55,247 | $ | 58,670 | $ | 49,518 | ||||||||||
Basic earnings/(loss) per common share: | ||||||||||||||||||||
Continuing operations | $ | 2.06 | $ | 2.38 | $ | 1.24 | $ | 1.89 | $ | 1.74 | ||||||||||
Discontinued operations | (0.08 | ) | (0.08 | ) | 0.16 | — | — | |||||||||||||
Total basic earnings per share | $ | 1.98 | $ | 2.30 | $ | 1.40 | $ | 1.89 | $ | 1.74 | ||||||||||
Diluted earnings/(loss) per common share: | ||||||||||||||||||||
Continuing operations | $ | 2.05 | $ | 2.36 | $ | 1.24 | $ | 1.88 | $ | 1.73 | ||||||||||
Discontinued operations | (0.08 | ) | (0.07 | ) | 0.15 | — | — | |||||||||||||
Total diluted earnings per share | $ | 1.97 | $ | 2.29 | $ | 1.39 | $ | 1.88 | $ | 1.73 | ||||||||||
Weighted average common shares outstanding - basic | 49,263 | 46,024 | 39,456 | 30,988 | 28,393 | |||||||||||||||
Weighted average common shares outstanding - diluted | 49,421 | 46,231 | 39,695 | 31,167 | 28,564 | |||||||||||||||
Dividends per preferred share | $ | 1.84 | $ | 1.76 | $ | 0.42 | $ | — | $ | — | ||||||||||
Dividends per common share | $ | 0.92 | $ | 0.88 | $ | 0.84 | $ | 0.80 | $ | 0.76 | ||||||||||
Asset Quality and Condition Ratios: (3) | ||||||||||||||||||||
Net loans charged-off/average loans | 0.35 | % | 0.18 | % | 0.19 | % | 0.21 | % | 0.25 | % | ||||||||||
Allowance for loan losses/total loans | 0.67 | 0.68 | 0.62 | 0.67 | 0.69 | |||||||||||||||
Loans/deposits | 92 | 101 | 95 | 99 | 102 | |||||||||||||||
Capital Ratios: | ||||||||||||||||||||
Tier 1 capital to average assets - Company | 9.33 | % | 9.04 | % | 9.01 | % | 7.88 | % | 7.71 | % | ||||||||||
Total capital to risk-weighted assets - Company | 13.73 | 12.99 | 12.43 | 11.87 | 11.91 | |||||||||||||||
Tier 1 capital to risk-weighted assets - Company | 12.30 | 11.57 | 11.15 | 10.07 | 9.94 | |||||||||||||||
Shareholders’ equity/total assets | 13.31 | 12.73 | 12.93 | 11.93 | 11.33 | |||||||||||||||
43
____________________________________
(1) All performance ratios are annualized and are based on average balance sheet amounts, where applicable.
(2) Fully taxable equivalent considers the impact of tax advantaged investment securities and loans.
(3) Generally accepted accounting principles require that loans acquired in a business combination be recorded at fair value, whereas loans from business activities are recorded at cost. The fair value of loans acquired in a business combination includes expected loan losses, and there is no loan loss allowance recorded for these loans at the time of acquisition. Accordingly, the ratio of the loan loss allowance to total loans is reduced as a result of the existence of such loans, and this measure is not directly comparable to prior periods. Similarly, net loan charge-offs are normally reduced for loans acquired in a business combination since these loans are recorded net of expected loan losses. Therefore, the ratio of net loan charge-offs to average loans is reduced as a result of the existence of such loans, and this measure is not directly comparable to prior periods. Other institutions may have loans acquired in a business combination, and therefore there may be no direct comparability of these ratios between and among other institutions.
44
Average Balances, Interest and Average Yields/Cost
The following table presents an analysis of average rates and yields on a fully taxable equivalent basis for the years presented. Tax exempt interest revenue is shown on a tax-equivalent basis for proper comparison.
Item 6 - Table 3 - Average Balance, Interest and Average Yields / Costs
2019 | 2018 | 2017 | |||||||||||||||||||||||||||||||
(Dollars in millions) | Average Balance | Interest | Average Yield/ Rate | Average Balance | Interest | Average Yield/ Rate | Average Balance | Interest | Average Yield/ Rate | ||||||||||||||||||||||||
Assets | |||||||||||||||||||||||||||||||||
Loans: (1) | |||||||||||||||||||||||||||||||||
Commercial real estate | $ | 3,789.5 | $ | 188.6 | 4.98 | % | $ | 3,283.6 | $ | 167.7 | 5.11 | % | $ | 2,789.8 | $ | 130.0 | 4.66 | % | |||||||||||||||
Commercial and industrial loans | 1,983.9 | 111.2 | 5.60 | 1,867.9 | 107.6 | 5.76 | 1,259.9 | 65.7 | 5.21 | ||||||||||||||||||||||||
Residential loans | 2,719.8 | 100.7 | 3.70 | 2,353.1 | 86.3 | 3.67 | 1,962.4 | 71.5 | 3.64 | ||||||||||||||||||||||||
Consumer loans | 1,038.4 | 46.5 | 4.48 | 1,115.3 | 47.2 | 4.23 | 1,032.6 | 39.4 | 3.82 | ||||||||||||||||||||||||
Total loans | 9,531.6 | 447.0 | 4.69 | 8,619.9 | 408.8 | 4.74 | 7,044.7 | 306.6 | 4.35 | ||||||||||||||||||||||||
Investment securities (2) | 1,846.9 | 62.6 | 3.39 | 1,931.7 | 64.4 | 3.33 | 1,757.3 | 60.3 | 3.43 | ||||||||||||||||||||||||
Short-term investments and loans held for sale (3) | 335.3 | 13.4 | 4.01 | 146.3 | 5.4 | 3.72 | 134.5 | 4.6 | 3.38 | ||||||||||||||||||||||||
Total interest-earning assets | 11,713.8 | 523.0 | 4.47 | 10,697.9 | 478.6 | 4.47 | 8,936.5 | 371.5 | 4.16 | ||||||||||||||||||||||||
Intangible assets | 578.1 | 0 | 554.6 | 449.7 | |||||||||||||||||||||||||||||
Other non-interest earning assets (3) | 669.1 | 0 | 516.9 | 428.4 | |||||||||||||||||||||||||||||
Total assets | $ | 12,961.0 | $ | 11,769.4 | $ | 9,814.6 | |||||||||||||||||||||||||||
Liabilities and shareholders' equity | |||||||||||||||||||||||||||||||||
Deposits: | |||||||||||||||||||||||||||||||||
NOW and other | $ | 1,053.9 | $ | 6.5 | 0.62 | % | $ | 824.7 | $ | 4.0 | 0.49 | % | $ | 591.0 | $ | 1.5 | 0.25 | % | |||||||||||||||
Money market | 2,542.6 | 31.4 | 1.23 | 2,432.2 | 21.9 | 0.90 | 1,935.8 | 11.2 | 0.58 | ||||||||||||||||||||||||
Savings | 798.2 | 1.2 | 0.15 | 740.8 | 1.1 | 0.15 | 680.1 | 0.9 | 0.14 | ||||||||||||||||||||||||
Certificates of deposit | 3,754.2 | 76.1 | 2.03 | 3,075.5 | 51.3 | 1.67 | 2,581.1 | 30.3 | 1.17 | ||||||||||||||||||||||||
Total interest-bearing deposits | 8,148.9 | 115.2 | 1.41 | 7,073.2 | 78.4 | 1.11 | 5,788.0 | 43.9 | 0.76 | ||||||||||||||||||||||||
Borrowings and notes (4) | 1,115.5 | 32.4 | 2.91 | 1,409.0 | 33.4 | 2.37 | 1,373.8 | 21.6 | 1.57 | ||||||||||||||||||||||||
Total interest-bearing liabilities | 9,264.4 | 147.6 | 1.59 | 8,482.2 | 111.8 | 1.32 | 7,161.8 | 65.5 | 0.91 | ||||||||||||||||||||||||
Non-interest-bearing demand deposits | 1,745.2 | 1,622.4 | 1,296.4 | ||||||||||||||||||||||||||||||
Other non-interest-bearing liabilities (3) | 257.1 | 119.3 | 112.6 | ||||||||||||||||||||||||||||||
Total liabilities | 11,266.7 | 10,223.9 | 8,570.8 | ||||||||||||||||||||||||||||||
Total shareholders' equity | 1,694.3 | 1,545.5 | 1,243.8 | ||||||||||||||||||||||||||||||
Total liabilities and equity | $ | 12,961.0 | $ | 11,769.4 | $ | 9,814.6 | |||||||||||||||||||||||||||
Net interest income | $ | 375.4 | $ | 366.8 | $ | 306.0 | |||||||||||||||||||||||||||
45
2019 | 2018 | 2017 | |||||||||||||||||||||||||||||||
(Dollars in millions) | Average Balance | Interest | Average Yield/ Rate | Average Balance | Interest | Average Yield/ Rate | Average Balance | Interest | Average Yield/ Rate | ||||||||||||||||||||||||
Net interest spread | 2.88 | % | 3.16 | % | 3.25 | % | |||||||||||||||||||||||||||
Net interest margin (5) | 3.17 | 3.40 | 3.40 | ||||||||||||||||||||||||||||||
Cost of funds | 1.34 | 1.11 | 0.77 | ||||||||||||||||||||||||||||||
Cost of deposits | 1.16 | 0.90 | 0.62 | ||||||||||||||||||||||||||||||
Interest-earning assets/interest-bearing liabilities | 126.44 | 126.12 | 124.78 | ||||||||||||||||||||||||||||||
Supplementary data | |||||||||||||||||||||||||||||||||
Total non-maturity deposits | $ | 6,139.9 | $ | 5,620.1 | $ | 4,503.3 | |||||||||||||||||||||||||||
Total deposits | 9,894.1 | 8,695.6 | 7,084.4 | ||||||||||||||||||||||||||||||
Fully taxable equivalent adjustment | 7.5 | 7.4 | 11.2 | ||||||||||||||||||||||||||||||
____________________________________
Notes:
(1) The average balances of loans include nonaccrual loans, and deferred fees and costs.
(2) The average balance of investment securities is based on amortized cost.
(3) Includes discontinued operations.
(4) The average balances of borrowings and notes include the capital lease obligation presented under other liabilities on the consolidated balance sheet.
(5) Purchase accounting accretion totaled $14.5 million, $23.1 million, and $14.8 million for the years-ended December 31, 2019, 2018, and 2017, respectively. The effect of purchase accounting accretion on the net interest margin was an increase in all years, which is shown sequentially as follows beginning with the most recent year and ending with the earliest year: 0.12%, 0.22%, and 0.17%.
46
Rate/Volume Analysis
The following table presents the effects of rate and volume changes on the fully taxable equivalent net interest income. Tax exempt interest revenue is shown on a tax-equivalent basis for proper comparison. For each category of interest-earning assets and interest-bearing liabilities, information is provided with respect to changes attributable to (1) changes in rate (change in rate multiplied by prior year volume), (2) changes in volume (change in volume multiplied by prior year rate), and (3) changes in volume/rate (change in rate multiplied by change in volume) have been allocated proportionately based on the absolute value of the change due to the rate and the change due to volume.
Item 6 - Table 4 - Rate Volume Analysis
2019 Compared with 2018 | 2018 Compared with 2017 | |||||||||||||||||||||||
(Decrease) Increase Due to | (Decrease) Increase Due to | |||||||||||||||||||||||
(In thousands) | Rate | Volume | Net | Rate | Volume | Net | ||||||||||||||||||
Interest income: | ||||||||||||||||||||||||
Commercial real estate | $ | (4,367 | ) | $ | 25,271 | $ | 20,904 | $ | 13,206 | $ | 24,444 | $ | 37,650 | |||||||||||
Commercial and industrial loans | (2,978 | ) | 6,558 | 3,580 | 7,492 | 34,426 | 41,918 | |||||||||||||||||
Residential loans | 901 | 13,571 | 14,472 | 467 | 14,318 | 14,785 | ||||||||||||||||||
Consumer loans | 2,630 | (3,357 | ) | (727 | ) | 4,487 | 3,304 | 7,791 | ||||||||||||||||
Total loans | (3,814 | ) | 42,043 | 38,229 | 25,652 | 76,492 | 102,144 | |||||||||||||||||
Investment securities | 1,098 | (2,863 | ) | (1,765 | ) | (1,784 | ) | 5,853 | 4,069 | |||||||||||||||
Short-term investments and loans held for sale (1) | 455 | 7,544 | 7,999 | 470 | 418 | 888 | ||||||||||||||||||
Total interest income | $ | (2,261 | ) | $ | 46,724 | $ | 44,463 | $ | 24,338 | $ | 82,763 | $ | 107,101 | |||||||||||
Interest expense: | ||||||||||||||||||||||||
NOW accounts | $ | 1,217 | $ | 1,265 | $ | 2,482 | $ | 1,809 | $ | 739 | $ | 2,548 | ||||||||||||
Money market accounts | 8,411 | 1,036 | 9,447 | 7,332 | 3,382 | 10,714 | ||||||||||||||||||
Savings accounts | 5 | 86 | 91 | 77 | 87 | 164 | ||||||||||||||||||
Certificates of deposit | 12,250 | 12,562 | 24,812 | 14,526 | 6,557 | 21,083 | ||||||||||||||||||
Total deposits | 21,883 | 14,949 | 36,832 | 23,744 | 10,765 | 34,509 | ||||||||||||||||||
Borrowings | 6,695 | (7,722 | ) | (1,027 | ) | 11,286 | 567 | 11,853 | ||||||||||||||||
Total interest expense | $ | 28,578 | $ | 7,227 | $ | 35,805 | $ | 35,030 | $ | 11,332 | $ | 46,362 | ||||||||||||
Change in net interest income | $ | (30,839 | ) | $ | 39,497 | $ | 8,658 | $ | (10,692 | ) | $ | 71,431 | $ | 60,739 | ||||||||||
(1) Includes discontinued operations.
NON-GAAP FINANCIAL MEASURES
This document contains certain non-GAAP financial measures in addition to results presented in accordance with Generally Accepted Accounting Principles (“GAAP”). These non-GAAP measures are intended to provide the reader with additional supplemental perspectives on operating results, performance trends, and financial condition. Non-GAAP financial measures are not a substitute for GAAP measures; they should be read and used in conjunction with the Company’s GAAP financial information. A reconciliation of non-GAAP financial measures to GAAP measures is provided below. In all cases, it should be understood that non-GAAP measures do not depict amounts that accrue directly to the benefit of shareholders. An item which management excludes when computing non-GAAP adjusted earnings can be of substantial importance to the Company’s results for any particular quarter or year. The Company’s non-GAAP adjusted earnings information set forth is not necessarily comparable to non-GAAP information which may be presented by other companies. Each non-GAAP measure used by the Company in this report as supplemental financial data should be considered in conjunction with the Company’s GAAP financial information.
The Company utilizes the non-GAAP measure of adjusted earnings in evaluating operating trends, including components for adjusted revenue and expense. These measures exclude amounts which the Company views as unrelated to its normalized operations, including securities gains/losses, gains on the sale of business operations, losses recorded for hedge terminations, merger costs, restructuring costs, systems conversion costs, and certain dispute settlement costs. Additionally, the results of national mortgage banking operations which have been designated as discontinued have been excluded from adjusted earnings for all three years summarized below.
Non-GAAP adjustments are presented net of an adjustment for income tax expense. In 2017, there was a large adjustment for the write-down of the deferred tax asset at year-end due to the passage of federal tax reform. There was also an adjustment for investments in employees and communities which were made by the Company in recognition of the future benefits of federal tax reform. The Company also measures adjusted revenues and adjusted expenses which result from the above adjustments.
The Company calculates certain profitability measures based on its adjusted revenue, expenses, and earnings. The Company also calculates adjusted earnings per share based on its measure of adjusted earnings. The Company views these amounts as important to understanding its operating trends, particularly due to the impact of accounting standards related to merger and acquisition activity. Analysts also rely on these measures in estimating and evaluating the Company’s performance. Management also believes that the computation of non-GAAP adjusted earnings and adjusted earnings per share may facilitate the comparison of the Company to other companies in the financial services industry.
Charges related to merger and acquisition activity consist primarily of severance/benefit related expenses, contract termination costs, and professional fees. Systems conversion costs relate primarily to the Company’s core systems conversion and related systems conversions costs. Restructuring costs primarily consist of the Company's continued effort to create efficiencies in operations through calculated adjustments to the branch banking footprint. Expense adjustments include variable rate compensation related to non-operating items. An adjustment was recorded in 2018 for an $8 million core systems contract restructuring charge, and an adjustment of $1.5 million was recorded for charges related to the CEO transition.
The Company also adjusts certain equity related measures to exclude intangible assets due to the importance of these measures to the investment community.
The following table summarizes the reconciliation of non-GAAP items recorded for the time periods indicated:
At or For the Years Ended | ||||||||||||
(Dollars in thousands) | December 31, 2019 | December 31, 2018 | December 31, 2017 | |||||||||
GAAP Net income | $ | 97,450 | $ | 105,765 | $ | 55,247 | ||||||
Non-GAAP measures | ||||||||||||
Adj: Loss/(gain) on securities, net | (4,389 | ) | 3,719 | (12,598 | ) | |||||||
Adj: Net gains on sale of business operations | — | (460 | ) | (296 | ) | |||||||
Adj: Loss on termination of hedges | — | — | 6,629 | |||||||||
Adj: Acquisition, restructuring, conversion, and other related expenses (1) | 28,046 | 10,752 | 31,558 | |||||||||
Adj: Employee and community investment | — | — | 3,400 | |||||||||
Adj: Legal settlements | — | 3,000 | — | |||||||||
Adj: Systems vendor restructuring costs | — | 8,379 | — | |||||||||
Adj: Deferred tax asset impairment | — | — | 18,145 | |||||||||
Adj: Loss from discontinued operations before income taxes | 5,539 | 4,767 | (8,545 | ) | ||||||||
Adj: Income taxes | (7,799 | ) | (7,102 | ) | (8,863 | ) | ||||||
Net non-operating charges | 21,397 | 23,055 | 29,430 | |||||||||
Total adjusted net income (non-GAAP) | $ | 118,847 | $ | 128,820 | $ | 84,677 | ||||||
GAAP Total revenue from continuing operations | $ | 449,260 | $ | 430,524 | $ | 365,207 | ||||||
Adj: Loss/(gain) on securities, net | (4,389 | ) | 3,719 | (12,598 | ) | |||||||
Adj: Net gains on sale of business operations | — | (460 | ) | (296 | ) | |||||||
Adj: Loss on termination of hedges | — | — | 6,629 | |||||||||
Total adjusted operating revenue (non-GAAP) | $ | 444,871 | $ | 433,783 | $ | 358,942 | ||||||
GAAP Total non-interest expense from continuing operations | $ | 289,857 | $ | 266,893 | $ | 252,978 | ||||||
Less: Total non-operating expense (see above) | (28,046 | ) | (10,752 | ) | (31,558 | ) | ||||||
Less: Employee and community reinvestment | — | — | (3,400 | ) | ||||||||
Less: Legal settlements | — | (3,000 | ) | — | ||||||||
Less: Systems vendor restructuring costs | — | (8,379 | ) | — | ||||||||
Adjusted operating non-interest expense (non-GAAP) | $ | 261,811 | $ | 244,762 | $ | 218,020 | ||||||
(in millions, except per share data) | ||||||||||||
Total average assets | $ | 12,961 | $ | 11,769 | $ | 9,815 | ||||||
Total average shareholders' equity | 1,694 | 1,546 | 1,244 | |||||||||
Total average tangible shareholders equity | 1,116 | 991 | 793 | |||||||||
Total average tangible common shareholders equity | 1,076 | 950 | 784 | |||||||||
Total tangible shareholders’ equity, period-end | 1,159 | 1,001 | 939 | |||||||||
Total tangible common shareholders’ equity, period-end | 1,119 | 961 | 898 | |||||||||
Total tangible assets, period-end | 12,613 | 11,660 | 11,013 | |||||||||
Total common shares outstanding, period-end (thousands) | 49,585 | 45,417 | 45,290 | |||||||||
Average diluted shares outstanding (thousands) | 49,421 | 46,231 | 39,695 | |||||||||
Earnings per share, diluted | $ | 1.97 | $ | 2.29 | $ | 1.39 | ||||||
Plus: Net adjustments per share, diluted | 0.43 | 0.50 | 0.74 | |||||||||
Adjusted earnings per share, diluted | 2.40 | 2.79 | 2.13 | |||||||||
Book value per common share, period-end | 34.65 | 33.30 | 32.14 | |||||||||
Tangible book value per common share, period-end | 22.56 | 21.15 | 19.83 | |||||||||
Total shareholders' equity/total assets | 13.31 | 12.72 | 12.93 | |||||||||
Total tangible shareholders' equity/total tangible assets | 9.19 | 8.59 | 8.52 | |||||||||
At or For the Years Ended | ||||||||||||
(Dollars in thousands) | December 31, 2019 | December 31, 2018 | December 31, 2017 | |||||||||
Performance Ratios | ||||||||||||
GAAP return on assets | 0.75 | 0.90 | 0.56 | |||||||||
Adjusted return on assets | 0.93 | 1.12 | 0.86 | |||||||||
GAAP return on equity | 5.75 | 6.84 | 4.45 | |||||||||
Adjusted return on equity | 7.01 | 8.33 | 6.81 | |||||||||
Adjusted return on tangible common equity | 11.35 | 13.48 | 11.04 | |||||||||
Efficiency ratio (2) | 55.63 | 53.64 | 56.40 | |||||||||
Supplementary Data (in thousands) | ||||||||||||
Tax benefit on tax-credit investments | 7,950 | 5,876 | 10,182 | |||||||||
Non-interest income charge on tax-credit investments | (6,455 | ) | (4,822 | ) | (8,693 | ) | ||||||
Net income on tax-credit investments | 1,495 | 1,054 | 1,489 | |||||||||
Intangible amortization | 5,783 | 4,934 | 3,493 | |||||||||
Fully taxable equivalent income adjustment | 7,451 | 7,423 | 11,227 | |||||||||
____________________________________
(1) | Acquisition, restructuring, conversion, and other related expenses included $18.7 million of merger and acquisition expenses and $9.3 million of restructuring expenses for the year-ended December 31, 2019. For the year-ended 2018, these expenses included $8.9 million in merger and acquisition expenses and $1.8 million of restructuring expenses. For the year-ended 2017, these expenses included $24.9 million in merger and acquisition expenses and $6.7 million of restructuring, conversion, and other expenses. |
(2) | Efficiency ratio is computed by dividing total core tangible non-interest expense by the sum of total net interest income on a fully taxable equivalent basis and total core non-interest income adjusted to include tax credit benefit of tax shelter investments. The Company uses this non-GAAP measure to provide important information regarding its operational efficiency. |
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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
This discussion is intended to assist in understanding the financial condition and results of operations of the Company. This discussion should be read in conjunction with the Consolidated Financial Statements ("financial statements") and accompanying notes contained in this report.
SUMMARY
Berkshire’s net income decreased by $8 million, or 8%, to $97 million in 2019 from $106 million in 2018. This was primarily due to the $12 million after-tax charge recorded in the third quarter related to one commercial loan write-off as a result of alleged borrower fraud. The income benefit from the acquisition of SI Financial Group, Inc (“SI Financial”). on May 17, 2019 was partially offset by charges related to the consummation of this merger. The Company uses the non-GAAP measure of operating earnings to measure profits before merger and other net charges deemed to be non-operating. This measure decreased by $10 million, or 8%, to $119 million from $129 million. Taking into account the shares issued as merger consideration, the non-GAAP measure of operating earnings per share decreased by 14% to $2.40 from $2.79. Adjusted for the $0.23 per share impact of the above loan write-off, 2019 operating EPS was $2.63, which was 6% lower than the 2018 result. This was primarily due to a lower net interest margin as a result of lower purchase accounting accretion as well as the impact of lower market interest rates in relation to the Company’s asset sensitive balance sheet. GAAP earnings per share decreased by 14% to $1.97 from $2.29. Most measures of financial condition and book value improved during the year, including liquidity and capital metrics.
In 2019, the Company adopted a goal of building a 21st century community bank. Its focus had previously been on expanding through acquisition as a regional bank. The Company is targeting to position the Company in coming decades to meet demand for values based, community focused financial providers. The Company adopted a Be First values statement and is pursuing a goal to expand through non-traditional product and service offerings in underbanked urban communities. The Company received numerous recognitions in 2019 for its social responsibility initiatives.
The acquisition of SI Financial Group, which was announced in December 2018, provided a market extension opportunity for the Company, with the acquisition of a 23 branch operation in Eastern Connecticut and Rhode Island, with $1.7 billion in assets. Recognizing the impact of decreasing purchased loan accretion due to the seasoning of purchased loan portfolios from past bank acquisitions and based on its strategic vision. In April 2019, the Company announced a strategic review which resulted in four main initiatives as follows:
• | Line of Business Review. The Company completed a line of business review and discontinued the origination of indirect auto loans and aircraft loans. The Company decided to attempt to sell its national mortgage banking operations, which continue to operate but which have been reclassified as discontinued operations in the financial statements and which remained held for sale at year-end amid ongoing discussions with potential purchasers. |
• | Balance Sheet Restructuring. The Company initiated a plan to liquidate up to $1.1 billion in non-strategic assets over the medium term through sales and run-off, and to use proceeds to pay down more expensive wholesale funds (borrowings and brokered deposits) and improve liquidity. In 2019, the Company reduced total assets by approximately $700 million under this plan and paid down wholesale funds by approximately $900 million. The Company set a goal to limit future growth in earning assets to the rate of organic core deposit growth. |
• | Efficiency Initiative. The Company worked with a third-party consultant to review its operations to improve efficiency. The Company consolidated eight existing branches (7%), continuing the branch consolidation program it has conducted in recent years. |
• | Stock Repurchases. The Board approved a one year 2.4 million share buyback program expiring March 31, 2020. The Company’s goal is to return to shareholders the excess capital freed up due to the balance sheet restructuring. At year-end, the Company had repurchased 1.7 million shares under its buyback program. |
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The year 2019 was the first year of operations under the leadership of CEO Richard Marotta, who was appointed to the position in November 2018. In December 2019, William Ryan resigned from his position as Board Chair, while remaining active as a Director. Existing Director J. Williar (“Bill”) Dunlaevy was elected to replace Mr. Ryan as Chair. During the year, the Company appointed three new directors, broadening the experience, diversity, and geographic representation on its Board. After year-end, experience and diversity were expanded with the appointment of an additional two directors. Also, after year-end, the Company promoted eight existing leaders to the new position of Regional President in each of the Company’s eight markets, leading its priority efforts around its Be FIRST values and commitment to being a 21st century community bank. The Regional Presidents are proven Berkshire leaders in a variety of disciplines, including commercial, retail and executive management. In this role, they report to Sean Gray, Berkshire Bank President, with a goal to drive Berkshire’s market positioning, enhance its performance, and maintain active community leadership roles.
The Company increased its dividend on common shares by a penny to $0.23 in January 2019, and an additional penny increase was announced in January 2020. Shortly after year-end, approximately half of the outstanding preferred shares were converted to common shares pursuant to the contracted conversion terms. This change has no impact on earnings per share and is slightly accretive to book value per share metrics.
The Company owns a $16 million participating interest in a secured commercial loan in its market area. In September 2019, this loan defaulted under circumstances involving alleged borrower fraud. In that same month, the Company determined that this loan was uncollectable and charged-off the full balance.
The Company maintains an asset sensitive profile in its interest rate risk management. The Federal Reserve Bank unexpectedly reduced the Fed Funds rate in three 25 basis point cuts in 2019. These changes resulted in compression of the Company’s net interest margin. The yield curve also flattened during the year, which is generally adverse to the net interest margin. The Company’s balance sheet restructuring is intended, in part, to support its margins by reducing dependence on high cost wholesale funding.
Our strategic vision is summarized below:
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Recent developments in the Company’s progress towards its strategic vision are shown below. Berkshire is committed to purpose driven performance. Learn more about the steps Berkshire is taking to be a values-based brand for all its stakeholders at www.berkshirebank.com/csr. Recent developments in the Company’s progress towards its strategic vision include the following:
Responsible & Sustainable Business Policy. As part of Berkshire Bank’s efforts to build a more socially responsible and values driven company, the Bank implemented a new Responsible & Sustainable Business Policy. The policy enhances the Company’s risk management and social responsibility practices with a focus on long-term sustainable performance.
U.S. Chamber of Commerce Foundation Citizens Award. The U.S. Chamber of Commerce Foundation honored Berkshire Bank with the 2019 Citizens Award, in the category of Top Corporate Steward- Small - Middle Market Business, for its Be FIRST Commitment, the company’s comprehensive corporate responsibility, culture, social impact and sustainability strategy. The Citizens Awards honor businesses for their significant positive impact in communities around the world, making them one of the most prestigious honors in corporate citizenship.
Bloomberg Gender Equality Index. Berkshire Bank’s focus on diversity, ensuring gender equality and pay equity was highlighted as Bloomberg announced the company would be included in the 2020 Bloomberg Gender-Equality Index (GEI). The GEI tracks the financial performance of public companies committed to supporting gender equality. Through disclosure of gender-related metrics, Berkshire Bank provided a comprehensive look at its investment in workplace gender equality reflecting a high level of overall performance in terms of gender equality.
Fostering Sustainable Communities & Reducing the Wealth Gap. The Company continued its commitment to closing the wealth gap so that all citizens, regardless of ethnicity, have equal opportunity for upward economic mobility, improving the business climate in communities where the bank operates. Berkshire Bank Foundation provided $2.9 million in grant funding to support 612 organizations in 2019 and the company’s XTEAM® employee volunteer program achieved a 100% participation rate for the fourth consecutive year impacting more than one million people with their volunteer efforts.
Reevx Labs. The Bank recently opened its first Reevx Labs in Boston’s Roxbury neighborhood. Reevx Labs is part of the Bank’s continued commitment to bettering the community and revolutionizing the banking experience. Reevx Labs feature a series of free co-working spaces for the community with the goal of creating spaces where entrepreneurs and non-profits can connect with their peers and access the Bank’s MyBankers for support of their financial needs, as they pursue their missions. Each Reevx Labs will take on a unique approach informed by the needs of the community, providing opportunities to build solutions together.
ACQUISITION OF SI FINANCIAL GROUP, INC.
On May 17, 2019, Berkshire completed the acquisition of SI Financial Group, Inc. (“SI Financial”), which added the Savings Institute operations consisting of 23 branches and $1.7 billion in total assets in eastern Connecticut and Rhode Island. The acquisition included $1.3 billion in loans and $1.3 billion in deposits. The SI Financial franchise is a mostly rural and suburban franchise viewed as economically stable and with an historically attractive loan and deposit structure. The merger was completed on time and on plan. Berkshire views the business retention as good based on experience through December 31, 2019. The systems conversion was completed early in the fourth quarter of 2019. At the acquisition date, SI Financial had assets with a gross fair value totaling $1.7 billion and a net fair value of $141 million net of liabilities. Berkshire recorded $177 million in total merger consideration, consisting primarily of the issuance of 5.7 million Berkshire common shares. Goodwill was recorded in the amount of $35 million, and the core deposit intangibles were recorded at $18 million. Most Berkshire consolidated balance sheet and income statement categories increased as a result of the merger.
Berkshire targets to achieve cost savings related efficiencies totaling approximately $12 million, or 30% of SI Financial annualized non-interest expense, which was reported by SI Financial as $41 million in 2018. The Company estimates that it remained within its target of approximately $29 million in total pre-tax transaction costs, or $23 million after-tax. Including all purchase accounting and targeted transaction costs the Company estimates that the transaction will be approximately $0.45 dilutive to the non-GAAP financial measure of tangible book value
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per common share used by the investment community. Projected dilution per share is less than originally anticipated primarily due to lower loan discount reflecting lower market interest rates at merger date.
Note 2 - Acquisitions in the Consolidated Financial Statements illustrates the pro forma impact on operations of the combination of Berkshire and SI Financial, assuming that the merger was completed on January 1, 2018 and excluding merger costs and planned efficiencies, and based on other assumptions set forth in the statements. This pro forma also excludes the impact of the Durbin Amendment on SI Financial revenue and any impacts on the loan loss provision for SI Financial loans. Based on the pro forma information, and taking into account the shares issued as merger consideration and the impact of purchase accounting adjustments, the Company's EPS would have been accreted by approximately $0.11 in 2018 and $0.17 in 2019 based on the pro forma assumptions. The 2019 impact includes the reversal of merger charges based on required assumptions. The total cost savings targeted by the Company are expected to produce overall positive EPS accretion of the merger after the completion of integration. These costs savings are not included within the pro forma assumptions.
COMPARISON OF FINANCIAL CONDITION AT DECEMBER 31, 2019 AND 2018
Summary: Berkshire reduced its leverage, increased its core funding, and focused its balance sheet more in support of its community banking franchise in 2019. Asset management disciplines reflected an emphasis on return, risk management, and relationship development. Berkshire’s total assets increased in 2019 due to the SI Financial acquisition, which was partially offset by the reduction of assets tied to its balance sheet restructuring. Total assets increased by $1 billion, or 8%, to $13.2 billion, including $1.7 billion acquired from SI Financial and net of a $700 million decrease in targeted investments and loans due to the balance sheet restructuring. Deposits increased by $1.4 billion including $1.3 billion acquired from SI financial. Borrowings decreased by $0.7 billion and equity increased by $0.2 billion due to stock consideration issued for the merger.
Many of Berkshire’s financial condition metrics improved during the year as a result of its operating strategies. Equity/assets improved to 13.3% from 12.7% and the non-GAAP financial measure of tangible equity/tangible assets improved to 9.2% from 8.6%. The liquidity measure of loans/deposits improved to 92% from 101%. Nonperforming assets remained unchanged at 0.3% of total assets. Book value per common share increased by 4% to $34.65 and the non-GAAP financial measure of tangible book value per common share increased by 7% to $22.56.
Investment Securities. The securities portfolio was reduced in 2019 to decrease the use of leveraged investments and return the related capital to shareholders so that the balance sheet is more focused on and funded by its community banking franchise. The investment portfolio decreased by $149 million in 2019. The SI Financial merger added $143 million in securities, and all other investments were reduced by a net amount of $292 million, which was a 15% reduction from the starting balance.
The portfolio balance stood at $1.7 billion at year-end 2019. The Company generally maintained the distribution of the portfolio, with a continuing emphasis on agency backed pass through securities and collateralized mortgage obligations which are targeted to manage prepayment risk. Portfolio credit risk was reduced with the sale of lower rated corporate obligations. Although new corporate and other bonds were added through the merger. The average life of the bond portfolio was 4.2 years at period-end, compared to 5.8 years at the start of the year, reflecting higher prepayment speeds related to lower interest rates that developed during the year. The fair value of investment securities was a 2.0% premium to book value at period-end, compared to a 1.2% discount at the start of the period due primarily to higher bond prices resulting from lower long-term rates. At period-end, all debt securities which were rated by public rating agencies had an investment grade rating. A total of $89 million in debt securities was not rated by rating agencies. All of these securities were either pre-funded with U.S./Agency collateral or rated “pass” or higher in the Company’s internal ratings system except for $4 million in unrated performing local municipal obligations and one substandard $8 million economic development bond which was performing in accordance with its terms. During the year, there were no impairments recorded and all securities were performing. The fourth quarter 2019 securities yield was 3.31% compared to 3.34% in the same quarter of 2018.
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Loans. The loan portfolio increased by $459 million, or 5%, in 2019 due to the SI Financial acquisition, which was substantially offset by the release of balances across most loan categories based on the Company’s strategic review to deleverage and focus on its community banking mission. A summary of changes in the loan portfolio is as follows:
(In millions) | December 31, 2018 Balance | Acquired SI Financial Balances | All Other Net Change | December 31, 2019 Balance | ||||||||||||
Total commercial real estate | $ | 3,400 | $ | 624 | $ | 10 | $ | 4,034 | ||||||||
Commercial and industrial loans | 1,980 | 244 | (383 | ) | 1,841 | |||||||||||
Total commercial loans | 5,380 | 868 | (373 | ) | 5,875 | |||||||||||
Total residential mortgages | 2,566 | 375 | (256 | ) | 2,685 | |||||||||||
Home equity | 377 | 58 | (54 | ) | 381 | |||||||||||
Auto and other | 720 | 2 | (161 | ) | 561 | |||||||||||
Total consumer loans | 1,097 | 60 | (215 | ) | 942 | |||||||||||
Total loans | $ | 9,043 | $ | 1,303 | $ | (844 | ) | $ | 9,502 | |||||||
The Company views SI Financial’s historic loan origination and management practices as generally conforming with the Company’s practices and industry norms and the acquired loans are not viewed as significantly changing the Company’s overall credit risk profile. The SI Financial loans were recorded at a $45 million (or 3.3%) discount to gross carrying value.
Excluding acquired SI Financial loans, most major loan categories decreased in 2019. The decrease in commercial and industrial loans included reductions in national syndicated and participated loans. The Company also discontinued originating commercial aircraft loans and sold a portion of the portfolio balance. Residential mortgages declined due primarily to accelerated prepayments when interest rates unexpectedly declined. Additionally there were lower net purchases of mortgage pools from community banks in the region. The Company discontinued the origination of indirect auto loans in the first quarter of 2019, which was the primary cause for the decrease in consumer loans.
This reflected the Company’s decision to exit certain assets with lower profitability and lower relationship potential. The Company’s lending teams remain active serving qualifying credit demand in its markets, and following selective criteria with an emphasis on credit quality and overall relationship potential and profitability. The Company is expanding its SBA lending operations, selling the guaranteed portion of its originations into the secondary market as a fee-oriented business activity.
For the longer term, the Company’s primary lending focus is on its commercial banking business across its franchise footprint. Commercial lending is organized around four major lending activities: commercial real estate, middle market banking, asset-based lending, and business banking. Commercial loans constituted 62% of total loans at year-end 2019. Berkshire’s total non-owner occupied commercial real estate exposure measured 238% of regulatory capital at period-end, compared to 250% at the start of the year and compared to the 300% regulatory monitoring guidelines (based on regulatory definitions). Construction loan exposure was 37% of bank regulatory capital at year-end 2019, compared to 34% at year-end 2018, and compared to the 100% regulatory guideline. Berkshire monitors its commercial real estate lending risk using the enhanced processes required for banks exceeding the monitoring thresholds even though it is well margined below those thresholds.
The Bank originates SBA 7(a) loans for sale through its 44 Business Capital division (primarily in the mid-Atlantic area), as well as direct loans by its business banking teams throughout its regions. Based on the annual SBA national originations rankings as of September 30, 2019, Berkshire was among the top 30 originators both in loan count and dollars loaned. Most earnings related to SBA lending are included in loan fee income arising from the sale of guaranteed portions of SBA loans.
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The fourth quarter loan yield decreased to 4.52% in 2019 from 4.94% in 2018. The contribution from purchased loan accretion decreased to 0.13% from 0.37% for these periods. The reduction in market interest rates also contributed to the decrease in portfolio yield.
Asset Quality. At period-end, non-performing assets were 0.31% of total assets. Net loan charge-offs were 0.35% of average loans in 2019, of which 0.17% was related to the previously discussed large commercial loan charge-off. The balance of troubled debt restructurings decreased to $19 million at year-end from $27 million at the start of the year. At year-end, the total contractual balance of purchased credit impaired loans was $147 million, with a $61 million carrying value. This balance includes taxi medallion loans acquired at a significant discount from Commerce Bank, with a net carrying value of $23 million at year-end 2019.
Loan Loss Allowance. The determination of the allowance for loan losses is a critical accounting estimate. The Company’s methodologies for determining the loan loss allowance are discussed in Item 1 of this report, and Item 8 includes further information about the accounting policy for the loan loss allowance and the Company’s accounting for the allowance in the Consolidated Financial Statements.
As of December 31, 2019 and 2018, the allowance for loan losses totaled $63.6 million and $61.5 million, respectively. The allowance for loan losses is broken down between a general component reserve (ASC 450) and specific reserve components (ASC 310). Specific reserves on individually evaluated loans amounted to $0.4 million and $0.3 million as of December 31, 2019 and 2018, respectively, with the remaining allowance being the general component of the calculation in accordance with ASC 450. The general component of the allowance for loan losses totaled approximately $63 million which consisted of $44 million attributable to observable historical data, adjusted for a temporal estimate of the incurred loss emergence and confirmation period and approximately $19 million attributable to qualitative adjustments. The breakdown between historical data and qualitative adjustments were consistent in the prior periods.
Because of the accounting for acquired loans, some measures of the loan loss allowance are not comparable to periods prior to the acquisition date or to other financial institutions. Loans acquired in business combinations totaled $2.3 billion, or 25% of total loans at year-end 2019, compared to $1.7 billion, or 19% of total loans at year-end 2018.
The loan loss allowance increased by 3% to $64 million in 2019. The allowance decreased to 0.67% of loans at year-end 2019 compared to 0.68% at year-end 2018. For business activities loans, the ratio of the allowance to loans increased to 0.80% from 0.76% of related loans. For acquired loans, this ratio decreased to 0.27% from 0.35% due to the addition of the SI Financial loans at fair value. The allowance provided 1.6X coverage of year-end non-accrual loans in 2019 compared to 1.9X in 2018.
The credit risk profile of the Company’s loan portfolio is described in Note 8 - Loan Loss Allowance of the Consolidated Financial Statements. The Company’s risk management process focuses primary attention on loans with higher than normal risk, which includes loans rated special mention and classified (substandard and lower). These loans are referred to as criticized loans. Including acquired loans, they totaled $237 million, or 1.8% of total assets at year-end 2019, compared to $189 million, or 1.5% of total assets at year-end 2018. Criticized loans from business activities increased to $146 million from $114 million. Criticized acquired loans increased to $92 million from $76 million, including acquired SI Financial loans. The increase in criticized loans from business activities was due to an increase in loans rated special mention. Substandard business activities loans decreased during the year.
The Company views its potential problem loans as those loans from business activities which are rated as classified and continue to accrue interest. These loans have a possibility of loss if weaknesses are not corrected. Classified loans acquired in business combinations are recorded at fair value and are classified as performing at the time of acquisition and therefore are not generally viewed as potential problem loans. In 2019, potential problem loans decreased to $49 million from $61 million.
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As discussed in Note 1 - Summary of Significant Accounting Policies of the Consolidated Financial Statements, in June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The ASU requires companies to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Forward-looking information will now be used in credit loss estimates. ASU No. 2016-13 is effective for interim and annual periods beginning after December 15, 2019. The Company is in the process of finalizing the required changes to loan loss estimation methodologies and processes as a result of the new accounting guidance. The Company is finalizing its control environment regarding the new processes, data validations, and model validation. CECL is expected to increase the allowance for credit losses, including the impact of reclassifying non-accretable credit discounts on existing purchased credit-impaired loans to the reserve. This increase to the allowance for credit losses does not include our medallion portfolio. Loans will have a resulting increase for the non-accretable credit discount and a negative adjustment to retained earnings for the remaining credit losses for financial assets.
Other Assets. At year-end 2019, the balance of payroll deposits totaled $744 million, an increase of $277 million over the prior year-end. The overnight funds were held in overnight investments, which increased by $388 million. The Company has also increased its use of short-term investments during 2019 to better match its liquidity related to payroll deposit balances which fluctuate daily. Several other asset accounts increased due to the SI Financial acquisition, including goodwill. Assets from discontinued operations primarily reflect mortgage loans held for sale by the Company’s national mortgage banking operation. The $114 million increase in Other Assets included impacts from the SI Financial acquisition as well as $84 million in right of use assets related to the adoption of a new lease accounting standard.
Deposits: Total deposits increased by $1.4 billion, or 15%, in 2019 including the acquired SI Financial deposits. A summary of changes in deposits is below:
(In millions) | December 31, 2018 Balance | Acquired SI Financial Balances | All Other Net Changes | December 31, 2019 Balance | ||||||||||||
Demand | $ | 1,603 | $ | 258 | $ | 23 | $ | 1,884 | ||||||||
NOW and other | 1,122 | 138 | 233 | 1,493 | ||||||||||||
Money market | 2,245 | 190 | 94 | 2,529 | ||||||||||||
Savings | 724 | 164 | (47 | ) | 841 | |||||||||||
Time deposits | 3,288 | 585 | (284 | ) | 3,589 | |||||||||||
Total deposits | $ | 8,982 | $ | 1,335 | $ | 19 | $ | 10,336 | ||||||||
Note: | ||||||||||||||||
Total payroll deposits | $ | 467 | $ | — | $ | 277 | $ | 744 | ||||||||
Total brokered deposits | $ | 1,419 | $ | 19 | $ | (225 | ) | $ | 1,213 | |||||||
The acquired deposits represented a market extension for Berkshire and are viewed as an attractive and stable core funding source. Due to its strategic asset reductions, the Company reduced its use of more expensive wholesale funding, including reduced brokered deposits. The Company’s payroll deposits were mostly in NOW and money market balances at year-end 2019. The Company consolidated eight branch offices in 2019. Deposit retention for these offices and for acquired balances was viewed by management as good and within the expected range through year-end. Deposit retention related to branch consolidations has been aided by the Company’s MyBanker program.
The average fourth quarter cost of deposits increased slightly to 1.11% in 2019 from 1.07% in 2018. Deposit costs have benefited from the accretion of a fair value mark on the acquired SI Financial deposits, which is producing a $2 million per quarter benefit as part of the purchase accounting accretion from this transaction. This reduced quarterly overall deposit costs by around 7 basis points; this accretion is scheduled to be completed in the second quarter of 2020.
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Borrowings and Other Liabilities: Total borrowings decreased by $690 million, or 45%, in 2019. This was due to a reduction in short term FHLBB advances, partially offset by an increase in longer term FHLBB advances. The reduction in borrowings was part of the Company’s reduction in higher cost wholesale funds as a result of its asset deleveraging strategy, and was net of $153 million in borrowings acquired with SI Financial. The Company is also using some overnight payroll funds to invest in short term investments rather than to reduce short term funding. Borrowings activity also reflected the Company’s liquidity management strategies after the Federal Reserve Bank initiated unusual interventions in short term funding markets in the third quarter of 2019. As a result, the Company lengthened its funding structure to reduce risk from unexpected short term market fluctuations.
Wholesale funds consist of brokered deposits and borrowings. Wholesale funds decreased by $896 million, or 44%, to $2.0 billion due to the Company’s strategic asset reduction strategy. The Company measures the ratio of its wholesale funds to total assets as a measure of liquidity. This ratio improved, decreasing to 15% at period-end from 24% at the start of the year. The fourth quarter cost of borrowings increased to 2.77% in 2019 from 2.67% in 2018 due to the higher proportionate amount of more costly subordinated debt. Because borrowings decreased as a funding source, the fourth quarter cost of funds decreased to 1.23% in 2019 from 1.31% in 2018. This was an important objective of the Company’s strategy to help mitigate the loss of asset yield due to less benefit from purchase accounting accretion.
The category of Other Liabilities increased by $112 million in 2019, including the impact of the SI Financial acquisition. Additionally, with the adoption of the new lease accounting standard, the Company recorded in Other Liabilities a total lease liability of $81 million, in addition to the $84 million lease right of use asset previously discussed. Other Liabilities also were impacted by a $47 million increase in derivative liabilities accompanied by a $45 million increase in derivative assets in Other Assets, related to hedge fair values at period-end.
Derivative Financial Instruments: The notional balance of derivative financial instruments increased to $4.1 billion from $3.3 billion during 2019. This was primarily due to a $0.6 billion, or 24% increase in derivatives related to interest rate swaps on commercial loans, including customer swaps and back-to-back hedges with national counterparties. This growth included swaps acquired with SI Financial.
Shareholders’ Equity: Shareholders’ equity increased by $206 million, or 13%, in 2019 due primarily to the issuance of $176 million in common stock as SI Financial merger consideration. Retained earnings contributed $52 million, which was offset by $53 million in stock repurchases. Other comprehensive income contributed $25 million, which was primarily due to unrealized gains on investment securities reflecting the price impact of lower interest rates at year-end 2019.
The Company’s Board approved a 2.4 million share one year stock buyback program in March 2020. Repurchases are subject to market conditions and the Company’s financial condition, among other factors. Repurchases are targeted in part as a means to return excess capital to shareholders based on capital freed-up as a result of the asset reductions being undertaken as a result of its strategic review. Repurchases were begun in June. As of year-end 2019, the Company had repurchased 1.726 million shares at an average price of $30.56 per share.
The Company’s goal is to maintain or improve capital metrics while returning excess capital to shareholders. For the year 2019, the ratio of equity/assets improved to 13.3% from 12.7%. The non-GAAP ratio of tangible equity to tangible assets improved to 9.2% from 8.6%. The Company has a capital planning policy, including a framework conforming to regulatory expectations for annual stress testing and reporting. Capital stress testing generally follows the mandatory process required for larger banks. The Company’s policy is to maintain sufficient capital such that the modeled ratios remain above the well capitalized benchmarks in the severely adverse maximum stress scenario. The capital policy targets a capital plan that provides adequate capital to support the Company’s three year strategic plan. The policy, plan, and stress test results are annually reviewed by management and Board committees responsible for risk oversight.
Subsequent to year-end, 521,400 unregistered common shares were issued from treasury for the conversion of approximately half of the outstanding participating preferred shares in accordance with the contracted conversion terms. The common equivalent impact of these shares has previously been included in operating results per share.
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COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2019 AND 2018
Summary: Revenue and expense in 2019 included the SI Financial operations acquired on May 17, 2019. As a result, many categories of revenue and expense increased in 2019 over the same period of 2018. Additionally, operations in 2019 included the benefit of restructuring actions in both years, and the benefit of the acquired Commerce Bank operations which were being fully integrated in the first half of 2018. Earnings per share reflected the shares issued as merger consideration for the SI Financial acquisition. References to revenue and expense in this discussion are generally related to continuing operations unless otherwise noted. In 2019, The Company designated its FCLS national mortgage banking operations as discontinued and the financial statements in all periods reflect this designation.
The comparison of operating results was previously discussed in the introductory summary of Management’s Discussion and Analysis. Year-over-year profitability declined primarily due to the $16 million charge related to the write-off of one commercial loan due to alleged fraud. Profitability was also adversely impacted by a lower net interest margin due to the decline in purchased loan accretion, which had been anticipated, as well as the impact of lower interest rates on the Company’s asset sensitive balance sheet. Total purchase accounting accretion decreased to $14 million in 2019 from $23 million in 2018. The Company undertook various initiatives following its strategic review, which has previously been described, to help mitigate these margin impacts. Operating results were also lower due to higher merger charges related to the completion and integration of the SI Financial acquisition.
The Company measures the non-GAAP financial measure of adjusted earnings to focus on earnings related to ongoing operations and excluding items described in the reconciliation of non-GAAP financial measures which was set forth in an earlier section of this report. Adjusted earnings per share declined by 14% for the year, and were down 6% excluding the impact of the above-noted loan write-off.
The Company’s return on equity was 5.7% in 2019, compared to 6.8% in the prior year. Its non-GAAP measure of adjusted return on tangible common equity was 11.3% compared to 13.5% for these respective periods. The Company focuses on this measure as important to its shareholder value, as well as measuring its internal capital generation to support operations, dividend growth, and its capital metrics supporting the balance sheet.
Revenue: Net revenue from continuing operations increased in 2019 by $19 million, or 4%, to $449 million in 2019 compared to the prior year, including acquired SI Financial operations. This increase was divided between net interest income and non-interest income. The SI Financial operations reported 2018 net revenue of $56 million in 2018; these operations were acquired on May 17, 2019. The first year pro forma revenue benefit of the SI Financial combination as set forth in the notes to the financial statements indicates a proforma full year revenue benefit of $67 million, including an estimated $11 million benefit from purchase accounting accretion. On a per share basis, net revenue decreased by 2% to $9.09 in 2019 from $9.31 in 2018, primarily reflecting the decrease in the net interest margin. Annualized revenue per share measured $9.05 in the final quarter of 2019.
Net Interest Income: Net interest income from continuing operations increased by $9 million, or 3%, in 2019 compared to 2018. This growth was due to a 9% increase in average earning assets, which was partially offset by a decrease in the net interest margin. The increase in average earning assets included the impact of approximately $1.48 billion in earning assets acquired from SI Financial on May 17. This was offset by a net decline in other average earning assets due to the Company’s strategic initiative to reduce less strategically important loans and investments in order to decrease expensive wholesale funding sources and related leverage.
The net interest margin decreased year-over-year to 3.17% from 3.40%, and the contribution from purchase accounting accretion decreased to 0.12% from 0.22%. The margin decreased further to 3.11% in the final quarter of the year, including a 0.17% contribution from purchase accounting accretion. The benefit of purchase accounting accretion decreased primarily due to the seasoning of purchased credit impaired loans from prior bank acquisitions. Purchase accounting accretion also benefited from accretion related to acquired SI Financial time deposits, which are contributing approximately 7 basis points per quarter accretion benefit which is scheduled to mature in the second quarter of 2020. Recoveries of purchased credit impaired loans have been a primary source of purchased loan accretion in recent years. Under the new CECL accounting standard, future purchased loan recoveries will be posted to the loan loss allowance rather than to interest income.
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The yield on earning assets measured 4.47% in both 2019 and 2018, despite the decrease in purchased loan accretion. The cost of funds increased to 1.31% from 1.11%. These results included the impacts of interest rates that were rising in much of 2018 and then falling for the much of 2019, as well as the impact of the SI Financial acquisition. The fourth quarter yield on earning assets decreased to 4.27% from 4.64%, while the fourth quarter cost of funds decreased to 1.23% from 1.31%. These results included the benefit of the Company’s strategies to reduce the reliance on higher cost wholesale funding. The quarterly net interest margin decreased from 3.41% in the fourth quarter of 2018 to 3.17% in the first quarter of 2019 due to a decline in purchased loan accretion from a relatively high level in the fourth quarter of 2018. The quarterly margin decreased further to 3.11% in the fourth quarter of 2019, primarily due to the impact of unexpected market interest rate cuts on the Bank’s asset sensitive balance sheet profile and the continued flattening of the yield curve throughout 2019.
Non-Interest Income. Non-interest income from continuing operations increased by $10 million, or 13%, in 2019 compared to 2018 due primarily to an $8 million swing in unrealized securities gains/losses which the Company views as non-operating in nature. Fee income increased by $3 million, or 4%, including the benefit of acquired operations. One major component of this income is SBA loan sale gains. Berkshire’s 44 Business Capital business generated record revenue in 2019. For the SBA fiscal year ended September 30, 2019, Berkshire’s team ranked as the 18th largest lender in the country for SBA 7A loan originations, advancing from 28th position in the prior SBA fiscal year. The category of Other Non-Interest Income includes income accrued on bank owned life insurance as well as any death benefits paid. This category also includes the amortization of tax credit investments related to tax credit benefits recorded to income tax expense.
Provision for Loan Losses. The provision increased year-over-year by $10 million, or 39%. As previously discussed, the Company is planning to adopt the new CECL accounting standard at the beginning of 2020. The posting of purchased credit impaired loan recoveries to the loan loss allowance under CECL may have the impact of reducing the provision for loan losses in this regard, compared to current accounting principles.
Non-Interest Expense. Non-interest expense from continuing operations increased year-over-year by $23 million, or 9%, including acquired operations. Merger related expense included the completion of the SI Financial merger. The Company focuses on its non-GAAP financial measure of adjusted expense which excludes merger charges and other items set forth in the reconciliation of non-GAAP measures. Adjusted expense increased by $17 million, or 7%.
Expenses in 2019 benefited from $3 million in FDIC premium rebates as a result of a return of FDIC reserves to smaller U.S. banks. Professional services expense increased due to legal cost and settlements. The category of other expense increased due to uninsured losses on check items as well higher loan workout expense. The full year efficiency ratio moved unfavorably to 55.6% in 2019 from 53.6% in 2018. The full efficiencies from the merger were not achieved until the fourth quarter of 2019.
Full-time equivalent staff in continuing operations totaled 1,550 positions at period-end, compared to 1,485 at year-end 2018; SI Financial reported approximately 284 full time equivalent positions at that date. At year-end 2019, full-time equivalent staff in the national mortgage banking operations designated as discontinued total 323 positions, compared to 432 positions at the start of the year.
Merger expenses recorded in 2019 related to the SI Financial acquisition, included severance expense, legal and professional transaction costs, and contract termination costs. Restructuring costs included employee severance, lease terminations, and contract termination costs related to the Company’s efficiency projects and branch consolidations. The loss from discontinued operations related to the Company’s national mortgage banking operations held for sale, including the write-down of related mortgage servicing right assets.
Income Tax Expense. Income taxes are discussed in a note to the Consolidated Financial Statements; this note is important to an understanding of the results of operations. The effective tax rate measured 18% in 2019, compared to 21% in 2018. As set forth in the tax note, this reflected the proportionate benefit of tax advantaged income on lower pretax earnings, along with structural changes in the Company’s tax position, including the impacts of the SI Financial acquisition.
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Discontinued Operations. As part of its strategic review, the Company decided at the beginning of 2019 to attempt to sell its national mortgage banking operations. These operations are not viewed as central to the Company’s current community banking focus. These operations have been reclassified as discontinued operations for financial statement presentation purposes for all periods shown in the financial statements. These operations became unprofitable in 2018 as a result of depressed industry conditions due to lower market demand for mortgages as interest rates rose in that period. While industry conditions improved in 2019 as interest rates moved downwards during the year, these operations continued to operate at a loss. The net loss was equivalent to $0.08 per share in 2019, compared to $0.07 per share in 2018. Total revenue improved to $41 million in 2019 from $39 million in 2018, but remained below the $55 million recorded during the profitable year of 2017. Most of the $5.5 million pretax loss in 2019 was due to a $4.5 million charge to write-down mortgage servicing rights based on market indications at year-end.
Total Comprehensive Income. Total comprehensive income includes net income together with other comprehensive income. Other comprehensive income is principally driven by unrealized gains/losses in the investment portfolio, which primarily reflect the impact of point-in-time interest rates on capital market prices. Falling interest rates at year-end resulted in $25 million in other comprehensive income for 2019, while rising year-end interest rates resulted in a $12 million other comprehensive loss in 2018. When combined with net income reported in those years, total comprehensive income was $123 million in 2019, compared to $93 million in 2018.
Quarterly Results. Quarterly results for 2019 and 2018 are presented in a note to the Consolidated Financial Statements. Results for all of these periods have been discussed in previous SEC Forms 10-Q and 10-K, except for operations in the fourth quarter of 2019. Prior SEC filings for 2018 presented results including national mortgage banking operations in continuing operations, rather than as discontinued operations as shown in the quarterly results footnote in the 2019 financial statements. The second and third quarters of each year are often the strongest quarters due to generally higher business activity during the spring and summer. Quarterly results also vary depending on the timing of expenses that are excluded from the measure of adjusted earnings, including merger related expenses. Quarterly results are also affected by the timing of recoveries of purchased credit impaired loans as well as changes in the loan loss provision. The third quarter of 2019 was the first full quarter to include the operations of SI Financial, which was acquired on May 17, 2019.
COMPARISON OF OPERATING RESULTS FOR THE YEARS ENDED DECEMBER 31, 2018 AND 2017
Summary: Berkshire achieved record revenue, earnings, and return on assets in 2018. GAAP results included significant charges viewed as non-operating. Based on its non-GAAP adjusted measures, Berkshire produced improvement in its earnings per share and ROA measures. Berkshire’s national mortgage banking operations have been retroactively classified as discontinued for these periods. Net income increased in 2018 by $51 million, or 91%, to $106 million. Adjusted net income increased to $129 million from $91 million. On a per share basis, net income increased by 65% to $2.29 and adjusted net income per share increased by 22% to $2.79.
Operations in 2018 benefited from the lower federal tax rate, which reduced the Company’s effective tax rate by an estimated 10.8%. Results of discontinued operations have been excluded from adjusted net income.
The operating results of the Company further benefited from a full year of fully integrated First Choice operations in the Mid Atlantic and a partial year of the fully integrated Commerce operations in Eastern Massachusetts. The successful integrations of these business combinations were a critical focus for the Company. Operating results also benefited from organic loan growth and improved efficiency resulting from increased business scale. Additionally, most restructuring actions were expected to benefit subsequent earnings, including restructuring actions in 2017 and 2018. Operating results benefited from higher purchased loan accretion resulting from unanticipated high levels of recoveries of purchased credit impaired loans. Total purchased loan accretion measured $23 million in 2018, compared to $15 million in the prior year. The GAAP return on assets improved to 0.90% in 2018, while the non-GAAP adjusted return on assets measured 1.12%. The return on equity improved to 6.8%, while the non-GAAP measure of adjusted return on tangible common equity improved to 13.5%. The efficiency ratio improved to 53.6% from 60.0%.
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Adjusted net income excludes certain amounts not viewed as related to normalized operations. These items are primarily related to acquisition expenses. Berkshire views its net acquisition related costs as part of the economic investment for its acquisitions. These investments are intended to contribute to long term earnings growth and franchise value. Other significant charges excluded in 2018 were related to the core systems contract restructuring, a legal settlement, and the CEO transition. Charges excluded from the 2017 adjusted earnings measure included contract termination costs for premises restructuring and the termination of hedges. These were mostly offset by the realization of gains on the sale of equity securities. The Company also recorded an $18 million charge in 2017 for the provisional write-down of its net deferred tax asset following the enactment of federal tax reform near year-end.
Berkshire’s 2018 results included the Commerce operations acquired in October 2017, and systems conversion and merger integration activities were completed by midyear 2018. Due to the Commerce acquisition, most measures of revenue, expense, income, and average balances increased in 2018 compared to 2017. The year 2018 was also the first full year of the fully integrated First Choice operations, which were acquired in December 2016 and fully integrated by midyear 2017. Per share measures were affected by the issuance of shares as merger consideration. Both of these acquisitions were targeted to be accretive to earnings and earnings per share when fully integrated, and to provide a long term double digit return on equity.
Total Net Revenue. Total net revenue increased in 2018 to $431 million from $365 million in 2017, including the benefit of acquired Commerce operations. Net interest income increased to $431 million from $365 million. Net interest income growth was due to the increase in average earning assets, including the benefit of the Commerce assets, together with organic loan growth in 2018. Non-interest income in 2018 remained flat at $74 million. An increase in fee income was offset by a change in gains/losses from securities and from hedge terminations.
Provision for Loan Losses. The provision for loan losses increased by $4 million, or 21%, to $25 million in 2018. The provision for loan losses exceeded net loan charge-offs and resulted in an increase in the loan loss allowance to 0.68% of total loans at year-end, compared to 0.62% at the start of the year.
Non-Interest Expense. Including the acquired Commerce operations, total non-interest expense increased to $267 million in 2018 from $253 million in 2017. Full time equivalent staff at year-end 2018 totaled 1,917 positions including 432 national mortgage banking positions. This is down from 1,992 positions including 513 national mortgage banking positions at year-end 2017. Excluding mortgage banking, all other FTE staff was essentially flat, with Commerce related reductions offset by staff recruitment to support Eastern Massachusetts expansion and infrastructure to support operations above the $10 billion asset size. Non-interest expense includes amounts viewed by the Company as not related to ongoing operations. These expenses are excluded from the Company’s non-GAAP measure of adjusted expense. The primary component of these expenses is merger related expense, which totaled $9 million in 2018 and $25 million in 2017. Merger expenses were primarily related to the Commerce acquisition in 2018 and the First Choice combination in 2017. For both of these business combinations, the Company estimates that merger costs were within its original projections. In 2018, other expenses excluded from adjusted expenses included $8 million for core systems contract restructuring costs, $3 million for a legal settlement, and $1.5 million for the CEO transition. The core systems restructuring included a full core systems technology assessment and a competitive vendor selection process. The restructured contract is targeted to provide more flexibility in developing technology and integrating third party solutions, together with improved efficiency and lower costs related to growth. The Company recorded restructuring and other expense totaling $7 million in 2017, which was primarily related to premises lease terminations as the Company has reduced its rented space. In 2017, the Company recorded $3 million in employee and community investment expense for initiatives undertaken due to the federal tax reform. Total expenses excluded from the measure of adjusted expenses totaled $22 million in 2018 and $35 million in 2017.
Income Tax Expense. The effective tax rate measured 21% in 2018. The GAAP tax rate of 45% in 2017 included the $18 million charge to write-down the net deferred tax assets as a result of the federal income tax reform near year-end. Before this charge, the effective tax rate in 2017 was 26%. As previously noted, federal income tax reform reduced the Company’s effective tax rate in 2018 by an estimated 11% compared to what it would have been without tax reform.Without this tax reform, the Company’s effective tax rate would have increased in 2018 due to
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its larger size and higher pretax income in relation to the tax advantaged income sources consisting primarily of tax exempt investment income, life insurance income, and investment tax credits.
LIQUIDITY AND CASH FLOWS
Liquidity is the ability to meet cash needs at all times with available cash and established external liquidity sources or by conversion of other assets to cash at a reasonable price and in a timely manner. Berkshire evaluates liquidity at the holding company and on a consolidated basis, which is primarily a function of the Bank’s liquidity.
The Company’s liquidity management focuses on the liquidity of the Bank, primarily to serve the deposit and loan needs of its customers. The Company undertook a focused program in 2019 to improve the liquidity of the Bank. Elements of this program included:
• | Completing the acquisition of SI Financial, which added a significant source of core deposits viewed as relatively stable. |
• | Reducing less strategically important assets in order to generate funds to pay down potentially more volatile wholesale funding sources which had been used to fund leveraged balance sheet expansion in recent years. |
• | Shifting borrowings to de-emphasize overnight FHLBB advances, using advances with due dates laddered into the future, to minimize the impacts of any potential disruptions in financial market liquidity. |
• | Maintaining more liquid assets on balance sheet, including overnight funds from payroll deposits which had been used to paydown overnight advances. |
One general measure of the Bank’s liquidity is the ratio of loans/deposits. This ratio improved to 92% from 101% during 2019. The measure of wholesale funding (borrowings and brokered deposits) decreased to 18% of funding liabilities (deposits and borrowings) from 28%. The ratio of brokered deposits decreased to 11% of funding liabilities from 14%. Unencumbered high quality liquid assets measured 8% of funding liabilities at year-end 2019. Actions taken to improve the liquidity of the balance sheet included runoff of illiquid loan portfolios, extension of wholesale funding maturities, and setting an objective to limit loan growth to the growth rate of core deposits. As part of a comprehensive review and update of funds management and liquidity policies, the Company expanded its liquidity stress management testing and contingency funding plans. The Company also uses national secondary markets to support its lending programs and facilitate the targeted sale of portfolio loans. The Federal Home Loan Bank of Boston ("FHLBB") is the Bank’s primary source of borrowings. The Bank’s total FHLBB unused borrowing availability was $1.6 billion at year-end 2019, compared to $1.2 billion at the start of the year. In recent periods, the Bank has expanded borrowings base of collateral assets to improve eligibility for FHLBB borrowings. The Bank is also expanding its list of approved correspondent banks and the availability of federal funds lines to the Company. The Company maintains cash flow projections over a series of monthly and quarterly time horizons and monitors projected liquidity indicators against established policy objectives. The Bank’s payroll deposit service generates deposits which fluctuate daily based on customer payroll cycles. During 2019, the Bank shifted its liquidity management to maintain more overnight funds on balance sheet rather than reducing borrowings.
The primary liquidity need at the holding company is to support its capital structure, including shareholder dividends and debt service. The holding company primarily relies on dividends from the Bank to meet its ongoing cash needs. The holding company generally expects to maintain cash on hand equivalent to normal cash uses, including common stock dividends, for at least a one year period. There are certain restrictions on the payment of dividends by the Bank based on retained earnings of the Bank. Dividends by the holding company require notice and non-objection from the Federal Reserve Bank in the event that earnings are not sufficient to cover the dividend.
In 2019, the Company initiated a stock repurchase program which was funded by additional cash dividends from the Bank utilizing the proceeds from strategic asset reductions. At year-end 2019, the holding company had $74 million in cash and equivalents, compared to $69 million at the start of the year. The Parent’s cash is held on deposit in the Bank. In 2019, the holding company eliminated a small unsecured line of credit which had been minimally used in recent years. The holding company manages a portfolio of liquid equity securities in support of the consolidated strategy for investments and asset liability management.
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CAPITAL RESOURCES
The Company and the Bank target to maintain sufficient capital to qualify for the “Well Capitalized” designation by federal regulators. Berkshire’s long term goal is to use capital efficiently to achieve its objective to become a higher performance company. The Company’s strategic initiatives in 2019 were targeted to reduce balance sheet leverage, release lower returning assets, and return excess capital to shareholders through stock buybacks, while maintaining or improving capital metrics.
Berkshire views its adjusted internal return on tangible capital as the primary capital resource of the Company. This non-GAAP financial measure is based on the Company’s measure of adjusted earnings, which excludes net charges viewed as not related to ongoing operations. The Company focuses on internal capital generation to support shareholder dividends and organic growth and also to support non-operating charges and/or improvement in its capital ratios. The Company has in the past maintained a universal shelf registration of capital securities with the SEC. The Company normally uses common stock as a significant component of consideration for business combinations. The resulting stock issuances have meaningfully increased the float and market capitalization of the Company. In 2019, the merger consideration for the SI Financial acquisition was 100% comprised of Company common stock, with the result that the acquisition’s dilution of tangible book value per share was primarily limited to the impact of transaction costs. Additional discussion of the Company’s capital management is contained in the Shareholders’ Equity section of the discussion of Changes in Financial Condition in this report.
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CONTRACTUAL OBLIGATIONS
The year-end 2019 contractual obligations were as follows:
Item 7-7A - Table 1 - Contractual Obligations
(In thousands) | Total | Less than One Year | One to Three Years | Three to Five Years | After Five Years | |||||||||||||||
FHLBB borrowings (1) | $ | 730,501 | $ | 419,996 | $ | 290,825 | $ | 11,993 | $ | 7,687 | ||||||||||
Subordinated notes | 97,049 | — | — | — | 97,049 | |||||||||||||||
Lease liabilities (2) | 80,734 | 11,287 | 19,721 | 14,283 | 35,443 | |||||||||||||||
Total Contractual Obligations | $ | 908,284 | $ | 431,283 | $ | 310,546 | $ | 26,276 | $ | 140,179 | ||||||||||
_______________________________
Acquisition related obligations are not included.
(1) Consists of borrowings from the Federal Home Loan Bank. The maturities extend through 2038 and the rates vary by borrowing.
(2) Consists of leases, bank branches, and ATMs through 2039.
Further information about borrowings and lease obligations is disclosed in Note 13 - Borrowed Funds and Note 18 - Leases of the Consolidated Financial Statements.
OFF-BALANCE SHEET ARRANGEMENTS
In the normal course of operations, Berkshire engages in a variety of financial transactions that, in accordance with generally accepted accounting principles, are not recorded in the Company’s financial statements. As previously reported in the discussion of changes in financial condition, Berkshire has outstanding derivative financial instruments and engages in hedging activities, and the fair value of these contracts is recorded on the balance sheet.
FAIR VALUE MEASUREMENTS
The most significant fair value measurements recorded by the Company are those related to assets and liabilities acquired in business combinations. These measurements are discussed further in the mergers and acquisitions note to the financial statements. The premium or discount value of acquired loans has historically been the most significant element of this presentation.
The Company makes further measurements of fair value of certain assets and liabilities, as described in the related note in the financial statements. The most significant measurements of recurring fair values of financial instruments primarily relate to securities available for sale, marketable equity securities, and derivative instruments. These measurements were included in the previous discussion of changes in financial condition, and were generally based on Level 2 market based inputs. Non-recurring fair value measurements primarily relate to certain corporate bonds, impaired loans, capitalized mortgage servicing rights, and other real estate owned. When measurement is required, these measures are generally based on Level 3 inputs. Acquired corporate bonds and industrial development bonds are valued based on Level 3 inputs.
Berkshire provides a summary of estimated fair values of financial instruments at each period-end. The premium or discount value of loans has historically been the most significant element of this presentation. This amount is a Level 3 estimate and reflects management’s subjective judgments. At year-end 2019, the premium value of the loan portfolio was $215 million, or 2.3% of carrying value, compared to $45 million, or 0.5% of carrying value at year-end 2018. This increase reflected the lower prevailing market interest rates at year-end 2019, resulting in a higher present value of the fixed rate instruments in the portfolio.
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IMPACT OF INFLATION AND CHANGING PRICES
The financial statements and related financial data presented in this Form 10-K have been prepared in conformity with accounting principles generally accepted in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike many industrial companies, substantially all of the assets and liabilities of the Bank are monetary in nature. As a result, interest rates have a more significant impact on the Bank’s performance than the general level of inflation. Interest rates may be affected by inflation, but the direction and magnitude of the impact may vary. A sudden change in inflation (or expectations about inflation), with a related change in interest rates, would have a significant impact on our operations.
IMPACT OF NEW ACCOUNTING PRONOUNCEMENTS
Please refer to the notes on Recently Adopted Accounting Principles and Future Application of Accounting Pronouncements in Note 1 - Summary of Significant Accounting Policies of the Consolidated Financial Statements.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The Company’s significant accounting policies are described in Note 1 to the financial statements. The preparation of the consolidated financial statements in accordance with GAAP and practices generally applicable to the financial services industry requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses, and to disclose contingent assets and liabilities. Actual results could differ from those estimates.
Management has identified the Company's most critical accounting policies as related to:
• | Allowance for Loan Losses |
• | Acquired Loans |
• | Fair Value of Financial Instruments |
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MANAGEMENT OF INTEREST RATE RISK AND MARKET RISK ANALYSIS
Qualitative Aspects of Market Risk. The Company’s most significant form of market risk is interest rate risk. The Company seeks to avoid fluctuations in its net interest income and to maximize net interest income within acceptable levels of risk through periods of changing interest rates. The Company also seeks to manage the risk of interest rate changes to its net income and the economic value of equity. The Company maintains an Enterprise Risk Management/Asset-Liability Committee (ERM/ALCO) that is responsible for reviewing its asset-liability policies and interest rate risk position. This Committee meets regularly, and the Chief Financial Officer and Treasurer report trends and interest rate risk position to the Risk Management and Capital Committee of the Board of Directors on a quarterly basis. The extent of the movement of interest rates is an uncertainty that could have a negative impact on the Company’s net interest income and earnings.
The Company manages its interest rate risk by analyzing the sensitivities and adjusting the mix of its assets and liabilities, including derivative financial instruments. The Company also uses secondary markets, brokerages, and counterparties to accommodate customer demand for long term fixed rate loans and to provide it with flexibility in managing its balance sheet positions. When the Company enters into business combinations, it considers interest rate risk as part of its merger analysis and it integrates existing and acquired operations as appropriate to achieve its objectives for the combined businesses.
Quantitative Aspects of Market Risk. The Company measures its interest rate sensitivity primarily by evaluating models of net interest income over one year, two years, and three year time horizons. The Company models a base case assuming no changes in interest rates or balance sheet composition and then assuming various scenarios of ramped interest rate changes, shocked interest rate changes, changes predicted by the forward yield curve, and changes involving twists in the yield curve. The focus is on a two-year scenario where interest rates ramp up by 200 basis points in the first year compared to a base case of flat interest rates. The Bank also evaluates its equity at risk from interest rate changes through discounted cash flow analysis. This measure assesses the present value of changes to equity based on long term impacts of rate changes beyond the time horizons evaluated for net interest income at risk.
The Company uses a simulation model to measure the changes in net interest income. The chart below shows the analysis of the ramped change described above, assuming a parallel shift in the yield curve. Loans, deposits, and borrowings were expected to reprice at the repricing or maturity date. Pricing caps and floors are included in the simulation model. The Company uses prepayment guidelines set forth by market sources as well as Company generated data where applicable. Cash flows from loans and securities are assumed to be reinvested to maintain a static balance sheet. Other assumptions about balance sheet mix are generally held constant. The input for loan prepayment speeds was updated, reducing the modeled prepayment speeds in downward rate environments and thereby reducing the related income sensitivity. This change in inputs was not viewed as material in the overall scope of interest rate risk analysis. There were no material changes to the way that the Company measures market risk in 2019.
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Item 7-7A - Table 2 - Qualitative Aspects of Market Risk
Change in Interest Rates-Basis Points (Rate Ramp) | ||||||||||||||
1- 12 Months | 13- 24 Months | |||||||||||||
$ Change | % Change | $ Change | % Change | |||||||||||
(In thousands) | ||||||||||||||
At December 31, 2019 | ||||||||||||||
+300 | $ | 17,080 | 4.70 | % | $ | 28,003 | 7.60 | % | ||||||
+200 | 11,070 | 3.00 | 19,589 | 5.30 | ||||||||||
+100 | 5,107 | 1.40 | 10,289 | 2.80 | ||||||||||
-100 | (6,559 | ) | (1.80 | ) | (13,611 | ) | (3.70 | ) | ||||||
At December 31, 2018 | ||||||||||||||
+300 | $ | 8,200 | 2.20 | % | $ | 4,400 | 1.20 | % | ||||||
+200 | 6,700 | 1.80 | 3,500 | 0.90 | ||||||||||
+100 | 4,600 | 1.20 | 2,100 | 0.60 | ||||||||||
-100 | (5,900 | ) | (1.60 | ) | (9,500 | ) | (2.50 | ) | ||||||
The Company’s interest rate sensitivity became more asset sensitive in 2019. This reflected the impact of the SI Financial acquisition along with the impact of the Company’s strategic deleveraging and reduction of wholesale funding. It also reflected the shorter projected lives of assets with prepayment activity, due to the lower long term interest rates at period-end. At period-end, in the second year of a 200 basis point parallel upward ramp of interest rates, net interest income was projected to increase by 5% compared to a baseline scenario of unchanged interest rates. This was modeled as 1% at the beginning of the year. With this added interest rate sensitivity, the Company is also more sensitive to declining net interest income in falling interest rate scenarios. In the second year of a 100 basis point downward parallel interest rate ramp, net interest income is modeled to decrease by 4%, compared to a decrease of 2% at the start of the year. In a 200 basis point downward ramp, the modeled downward impact is 6%. The Company’s model assumes that it will not reduce the rate on its financial instruments below zero, and there are no significant contracted indexed instruments which would reset below zero in a down 200 basis point scenario at December 31, 2019. The above sensitivities are compared to the baseline static model and based on current interest rates and modeling assumptions. The yield curve at period-end, if unchanged, could additionally pressure the net interest margin in the future compared to recent results due to ongoing asset yield compression in a static environment before the targeted benefit of further potential asset reductions. Further flattening of the yield curve also presents the possibility of compressing the margin, including the impact of tighter market spreads due to competitive factors in such environments.
The Company’s equity at risk is normally liability sensitive due to the overall shorter duration of its funds sources compared to its loan and investments. Due to the changes described above, this sensitivity has declined. At year-end 2019, the economic value of equity at risk was modeled to decrease by only 1% in the scenario of a modeled 200 basis point parallel upward rate shock. This sensitivity has declined from 6% at year-end 2018. At year-end, the economic value of equity was negatively at risk for most modeled scenarios of interest rate changes. A 2% downward interest rate shock was modeled to result in an 11% decrease in the economic value of equity due to assumed market floors in the cost of deposits.
In addition to modeling net interest income, the Company also estimates the sensitivity of net income to interest rate changes. This sensitivity is generally larger on a percentage basis, since net income is lower than net interest income. The national mortgage banking operations had been a partial hedge to the asset sensitivity of net interest income, with mortgage banking fee income increasing in downward rate scenarios. The removal of these operations has removed this hedging influence related to net income. At year-end 2019, net income at risk in year two in the event of a 200 basis point ramp was an increase of 11% in an upward ramp and a decrease of 13% in a downward ramp. Sensitivity had been modeled as generally neutral at the end of 2018. A critical component of the Company’s modeling is the assumption of deposit interest rate sensitivity, which the Company continues to model at a 40% beta level. The Company does not believe that the addition of the SI Financial deposits materially impacted this estimate. The behavior of markets under the historically unusual conditions currently prevailing may be different from modeling assumptions, and the Company continues to monitor the markets and the assumptions in its model.
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ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Consolidated Financial Statements and supplementary data required by this item are presented elsewhere in this report beginning on page F-1, in the order shown below:
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
The Company’s management, including the Company’s Principal Executive Officer and Principal Financial Officer, have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a and 15(d) -15(e) promulgated under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) as of December 31, 2019. Based upon their evaluation, the Principal Executive Officer and Principal Financial Officer concluded that, as of that date, the Company’s disclosure controls and procedures were effective for the purpose of ensuring that the information required to be disclosed in the reports that the Company files or submits under the Exchange Act with the Securities and Exchange Commission (the “SEC”): (1) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms; and (2) is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
The Company evaluated changes in its internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) that occurred during the last fiscal quarter. The Company determined that there were no changes that materially affected, or were reasonably likely to materially affect, the Company’s internal control over financial reporting. Management’s report on internal control over financial reporting and the independent registered public accounting firm’s report on the Company’s internal control over financial reporting are contained in “Item 8 — Consolidated Financial Statements and Supplementary Data.”
ITEM 9B. OTHER INFORMATION
None.
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PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
For information concerning the directors of the Company, the information contained under the sections captioned “Proposal 1 - Election of Directors for a One-Year Term” in Berkshire’s Proxy Statement for the 2019 Annual Meeting of Stockholders (“Proxy Statement”) is incorporated by reference. The following table sets forth certain information regarding the executive officers of the Company.
Name | Age | Position |
Richard M. Marotta | 61 | President and Chief Executive Officer of the Company; Chief Executive Officer - Berkshire Bank; Director of Berkshire Hills Bancorp and Berkshire Bank |
Sean A. Gray | 44 | Senior Executive Vice President of the Company; President - Berkshire Bank |
James M. Moses | 43 | Senior Executive Vice President, Chief Financial Officer of the Company; Senior Executive Vice President, Chief Financial Officer - Berkshire Bank |
George F. Bacigalupo | 65 | Senior Executive Vice President, Commercial Banking - Berkshire Bank |
Tami F. Gunsch | 57 | Senior Executive Vice President & Director of Relationship Banking - Berkshire Bank |
Malia C. Lazu | 42 | Executive Vice President, Chief Experience & Culture Officer - Berkshire Bank |
Gregory D. Lindenmuth | 52 | Senior Executive Vice President, Chief Risk Officer - Berkshire Bank |
Wm. Gordon Prescott | 58 | Executive Vice President, General Counsel and Corporate Secretary - Berkshire Bank |
The executive officers are elected annually and hold office until their successors have been elected and qualified or until they are removed or replaced.
BIOGRAPHICAL INFORMATION
Richard M. Marotta. Age 61. Mr. Marotta was appointed to the role of President and Chief Executive Officer of the Company and Chief Executive Officer of the Bank in November 2018. He was also appointed as a Director of the Company and the Bank. Prior to these appointments, Mr. Marotta served as Senior Executive Vice President of the Company and President of the Bank from 2015. Mr. Marotta joined the Company in 2010 as Executive Vice President, Chief Risk Officer and has held additional positions including Chief Credit Officer and Chief Administrative Officer. Mr. Marotta has all functions reporting to him except for those reporting to Mr. Gray and Mr. Moses. Mr. Marotta was previously Executive Vice President and Group Head, Asset Recovery at KeyBank. | |
Sean A. Gray. Age 44. Mr. Gray was appointed to the role of Senior Executive Vice President and Chief Operating Officer of the Company and President of the Bank in November 2018. Prior to this appointment, Mr. Gray was Senior Executive Vice President of the Company and Chief Operating Officer of the Bank from 2015. Mr. Gray joined the Company in 2007 as First VP, Retail Banking and has held various position including, Executive Vice President, Retail Banking and Senior VP. Mr. Gray has Ms. Gunsch and Mr. Bacigalupo reporting to him, together with the wealth management, insurance, government banking, cash management, information technology, business line analytics, and corporate development functions. The newly appointed Regional Presidents report to Mr. Gray in their capacity as market leaders. Prior to joining the Bank, Mr. Gray was Vice President and Consumer Market Manager at Bank of America, in Waltham, Massachusetts. | |
James M. Moses. Age 43. Mr. Moses is Senior Executive Vice President, Chief Financial Officer of the Company and the Bank, since joining the Bank in July 2016. Mr. Moses has Mr. Prescott reporting to him, together with the accounting, treasury, tax, investor relations, and capital markets functions. Mr. Moses previously served at Webster Bank as Senior Vice President and Asset/Liability Manager. Mr. Moses joined Webster Bank in 2011 from M&T Bank where he spent four years in various roles including head mortgage trader, deposit products pricing manager, and consumer credit card product manager. | |
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George F. Bacigalupo. Age 65. Mr. Bacigalupo was promoted to Senior Executive Vice President, Commercial Banking in September 2015, having previously served as an Executive Vice President since October 2013 and Senior Vice President, Chief Credit Officer since 2011. Mr. Bacigalupo is responsible for commercial banking, including the commercial real estate, middle-market (commercial and industrial), asset-based lending, and small business banking. Previously, Mr. Bacigalupo was EVP of Specialty Lending at TD Banknorth, where he established the ABL and other middle-market lending groups. Subsequently, at TD Bank, he was the Senior Lender for New England. | |
Tami F. Gunsch. Age 57. Ms. Gunsch is Senior Executive Vice President & Director of Relationship Banking, she also serves as President of First Choice Loan Services, a subsidiary of Berkshire Bank. Ms. Gunsch is responsible for all aspects of the retail banking consumer experience, including branches, branch operations, consumer lending, home lending, private banking, investment services, call center, electronic/mobile banking, operations, loan servicing, and the MyBanker team, as well as the deployment of the Bank's relationship banking strategy across all lines of business. Ms. Gunsch has previously held the positions of EVP, Retail Banking and Senior Vice President. Ms. Gunsch joined Berkshire from Citizens Bank in 2009 as First VP of Retail Banking. | |
Malia C. Lazu. Age 42. Ms. Lazu is Executive Vice President, Chief Experience and Culture Officer for Berkshire Bank. She oversees and directs internal and external experience and culture management, and is a key advisor to the Corporate Responsibility and Culture Committee of the Company's Board of Directors. Ms. Lazu is also the Regional President for the Company's Boston region. She manages corporate communications, marketing, corporate social responsibility, and facilities. She also coordinates with the Executive Director of the Berkshire Bank Foundation. Ms. Lazu joined in July 2019, having served the Company as an independent consultant for more than a year. Ms. Lazu has more than 20 years experience as a culture creator and strategist for cities, institutions, and organizations throughout the U.S. | |
Gregory D. Lindenmuth. Age 52. Mr. Lindenmuth is Senior Executive Vice President, Chief Risk Officer of the Bank, a position he was promoted to in October 2018. Mr. Lindenmuth is responsible for enterprise risk management as well as compliance, loan review, information security, and strategic services. Mr. Lindenmuth joined Berkshire in 2016 from the FDIC where he was employed for 24 years and held multiple positions including Senior Risk Examiner for the Division of Risk Management Supervision and Acting Regional Manager for the Division of Insurance and Research. With the FDIC, Mr. Lindenmuth was also a Capital Markets, Mortgage Banking, and Fraud Specialist. | |
Wm. Gordon Prescott, Age 58. Mr. Prescott is Executive Vice President, General Counsel and Corporate Secretary of the Bank, a position he was promoted to in October 2018. Mr. Prescott joined Berkshire in 2008 as VP, General Counsel and Corporate Secretary. Mr. Prescott has 30 plus years of experience in the legal profession, including extensive experience as in-house corporate counsel, and holds a law degree from Boston University School of Law. |
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Reference is made to the cover page of this report and to the section captioned “Additional Information - Other Information Relating to Directors and Executive Officers - Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement for information regarding compliance with Section 16(a) of the Exchange Act. For information concerning the audit committee and the audit committee financial expert, reference is made to the section captioned “Proposal 1 - Election of Directors for a One-Year Term”, “Corporate Governance - Committees of the Board of Directors”, and “Corporate Governance - Audit Committee” in the Proxy Statement.
For information concerning the Company’s code of ethics, the information contained under the section captioned “Corporate Governance - Code of Business Conduct” in the Proxy Statement is incorporated herein by reference.
A copy of the Company’s code of ethics is available to stockholders on the Company’s website at:
http://ir.berkshirebank.com.
ITEM 11. EXECUTIVE COMPENSATION
For information regarding executive compensation, the sections captioned “Proposal 1 - Election of Directors for a One-Year Term”, “Corporate Governance - Committees of the Board of Directors”, and “Corporate Governance - Audit Committee” in the Proxy Statement are incorporated herein by reference.
For information regarding the Compensation Committee Report, the section captioned “Compensation Discussion and Analysis” in the Proxy Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
(a)Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by reference to the section captioned “Additional Information - Stock Ownership” in the Proxy Statement.
(b)Security Ownership of Management
Information required by this item is incorporated herein by reference to the section captioned “Additional Information - Stock Ownership” in the Proxy Statement.
(c)Changes in Control
Management of Berkshire knows of no arrangements, including any pledge by any person of securities of Berkshire, the operation of which may at a subsequent date result in a change in control of the registrant.
(d)Equity Compensation Plan Information
The following table sets forth information, as of December 31, 2019, about Company common stock that may be issued upon exercise of options under stock-based benefit plans maintained by the Company, as well as the number of securities available for issuance under equity compensation plans:
Plan category | Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted-average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in the first column) | |||||||
Equity compensation plans approved by security holders | 153,272 | $ | 22.00 | 1,123,411 | ||||||
Equity compensation plans not approved by security holders | — | — | — | |||||||
Total | 153,272 | $ | 22.00 | 1,123,411 | ||||||
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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this item is incorporated herein by reference to the sections captioned “Additional Information - Other Information Relating to Directors and Executive Officers - Transactions with Related Persons and - Procedures Governing Related Persons Transactions” in the Proxy Statement. Information regarding director independence is incorporated herein by reference to the section “Proposal 1 - Election of Directors for a One Year Term” in the Proxy Statement.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item is incorporated herein by reference to the section captioned “Proposal 3 — Ratification of the Appointment of the Independent Registered Public Accounting Firm” in the Proxy Statement.
70
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) | [1] Consolidated Financial Statements |
• |
• |
• |
• |
• |
• |
• |
The Consolidated Financial Statements required to be filed in our Annual Report on Form 10-K are included in Part II, Item 8 hereof.
[2] | Financial Statement Schedules |
All financial statement schedules are omitted because the required information is either included or is not applicable.
71
[3] | Exhibits |
3.1 | |||
3.2 | |||
3.3 | |||
3.4 | |||
4.1 | |||
4.2 | |||
4.3 | |||
10.1 | |||
10.2 | |||
10.3 | |||
10.4 | |||
10.5 | |||
10.6 | |||
10.7 | |||
10.8 | |||
10.10 | |||
10.11 | |||
10.12 | |||
10.13 | |||
10.14 | |||
21.0 | |||
23.1 | |||
31.1 | |||
31.2 | |||
32.1 | |||
32.2 | |||
101 | |||
72
(1) | Incorporated herein by reference from the Exhibits to Form S-1, Registration Statement and amendments thereto, initially filed on March 10, 2000, Registration No. 333-32146. | |
(2) | Incorporated herein by reference from the Exhibits to the Form 8-K as filed on June 26, 2017. | |
(3) | Incorporated herein by reference from the Exhibits to the Form 10-Q as filed on November 9, 2017. | |
(4) | Incorporated herein by reference from the Exhibits to the Form 8-K as filed on October 16, 2017. | |
(5) | Incorporated herein by reference from the Exhibits to the Form 8-K as filed on September 26, 2012. | |
(6) | Incorporated herein by reference from the Exhibits to the Form 8-K as filed on February 22, 2019. | |
(7) | Incorporated herein by reference from the Exhibit to the Form 10-K as filed on March 17, 2014. | |
(8) | Incorporated herein by reference from the Exhibits to the Form 8-K as filed on September 23, 2016. | |
(9) | Incorporated herein by reference from the Exhibits to the Form 10-K as filed on March 16, 2011. | |
(10) | Incorporated herein by reference from the Exhibit to the Form 8-K as filed on January 19, 2011. | |
(11) | Incorporated herein by reference from the Appendix to the Proxy Statement as filed on March 24, 2011. | |
(12) | Incorporated herein by reference from the Appendix to the Proxy Statement as filed on April 2, 2013. | |
(13) | Incorporated herein by reference from the Exhibits to the Form 8-K as filed on January 23, 2015. | |
(14) | Incorporated herein by reference from the Appendix to the Proxy Statement as filed on April 6, 2018. | |
(15) | Incorporated herein by reference from the Exhibits to the Form 10-Q as filed on May 10, 2019. | |
ITEM 16. FORM 10-K SUMMARY
None.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Berkshire Hills Bancorp, Inc. | ||
Date: February 28, 2020 | By: | /s/ Richard M. Marotta |
Richard M. Marotta | ||
President & Chief Executive Officer | ||
74
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
/s/ Richard M. Marotta | Director, President, & Chief Executive Officer | February 28, 2020 | ||
Richard M. Marotta | (principal executive officer) | |||
/s/ James M. Moses | Senior Executive Vice President, Chief Financial Officer | February 28, 2020 | ||
James M. Moses | (principal financial and accounting officer) | |||
/s/ J. Williar Dunlaevy | Chairman | February 28, 2020 | ||
J. Williar Dunlaevy | ||||
/s/ Baye Adofo-Wilson | Director | February 28, 2020 | ||
Baye Adofo-Wilson | ||||
/s/ Rheo A. Brouillard | Director | February 28, 2020 | ||
Rheo A. Brouillard | ||||
/s/ David M. Brunelle | Director | February 28, 2020 | ||
David M. Brunelle | ||||
/s/ Robert M. Curley | Director | February 28, 2020 | ||
Robert M. Curley | ||||
/s/ John B. Davies | Director | February 28, 2020 | ||
John B. Davies | ||||
/s/ William H. Hughes, III | Director | February 28, 2020 | ||
William H. Hughes, III | ||||
/s/ Cornelius D. Mahoney | Director | February 28, 2020 | ||
Cornelius D. Mahoney | ||||
/s/ Pamela A. Massad | Director | February 28, 2020 | ||
Pamela A. Massad | ||||
Director | February 28, 2020 | |||
Sylvia Maxfield | ||||
/s/ Laurie Norton Moffatt | Director | February 28, 2020 | ||
Laurie Norton Moffatt | ||||
/s/ William J. Ryan | Director | February 28, 2020 | ||
William J. Ryan | ||||
/s/ Jonathan I. Shulman | Director | February 28, 2020 | ||
Jonathan I. Shulman | ||||
/s/ D. Jeffrey Templeton | Director | February 28, 2020 | ||
D. Jeffrey Templeton | ||||
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ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s Consolidated Financial Statements for external reporting purposes in accordance with generally accepted accounting principles.
As of December 31, 2019, management conducted an assessment of the effectiveness of the Company’s internal control over financial reporting based on the framework established in Internal Control—Integrated Framework issued in 2013, by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has determined that the Company’s internal control over financial reporting as of December 31, 2019 was effective.
The Company’s internal control over financial reporting includes policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
The effectiveness of the Company’s internal control over financial reporting as of December 31, 2019 has been audited by Crowe LLP, an independent registered public accounting firm, as stated in their report, which follows. This report expresses an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019.
/s/ Richard M. Marotta | /s/ James M. Moses | |
Richard M. Marotta | James M. Moses | |
President & Chief Executive Officer | Senior Executive Vice President & Chief Financial Officer | |
February 28, 2020 | February 28, 2020 | |
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and the Board of Directors
of Berkshire Hills Bancorp, Inc.
Boston, Massachusetts
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of Berkshire Hills Bancorp, Inc. (the "Company") as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2019, and the related notes (collectively referred to as the "financial statements"). We also have audited the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2019 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control - Integrated Framework issued in 2013 by COSO.
Basis for Opinions
The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s financial statements and an opinion on the Company’s internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the financial statements included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and the significant estimates made by management, as well as evaluating the overall presentation of the financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
F-2
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Loan Losses - General Component
The allowance for loan losses is a significant estimate that is a determination of estimated probable incurred credit losses in the Company’s loan portfolio. Refer to Note 1 - Summary of Significant Accounting Policies for the Company’s accounting policy related to the allowance for loan losses and Note 8 - Loan Loss Allowance for the Company’s disclosures related to loans and the associated allowance for loan losses. The Company has deemed its policy for determining the allowance for loan losses to be a critical accounting estimate.
The allowance for loan losses includes allowance allocations calculated in accordance with ASC 310, “Receivables,” and allowance allocations calculated in accordance with ASC 450, “Contingencies.” The allowance for loan losses is allocated to loan types using both a formula-based approach applied to groups of loans (“general component”) and an analysis of certain individual loans for impairment (“specific component”).
As of December 31, 2019, the allowance for loan losses totaled approximately $63.6 million. The general component of the allowance totaled approximately $63 million which consisted of approximately $44 million attributable to observable historical data and approximately $19 million attributable to qualitative adjustments. The formula-based approach emphasizes loss factors derived from actual historical and industry portfolio loss rates, which are combined with an assessment of certain qualitative factors to determine the allowance amounts allocated to the various loan categories. Allowance amounts are based on an estimate of historical average annual percentage rate of loan loss for each group of loan, a temporal estimate of the incurred loss emergence and confirmation period for each group of loan, and certain qualitative risk factors considered in the computation of the allowance for loan losses.
We considered auditing the general component of the allowance for loan losses to be a critical audit matter due to complex nature of the calculation resulting from the high volume of the data inputs. The high degree of manual intervention for the data to be appropriately evaluated in the calculation makes auditing the general component of the allowance for loan loss calculation especially challenging. The calculation utilizes numerous external and internal data sources as well as a high volume of reports. The dependability of the calculation relies heavily on the
F-3
completeness, accuracy and validity of the data sources and appropriate application of these data points within the calculation.
The primary procedures we performed to address this critical audit matter included:
• | Testing the design and operating effectiveness of controls pertaining to the significant data inputs related to the completeness and accuracy of the data inputs as well as the accuracy of the allowance calculation itself. These specific procedures included: |
◦ | Management’s control over the completeness and accuracy of reports utilized to prepare the allowance for loan loss calculation |
◦ | Management’s control over the completeness and accuracy of historical loss calculations over the groups of loans included in the general component of the allowance calculation |
◦ | Management’s control over the completeness and accuracy of the loss emergence period calculation |
◦ | Management’s review of the mathematical accuracy of the allowance for loan loss calculation |
• | Substantively testing the completeness and accuracy over management’s allowance calculation including the various significant data inputs. These specific procedures included: |
◦ | Testing of the completeness and accuracy of reports utilized in the calculation of the allowance for loan losses. |
◦ | Testing the completeness and accuracy of the historical loss calculation |
◦ | Testing the accuracy and completeness of loss emergence period calculation |
◦ | Testing the mathematical accuracy of management’s allowance calculation |
/s/ Crowe LLP
We have served as the Company's auditor since 2017.
New York, New York
February 28, 2020
F-4
December 31, | ||||||||
(In thousands, except share data) | 2019 | 2018 | ||||||
Assets | ||||||||
Cash and due from banks | $ | $ | ||||||
Short-term investments | ||||||||
Total cash and cash equivalents | ||||||||
Trading security | ||||||||
Marketable equity securities, at fair value | ||||||||
Securities available for sale, at fair value | ||||||||
Securities held to maturity (fair values of $373,277 in 2019 and $371,224 in 2018) | ||||||||
Federal Home Loan Bank stock and other restricted securities | ||||||||
Total securities | ||||||||
Loans held for sale | ||||||||
Commercial real estate loans | ||||||||
Commercial and industrial loans | ||||||||
Residential mortgages | ||||||||
Consumer loans | ||||||||
Total loans | ||||||||
Less: Allowance for loan losses | ( | ) | ( | ) | ||||
Net loans | ||||||||
Premises and equipment, net | ||||||||
Goodwill | ||||||||
Other intangible assets | ||||||||
Cash surrender value of bank-owned life insurance | ||||||||
Deferred tax assets, net | ||||||||
Other assets | ||||||||
Assets from discontinued operations | ||||||||
Total assets | $ | $ | ||||||
Liabilities | ||||||||
Demand deposits | $ | $ | ||||||
NOW and other deposits | ||||||||
Money market deposits | ||||||||
Savings deposits | ||||||||
Time deposits | ||||||||
Total deposits | ||||||||
Short-term debt | ||||||||
Long-term Federal Home Loan Bank advances | ||||||||
Subordinated notes | ||||||||
Total borrowings | ||||||||
Other liabilities | ||||||||
Liabilities from discontinued operations | ||||||||
Total liabilities | ||||||||
(continued)
December 31, | ||||||||
(In thousands, except share data) | 2019 | 2018 | ||||||
Shareholders’ equity | ||||||||
Preferred Stock (Series B non-voting convertible preferred stock - $0.01 par value; 2,000,000 shares authorized, 521,607 shares issued and outstanding in 2019; 2,000,000 shares authorized, 521,607 shares issued and outstanding in 2018) | ||||||||
Common stock ($.01 par value; 100,000,000 shares authorized and 51,903,190 shares issued and 49,585,143 shares outstanding in 2019; 100,000,000 shares authorized; 46,211,894 shares issued, and 45,416,855 shares outstanding in 2018) | ||||||||
Additional paid-in capital - common stock | ||||||||
Unearned compensation | ( | ) | ( | ) | ||||
Retained earnings | ||||||||
Accumulated other comprehensive income/(loss) | ( | ) | ||||||
Treasury stock, at cost (2,318,047 shares in 2019 and 795,039 shares in 2018) | ( | ) | ( | ) | ||||
Total shareholders’ equity | ||||||||
Total liabilities and shareholders’ equity | $ | $ | ||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-5
Years Ended December 31, | ||||||||||||
(In thousands) | 2019 | 2018 | 2017 | |||||||||
Interest and dividend income | ||||||||||||
Loans | $ | $ | $ | |||||||||
Securities and other | ||||||||||||
Total interest and dividend income | ||||||||||||
Interest expense | ||||||||||||
Deposits | ||||||||||||
Borrowings and subordinated notes | ||||||||||||
Total interest expense | ||||||||||||
Net interest income | ||||||||||||
Non-interest income | ||||||||||||
Mortgage banking income | ||||||||||||
Loan related income | ||||||||||||
Deposit related fees | ||||||||||||
Insurance commissions and fees | ||||||||||||
Wealth management fees | ||||||||||||
Total fee income | ||||||||||||
Other | ( | ) | ||||||||||
Gain/(loss) on securities, net | ( | ) | ||||||||||
Gain on sale of business operations and assets, net | ||||||||||||
Loss on termination of hedges | ( | ) | ||||||||||
Total non-interest income | ||||||||||||
Total net revenue | ||||||||||||
Provision for loan losses | ||||||||||||
Non-interest expense | ||||||||||||
Compensation and benefits | ||||||||||||
Occupancy and equipment | ||||||||||||
Technology and communications | ||||||||||||
Marketing and promotion | ||||||||||||
Professional services | ||||||||||||
FDIC premiums and assessments | ||||||||||||
Other real estate owned and foreclosures | ||||||||||||
Amortization of intangible assets | ||||||||||||
Merger, restructuring and conversion related expenses | ||||||||||||
Other | ||||||||||||
Total non-interest expense | ||||||||||||
Income from continuing operations before income taxes | ||||||||||||
Income tax expense from continuing operations | ||||||||||||
Net income from continuing operations | ||||||||||||
(Loss)/income from discontinued operations before income taxes | ( | ) | ( | ) | ||||||||
Income tax (benefit)/expense from discontinued operations | ( | ) | ( | ) | ||||||||
Net (loss)/income from discontinued operations | ( | ) | ( | ) | ||||||||
Net income | $ | $ | $ | |||||||||
Preferred stock dividend | ||||||||||||
Income available to common shareholders | $ | $ | $ | |||||||||
Years Ended December 31, | ||||||||||||
(in thousands, except per share data) | 2019 | 2018 | 2017 | |||||||||
Basic earnings/(loss) per share: | ||||||||||||
Continuing Operations | $ | $ | $ | |||||||||
Discontinued operations | ( | ) | ( | ) | ||||||||
Total basic earning per share | $ | $ | $ | |||||||||
Diluted earnings/(loss) per share: | ||||||||||||
Continuing Operations | $ | $ | $ | |||||||||
Discontinued operations | ( | ) | ( | ) | ||||||||
Total diluted earnings per share | $ | $ | $ | |||||||||
Weighted average common shares outstanding: | ||||||||||||
Basic | ||||||||||||
Diluted | ||||||||||||
F-6
Years Ended December 31, | ||||||||||||
(In thousands) | 2019 | 2018 | 2017 | |||||||||
Net income | $ | $ | $ | |||||||||
Other comprehensive income (loss), before tax: | ||||||||||||
Changes in unrealized gains and losses on securities available-for-sale | ( | ) | ( | ) | ||||||||
Changes in unrealized gains and losses on derivative hedges | ||||||||||||
Changes in unrealized gains and losses on pension | ( | ) | ( | ) | ||||||||
Total other comprehensive income/(loss), before tax | ( | ) | ( | ) | ||||||||
Income taxes related to other comprehensive income (loss): | ||||||||||||
Changes in unrealized gains and losses on securities available-for-sale | ( | ) | ||||||||||
Changes in unrealized gains and losses on derivative hedges | ( | ) | ||||||||||
Changes in unrealized gains and losses on pension | ( | ) | ||||||||||
Total income tax (expense) benefit related to other comprehensive income (loss) | ( | ) | ||||||||||
Total other comprehensive income/(loss) | ( | ) | ( | ) | ||||||||
Total comprehensive income | $ | $ | $ | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-7
BERKSHIRE HILLS BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Preferred Stock | Common Stock | Additional paid-in | Unearned | Retained | Accumulated other comprehensive | Treasury | ||||||||||||||||||||||
(In thousands, except per share data) | Shares | Amount | Shares | Amount | capital | compensation | earnings | (loss) income | stock | Total | ||||||||||||||||||
Balance at January 1, 2017 | $ | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | |||||||||||||||||
Comprehensive income: | ||||||||||||||||||||||||||||
Net income | — | — | — | — | — | — | — | — | ||||||||||||||||||||
Other net comprehensive (loss) | — | — | — | — | — | — | — | ( | ) | — | ( | ) | ||||||||||||||||
Total comprehensive income | =sum(J5:J6) | =sum(J5:J6) | =sum(J5:J6) | =sum(J5:J6) | =sum(J5:J6) | =sum(J5:J6) | ( | ) | — | |||||||||||||||||||
Acquisition of Commerce Bank | — | — | — | — | ||||||||||||||||||||||||
Common stock issued, net of $7.1 million offering costs | — | — | — | — | — | — | ||||||||||||||||||||||
Cash dividends declared on common shares ($0.84 per share) | — | — | — | — | — | — | ( | ) | — | — | ( | ) | ||||||||||||||||
Cash dividends declared on preferred shares ($0.42 per share) | — | — | — | — | — | — | ( | ) | — | — | ( | ) | ||||||||||||||||
Forfeited shares | — | — | ( | ) | — | — | — | ( | ) | |||||||||||||||||||
Exercise of stock options | — | — | — | — | — | ( | ) | — | ||||||||||||||||||||
Restricted stock grants | — | — | — | ( | ) | — | — | |||||||||||||||||||||
Stock-based compensation | — | — | — | — | — | — | — | — | ||||||||||||||||||||
Other, net | — | — | ( | ) | — | — | ( | ) | — | ( | ) | ( | ) | |||||||||||||||
Balance at December 31, 2017 | $ | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | |||||||||||||||||
Comprehensive income: | 0 | |||||||||||||||||||||||||||
Net income | — | — | — | — | — | — | — | — | ||||||||||||||||||||
Other net comprehensive (loss) | — | — | — | — | — | — | — | ( | ) | — | ( | ) | ||||||||||||||||
Total comprehensive income | — | — | — | — | — | — | ( | ) | — | |||||||||||||||||||
Adoption of ASU No 2016-01, Financial Instruments - Overall (Subtopic 825-10) - Recognition and Measurement of Financial Assets and Liabilities | — | — | — | — | — | — | ( | ) | — | |||||||||||||||||||
Adoption of ASU No 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income | — | — | — | — | — | — | ( | ) | — | |||||||||||||||||||
Cash dividends declared on common shares ($0.88 per share) | — | — | — | — | — | — | ( | ) | — | — | ( | ) | ||||||||||||||||
Cash dividends declared on preferred shares ($1.76 per share) | — | — | — | — | — | — | ( | ) | — | — | ( | ) | ||||||||||||||||
Forfeited shares | — | — | ( | ) | — | — | — | ( | ) | |||||||||||||||||||
Exercise of stock options | — | — | — | — | — | ( | ) | — | ||||||||||||||||||||
Restricted stock grants | — | — | — | ( | ) | — | — | |||||||||||||||||||||
Stock-based compensation | — | — | — | — | — | — | — | — | ||||||||||||||||||||
Other, net | — | — | ( | ) | — | — | — | — | ( | ) | ( | ) | ||||||||||||||||
Balance at December 31, 2018 | $ | $ | $ | ( | ) | $ | $ | ( | ) | $ | ( | ) | $ | |||||||||||||||
Comprehensive income: | ||||||||||||||||||||||||||||
Net income | — | — | — | — | — | — | — | — | ||||||||||||||||||||
Other net comprehensive income | — | — | — | — | — | — | — | — | ||||||||||||||||||||
Total comprehensive income | — | — | — | — | — | — | — | |||||||||||||||||||||
Acquisition of SI Financial Group, Inc. | — | — | — | — | — | — | ||||||||||||||||||||||
Cash dividends declared on common shares ($0.92 per share) | — | — | — | — | — | — | ( | ) | — | — | ( | ) | ||||||||||||||||
Cash dividends declared on preferred shares ($1.84 per share) | — | — | — | — | — | — | ( | ) | — | — | ( | ) | ||||||||||||||||
Treasury stock purchased | — | — | ( | ) | — | — | — | — | — | ( | ) | ( | ) | |||||||||||||||
Forfeited shares | — | — | ( | ) | — | ( | ) | — | — | ( | ) | |||||||||||||||||
Exercise of stock options | — | — | — | — | — | ( | ) | — | ||||||||||||||||||||
Restricted stock grants | — | — | — | ( | ) | — | — | |||||||||||||||||||||
Stock-based compensation | — | — | — | — | — | — | — | — | ||||||||||||||||||||
Other, net | — | — | ( | ) | — | — | — | — | ( | ) | ( | ) | ||||||||||||||||
Balance at December 31, 2019 | $ | $ | $ | $ | ( | ) | $ | $ | $ | ( | ) | $ | ||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-8
Years Ended December 31, | ||||||||||||
(In thousands) | 2019 | 2018 | 2017 | |||||||||
Cash flows from operating activities: | ||||||||||||
Net income from continuing operations | ||||||||||||
Net income from discontinued operations | ( | ) | ( | ) | ||||||||
Net income | $ | $ | $ | |||||||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||||||
Provision for loan losses | ||||||||||||
Net amortization of securities | ||||||||||||
Change in unamortized net loan origination costs and premiums | ( | ) | ||||||||||
Premises and equipment depreciation and amortization expense | ||||||||||||
Stock-based compensation expense | ||||||||||||
Accretion of purchase accounting entries, net | ( | ) | ( | ) | ( | ) | ||||||
Amortization of other intangibles | ||||||||||||
Write down of other real estate owned | ||||||||||||
Income from cash surrender value of bank-owned life insurance policies | ( | ) | ( | ) | ( | ) | ||||||
Securities (gains) losses, net | ( | ) | ( | ) | ||||||||
Net change in loans held-for-sale | ( | ) | ||||||||||
Change in right-of-use lease assets | — | — | ||||||||||
Change in lease liabilities | ( | ) | — | — | ||||||||
Loss on disposition of assets | ||||||||||||
Loss (gain) on sale of real estate | ( | ) | ||||||||||
Amortization of interest in tax-advantaged projects | ||||||||||||
Remeasurement of deferred tax asset | ||||||||||||
Net change in other | ( | ) | ||||||||||
Net cash provided by operating activities of continuing operations | ||||||||||||
Net cash (used) provided by operating activities of discontinued operations | ( | ) | ( | ) | ||||||||
Net cash provided by operating activities | ||||||||||||
Cash flows from investing activities: | ||||||||||||
Net decrease in trading security | ||||||||||||
Purchases of marketable equity securities | ( | ) | ( | ) | ( | ) | ||||||
Proceeds from sales of marketable equity securities | ||||||||||||
Purchases of securities available for sale | ( | ) | ( | ) | ( | ) | ||||||
Proceeds from sales of securities available for sale | ||||||||||||
Proceeds from maturities, calls, and prepayments of securities available for sale | ||||||||||||
Purchases of securities held to maturity | ( | ) | ( | ) | ( | ) | ||||||
Proceeds from maturities, calls, and prepayments of securities held to maturity | ||||||||||||
Net change in loans | ( | ) | ( | ) | ||||||||
Acquisitions, net of cash paid | ||||||||||||
Proceeds from surrender of bank-owned life insurance | ||||||||||||
Purchase of bank-owned life insurance | ( | ) | ||||||||||
Purchase of Federal Home Loan Bank stock | ( | ) | ( | ) | ( | ) | ||||||
Proceeds from sales of Federal Home Loan Bank stock | ||||||||||||
Net investment in limited partnership tax credits | ( | ) | ( | ) | ( | ) | ||||||
Purchase of premises and equipment, net | ( | ) | ( | ) | ( | ) | ||||||
(Continued) | ||||||||||||
F-9
Years ended December 31, | ||||||||||||
(In thousands) | 2019 | 2018 | 2017 | |||||||||
Proceeds from sales of seasoned commercial loan portfolios | ||||||||||||
Payment to terminate cash flow hedges | ||||||||||||
Proceeds from sales of other real estate owned | ||||||||||||
Net investing cash flows (used) by discontinued operations | ( | ) | ( | ) | ( | ) | ||||||
Net cash provided (used) by investing activities | ( | ) | ( | ) | ||||||||
Cash flows from financing activities: | ||||||||||||
Net increase in deposits | $ | $ | $ | |||||||||
Proceeds from Federal Home Loan Bank advances and other borrowings | ||||||||||||
Repayments of Federal Home Loan Bank advances and other borrowings | ( | ) | ( | ) | ( | ) | ||||||
Issuance of common stock, net | ||||||||||||
Purchase of treasury stock | ( | ) | ||||||||||
Exercise of stock options | ||||||||||||
Common and preferred stock cash dividends paid | ( | ) | ( | ) | ( | ) | ||||||
Acquisition contingent consideration paid | ( | ) | ||||||||||
Net cash (used) provided by financing activities | ( | ) | ||||||||||
Net change in cash and cash equivalents | ( | ) | ||||||||||
Cash and cash equivalents at beginning of year | ||||||||||||
Cash and cash equivalents at end of year | $ | $ | $ | |||||||||
Supplemental cash flow information: | ||||||||||||
Interest paid on deposits | $ | $ | $ | |||||||||
Interest paid on borrowed funds | ||||||||||||
Income taxes paid, net | ||||||||||||
Acquisition of non-cash assets and liabilities: | ||||||||||||
Assets acquired | ||||||||||||
Liabilities assumed | ( | ) | ( | ) | ||||||||
Other non-cash changes: | ||||||||||||
Other net comprehensive income/(loss) | ( | ) | ( | ) | ||||||||
Real estate owned acquired in settlement of loans | ||||||||||||
Reclass of aircraft, HOA, and SBA loan portfolios to HFS, net | ||||||||||||
Goodwill measurement period adjustment | ||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years Ended December 31, 2019, 2018, and 2017
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Consolidation
The Consolidated Financial Statements (the “financial statements”) of Berkshire Hills Bancorp, Inc. and its subsidiaries (the “Company” or “Berkshire”) have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The Company is a Delaware corporation, headquartered in Boston, Massachusetts, and the holding company for Berkshire Bank (the “Bank”), a Massachusetts-chartered trust company headquartered in Pittsfield, Massachusetts, and Berkshire Insurance Group, Inc. These financial statements include the accounts of the Company, its wholly-owned subsidiaries and the Bank’s consolidated subsidiaries. In consolidation, all significant intercompany accounts and transactions are eliminated. The results of operations of companies or assets acquired are included only from the dates of acquisition. All material wholly-owned and majority-owned subsidiaries are consolidated unless GAAP requires otherwise.
The Company has evaluated subsequent events for potential recognition and/or disclosure through the date these financial statements were issued.
Reclassifications
Certain items in prior financial statements have been reclassified to conform to the current presentation.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements. Actual results could differ from those estimates.
Business Combinations
Business combinations are accounted for using the acquisition method of accounting. Under this method, the accounts of an acquired entity are included with the acquirer’s accounts as of the date of acquisition with any excess of purchase price over the fair value of the net assets acquired (including identifiable intangibles) capitalized as goodwill.
To consummate an acquisition, the Company will typically issue common stock and/or pay cash, depending on the terms of the acquisition agreement. The value of common shares issued is determined based upon the market price of the stock as of the closing of the acquisition.
Cash and Cash equivalents
Cash and cash equivalents include cash, balances due from banks, and short-term investments, all of which had an original maturity within 90 days. Due to the nature of cash and cash equivalents and the near term maturity, the Company estimated that the carrying amount of such instruments approximated fair value. The nature of the Bank’s business requires that it maintain amounts due from banks which at times, may exceed federally insured limits. The Bank has not experienced any losses on such amounts and all amounts are maintained with well-capitalized institutions.
Trading Security
The Company accounts for a tax advantaged economic development bond originated in 2008 at fair value, in accordance with Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) 320. The bond has been designated as a trading account security and is recorded at fair value, with changes in unrealized gains and losses recorded through earnings each period as part of non-interest income.
F-11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Securities
Debt securities that management has the intent and ability to hold to maturity are classified as held to maturity and carried at amortized cost. All other debt securities are classified as available for sale and carried at fair value, with unrealized gains and losses reported as a component of other net comprehensive income. Equity securities are carried at fair value, with changes in fair value reported in net income. Management determines the appropriate classification of securities at the time of purchase. Restricted equity securities, such as stock in the Federal Home Loan Bank of Boston (“FHLBB”) are carried at cost. There are no quoted market prices for the Company’s restricted equity securities. The Bank is a member of the FHLBB, which requires that members maintain an investment in FHLBB stock, which may be redeemed based on certain conditions. The Bank reviews for impairment based on the ultimate recoverability of the cost bases in the FHLBB stock.
Purchase premiums and discounts are recognized in interest income using the interest method, without anticipating prepayments, except mortgage-backed securities where prepayments are anticipated, over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
The Company evaluates debt securities within the Company’s available for sale and held to maturity portfolios for other-than-temporary impairment (“OTTI”), at least quarterly. If the fair value of a debt security is below the amortized cost basis of the security, OTTI is required to be recognized if any of the following are met: (1) the Company intends to sell the security; (2) it is “more likely than not” that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. For all impaired debt securities that the Company intends to sell, or more likely than not will be required to sell, the full amount of the depreciation is recognized as OTTI through earnings. Credit-related OTTI for all other impaired debt securities is recognized through earnings. Non-credit related OTTI for such debt securities is recognized in other comprehensive income, net of applicable taxes.
Loans Held for Sale
Loans originated with the intent to be sold in the secondary market are accounted for under the fair value option. Non-refundable fees and direct loan origination costs related to residential mortgage loans held for sale are recognized in non-interest income or non-interest expense as earned or incurred. Fair value is primarily determined based on quoted prices for similar loans in active markets. Gains and losses on sales of residential mortgage loans (sales proceeds minus carrying value) are recorded in non-interest income.
Loans that were previously held for investment that the Company has an active plan to sell are transferred to loans held for sale at the lower of cost or market (fair value). The market price is primarily determined based on quoted prices for similar loans in active markets or agreed upon sales prices. Gains are recorded in non-interest income at sale to the extent that the sale price of the loan exceeds carrying value. Any reduction in the loan’s value, prior to being transferred to loans held for sale, is reflected as a charge-off of the recorded investment in the loan resulting in a new cost basis, with a corresponding reduction in the allowance for loan losses. Further decreases in the fair value of the loan are recognized in non-interest expense.
F-12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Loans
Loans are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, the unamortized balance of any deferred fees or costs on originated loans and the unamortized balance of any premiums or discounts on loans purchased or acquired through mergers. Interest income is accrued on the unpaid principal balance. Interest income includes net accretion or amortization of deferred fees or costs and of premiums or discounts. Direct loan origination costs, net of any origination fees, in addition to premiums and discounts on loans, are deferred and recognized as an adjustment of the related loan yield using the interest method. Interest on loans, excluding automobile loans, is generally not accrued on loans which are ninety days or more past due unless the loan is well-secured and in the process of collection. Past due status is based on contractual terms of the loan. Automobile loans generally continue accruing until one hundred and twenty days delinquent, at which time they are charged off. All interest accrued but not collected for loans that are placed on non-accrual or charged-off is reversed against interest income, except for certain loans designated as well-secured. The interest on non-accrual loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Acquired Loans
Loans that the Company acquired in acquisitions are initially recorded at fair value with no carryover of the related allowance for credit losses. Determining the fair value of the loans involves estimating the amount and timing of principal and interest cash flows initially expected to be collected on the loans and discounting those cash flows at an appropriate market rate of interest.
For loans that meet the criteria stipulated in ASC 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality,” the Company recognizes the accretable yield, which is defined as the excess of all cash flows expected at acquisition over the initial fair value of the loan, as interest income on a level-yield basis over the expected remaining life of the loan. The excess of the loan’s contractually required payments over the cash flows expected to be collected is the nonaccretable difference. The nonaccretable difference is not recognized as an adjustment of yield, a loss accrual, or a valuation allowance.
For ASC 310-30 loans, the expected cash flows reflect anticipated prepayments, determined on a loan by loan or pool basis according to the anticipated collection plan of these loans. The expected prepayments used to determine the accretable yield are consistent between the cash flows expected to be collected and projections of contractual cash flows so as to not affect the nonaccretable difference. For ASC 310-30 loans, prepayments result in the recognition of the nonaccretable balance as current period yield. Changes in prepayment assumptions may change the amount of interest income and principal expected to be collected. Interest income is also net of recoveries recorded on acquired impaired loans. ASC310-30 loans that have similar risk characteristics, primarily credit risk, collateral type and interest rate risk, and are homogenous in size, are pooled and accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. ASC 310-30 loans that cannot be aggregated into a pool are accounted for individually.
After we acquire loans determined to be accounted for under ASC 310-30, actual cash collections are monitored to determine if they conform to management’s expectations. Revised cash flow expectations are prepared each quarter. A decrease in expected cash flows in subsequent periods may indicate impairment and would require us to establish an allowance for loan and lease losses (“ALLL”) by recording a charge to the provision for loan and lease losses. An increase in expected cash flows in subsequent periods initially reduces any previously established ALLL by the increase in the present value of cash flows expected to be collected, and requires us to recalculate the amount of accretable yield for the ASC 310-30 loan or pool. The adjustment of accretable yield due to an increase in expected cash flows is accounted for as a change in estimate. The additional cash flows expected to be collected are reclassified from the nonaccretable difference to the accretable yield, and the amount of periodic accretion is adjusted accordingly over the remaining life of the ASC 310-30 loan or pool.
An ASC 310-30 loan may be derecognized either through receipt of payment (in full or in part) from the borrower, the sale of the loan to a third party, foreclosure of the collateral, or charge-off. If one of these events occurs, the loan
F-13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
is removed from the loan pool, or derecognized if it is accounted for as an individual loan. ASC 310-30 loans subject to modification are not removed from an ASC 310-30 pool even if those loans would otherwise be deemed troubled debt restructurings (“TDRs”) since the pool, and not the individual loan, represents the unit of account. Individually accounted for ASC 310-30 loans that are modified in a TDR are no longer classified as ASC 310-30 loans and are subject to TDR recognition.
Acquired loans that met the criteria for nonaccrual of interest prior to the acquisition are considered performing upon acquisition, regardless of whether the customer is contractually delinquent, if the Company can reasonably estimate the timing and amount of the expected cash flows on such loans and if the Company expects to fully collect the new carrying value of the loans. As such, the Company may no longer consider the loan to be nonaccrual or nonperforming and may accrue interest on these loans, including the impact of any accretable yield. The Company has determined that the Company can reasonably estimate future cash flows on the Company’s current portfolio of acquired loans that are past due 90 days or more and on which the Company is accruing interest and the Company expects to fully collect the carrying value of the loans.
For loans that do not meet the ASC 310-30 criteria, the Company accretes interest income based on the contractually required cash flows. Subsequent to the purchase date, the methods utilized to estimate the required allowance for loan losses for these loans is similar to originated loans.
Allowance for Loan Losses
The allowance for loan losses is established based upon the level of estimated probable incurred losses in the current loan portfolio. Loan losses are charged against the allowance when management believes the collectability of a loan balance is doubtful. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses includes allowance allocations calculated in accordance with ASC 310, “Receivables,” and allowance allocations calculated in accordance with ASC 450, “Contingencies.” The allowance for loan losses is allocated to loan types using both a formula-based approach applied to groups of loans and an analysis of certain individual loans for impairment. The formula-based approach emphasizes loss factors derived from actual historical and industry portfolio loss rates, which are combined with an assessment of certain qualitative factors to determine the allowance amounts allocated to the various loan categories. Allowance amounts are based on an estimate of historical average annual percentage rate of loan loss for each loan segment, a temporal estimate of the incurred loss emergence and confirmation period for each loan category, and certain qualitative risk factors considered in the computation of the allowance for loan losses.
Qualitative risk factors impacting the inherent risk of loss within the portfolio include the following:
• | National and local economic conditions, regulatory/legislative changes, or other competitive factors affecting the collectability of the portfolio |
• | Trends in underwriting characteristics, composition of the portfolio, and/or asset quality |
• | Changes in underwriting standards and/or collection, charge off, recovery, and account management practice |
• | The existence and effect of any concentrations of credit |
Risk characteristics relevant to each portfolio segment are as follows:
Commercial real estate - Loans in this segment are primarily owner-occupied or income-producing properties throughout New England and Northeastern New York. The underlying cash flows generated by the properties are adversely impacted by a downturn in the economy, which in turn, will have an effect on the credit quality in this segment. Management monitors the cash flows of these loans. In addition, construction loans in this segment primarily include real estate development loans for which payment is derived from sale of the property or long term financing at completion. Credit risk is affected by cost overruns, time to sell at an adequate price, and market conditions
Commercial and industrial loans - Loans in this segment are made to businesses and are generally secured by assets of the business. Repayment is expected from the cash flows of the business. Loans in this segment include asset based loans which generally have no scheduled repayment and which are closely monitored
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against formula based collateral advance ratios. A weakened economy, and resultant decreased consumer spending, will have an effect on the credit quality in this segment.
Residential mortgage - All loans in this segment are collateralized by residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment.
Consumer loans - Loans in this segment are primarily home equity lines of credit and second mortgages, together with automobile loans and other consumer loans. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment.
The Company utilizes a blend of historical and industry portfolio loss rates for commercial real estate and commercial and industrial loans that are assessed by internal risk rating. Historical loss rates for residential mortgages, home equity and other consumer loans are not risk graded but are assessed based on the total of each loan segment. This approach incorporates qualitative adjustments based upon management’s assessment of various market and portfolio specific risk factors into its formula-based estimate. Due to the subjective nature of the loan loss estimation process and ever changing conditions, the qualitative risk attributes may not adequately capture amounts of incurred loss in the formula-based loan loss components used to determine allocations in the Company’s analysis of the adequacy of the allowance for loan losses.
The Company evaluates certain loans individually for specific impairment. Large groups of small balance homogeneous loans such as the residential mortgage, home equity, and other consumer portfolios are collectively evaluated for impairment. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Loans are selected for evaluation based upon a change in internal risk rating, occurrence of delinquency, loan classification, or non-accrual status. The evaluation of certain loans individually for specific impairment includes non-accrual loans over a threshold and loans that were determined to be Troubled Debt Restructurings (“TDRs”). A specific allowance amount is allocated to an individual loan when such loan has been deemed impaired and when the amount of the probable loss is able to be estimated. Estimates of loss may be determined by the present value of anticipated future cash flows or the loan’s observable fair market value, or the fair value of the collateral less costs to sell, if the loan is collateral dependent. However, for collateral dependent loans, the amount of the recorded investment in a loan that exceeds the fair value of the collateral is charged-off against the allowance for loan losses in lieu of an allocation of a specific allowance amount when such an amount has been identified definitively as uncollectible.
Regarding acquired loans, the Company subjects loans that do not meet the ASC 310-30 criteria to ASC 450-20 by collectively evaluating these loans for an allowance for loan loss. The Company applies a methodology similar to the methodology prescribed for business activities loans, which includes the application of environmental factors to each category of loans. The methodology to collectively evaluate the acquired loans outside the scope of ASC 310-30 includes the application of a number of environmental factors that reflect management’s best estimate of the level of incremental credit losses that might be recognized given current conditions. This is reviewed as part of the allowance for loan loss adequacy analysis. As the loan portfolio matures and environmental factors change, the loan portfolio will be reassessed each quarter to determine an appropriate reserve allowance.
Additionally, the Company considers the need for an additional reserve for acquired loans accounted for outside of the scope of ASC 310-30 under ASC 310-20. At acquisition date, the Bank determined a fair value mark with credit and interest rate components. Under the Company’s model, the impairment evaluation process involves comparing the carrying value of acquired loans, including the unamortized premium or discount, to the calculated reserve
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allowance. If necessary, the Company books an additional reserve to account for shortfalls identified through this calculation. A decrease in the expected cash flows in subsequent periods requires the establishment of an allowance for loan losses at that time for ASC 310-30 loans.
Bank-Owned Life Insurance
Bank-owned life insurance policies are reflected on the Consolidated Balance Sheets at the amount that can be realized under the insurance contract at the balance sheet date which is the cash surrender value. Changes in the net cash surrender value of the policies, as well as insurance proceeds received, are reflected in non-interest income on the Consolidated Statements of Income and are not subject to income taxes.
Foreclosed and Repossessed Assets
Other real estate owned is comprised of real estate acquired through foreclosure proceedings or acceptance of a deed in lieu of foreclosure. Repossessed collateral is primarily comprised of taxi medallions. Both other real estate owned and repossessed collateral are held for sale and are initially recorded at the fair value less estimated costs to sell at the date of foreclosure or repossession, establishing a new cost basis. The shortfall, if any, of the loan balance over the fair value of the property or collateral, less cost to sell, at the time of transfer from loans to other real estate owned or repossessed collateral is charged to the allowance for loan losses. Subsequent to transfer, the asset is carried at lower of cost or fair value less cost to sell and periodically evaluated for impairment. Subsequent impairments in the fair value of other real estate owned and repossessed collateral are charged to expense in the period incurred. Net operating income or expense related to other real estate owned and repossessed collateral is included in operating expenses in the accompanying Consolidated Statements of Income. Because of changing market conditions, there are inherent uncertainties in the assumptions with respect to the estimated fair value of other real estate owned and repossessed collateral. Because of these inherent uncertainties, the amount ultimately realized on other real estate owned and repossessed collateral may differ from the amounts reflected in the financial statements.
Capitalized Servicing Rights
Capitalized servicing rights are included in “other assets” in the Consolidated Balance Sheets. Servicing assets are initially recognized as separate assets at fair value when rights are acquired through purchase or through sale of financial assets with servicing retained.
The Company's servicing rights accounted for under the fair value method are carried on the Consolidated Balance Sheets at fair value with changes in fair value recorded in income in the period in which the change occurs. Changes in the fair value of servicing rights are primarily due to changes in valuation assumptions, such as discount rates and prepayment speeds, and the collection and realization of expected cash flows.
The Company’s servicing rights accounted for under the amortization method are initially recorded at fair value. Under that method, capitalized servicing rights are charged to expense in proportion to and over the period of estimated net servicing income. Fair value of the servicing rights is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, prepayment speeds and default rates and losses. Impairment is recognized through a valuation allowance for an individual tranche, to the extent that fair value is less than the capitalized amount for the tranches. If the Company later determines that all or a portion of the impairment no longer exists for a particular tranche, a reduction of the allowance may be recorded as an increase to income.
Premises and Equipment
Land is carried at cost. Buildings, improvements, and equipment are carried at cost less accumulated depreciation and amortization computed on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized on the straight-line method over the shorter of the lease term, plus optional terms if certain conditions are met, or the estimated useful life of the asset.
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Goodwill represents the excess of the purchase price over the fair value of the net assets acquired in a business combination. Goodwill is assessed annually for impairment, and more frequently if events or changes in circumstances indicate that there may be an impairment. Adverse changes in the economic environment, declining operations, unanticipated competition, loss of key personnel, or other factors could result in a decline in the implied fair value of goodwill. If the implied fair value of goodwill is less than the carrying amount, a loss would be recognized in other non-interest expense to reduce the carrying amount to the implied fair value of goodwill. The Company performs an annual qualitative assessment of whether it is more likely than not that the reporting unit's fair value is less than its carrying amount. If the results of the qualitative assessment suggest goodwill impairment, the Company would perform a two-step impairment test through the application of various quantitative valuation methodologies. Step 1, used to identify instances of potential impairment, compares the fair value of the reporting unit with its carrying amount, including goodwill. If the carrying amount, including goodwill, exceeds its fair value, the second step of the goodwill impairment analysis is performed to measure the amount of impairment loss, if any. Step 2 of the goodwill impairment analysis compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of goodwill for the reporting unit exceeds the implied fair value of the reporting unit’s goodwill, an impairment loss is recognized in an amount equal to that excess. Subsequent reversals of goodwill impairment are prohibited. The Company may elect to bypass the qualitative assessment and begin with Step 1.
Other Intangibles
Intangible assets are acquired assets that lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset or liability.
The fair values of these assets are generally determined based on appraisals and are subsequently amortized on a straight-line basis or an accelerated basis over their estimated lives. Management assesses the recoverability of these intangible assets at least annually or whenever events or changes in circumstances indicate that their carrying value may not be recoverable. If the carrying amount exceeds fair value, an impairment charge is recorded to income.
Transfers of Financial Assets
Transfers of an entire financial asset, group of entire financial assets, or a participating interest in an entire financial asset are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets.
Income Taxes
Deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable for future years to differences between financial statement and tax bases of existing assets and liabilities. The effect of tax rate changes on deferred taxes is recognized in the income tax provision in the period that includes the enactment date. A tax valuation allowance is established, as needed, to reduce net deferred tax assets to the amount expected to be realized. In the event it becomes more likely than not that some or all of the deferred tax asset allowances will not be needed, the valuation allowance will be adjusted.
In the ordinary course of business there is inherent uncertainty in quantifying the Company’s income tax
positions. Income tax positions and recorded tax benefits are based upon management’s evaluation of the facts, circumstances, and information available at the reporting date. For those tax positions where it is more likely than not that a tax benefit will be sustained, we have determined the amount of the tax benefit to be recognized by estimating the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with a taxing authority that has full knowledge of all relevant information. For those income tax positions where it is more-likely-than-not that a tax benefit will not be sustained, no tax benefit has been recognized
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Insurance Commissions
Commission revenue is recognized as of the effective date of the insurance policy or the date the customer is billed, whichever is later, net of return commissions related to policy cancellations. Policy cancellation is a variable consideration that is not deemed significant and thus, does not impact the amount of revenue recognized.
In addition, the Company may receive additional performance commissions based on achieving certain sales and loss experience measures. Such commissions are recognized when determinable, which is generally when such commissions are received or when the Company receives data from the insurance companies that allows the reasonable estimation of these amounts.
Stock-Based Compensation
The Company measures and recognizes compensation cost relating to share-based payment transactions based on the grant-date fair value of the equity instruments issued. The fair value of restricted stock is recorded as unearned compensation. The deferred expense is amortized to compensation expense based on one of several permitted attribution methods over the longer of the required service period or performance period. For performance-based restricted stock awards, the Company estimates the degree to which performance conditions will be met to determine the number of shares that will vest and the related compensation expense. Compensation expense is adjusted in the period such estimates change.
Income tax benefits and/or tax deficiencies related to stock compensation determined as the difference between compensation cost recognized for financial reporting purposes and the deduction for tax, are recognized in the income statement as income tax expense or benefit in the period in which they occur.
Wealth Management
Wealth management assets held in a fiduciary or agent capacity are not included in the accompanying Consolidated
Balance Sheets because they are not assets of the Company.
Wealth management fees is primarily comprised of fees earned from consultative investment management, trust administration, tax return preparation, and financial planning. The Company’s performance obligation is generally satisfied over time and the resulting fees are recognized monthly, based on the daily accrual of the market value of the investment accounts and the applicable fee rate.
Derivative Instruments and Hedging Activities
The Company enters into interest rate swap agreements as part of the Company’s interest rate risk management strategy for certain assets and liabilities and not for speculative purposes. Based on the Company’s intended use for the interest rate swap at inception, the Company designates the derivative as either an economic hedge of an asset or liability or a hedging instrument subject to the hedge accounting provisions of ASC 815, “Derivatives and Hedging.”
Interest rate swaps designated as economic hedges are recorded at fair value within other assets or liabilities. Changes in the fair value of these derivatives are recorded directly through earnings.
For interest rate swaps that management intends to apply the hedge accounting provisions of ASC 815, the Company formally documents at inception all relationships between hedging instruments and hedged items, as well as its risk management objectives and strategies for undertaking the various hedges. Additionally, the Company uses dollar offset or regression analysis at the hedge’s inception and for each reporting period thereafter, to assess whether the derivative used in its hedging transaction is expected to be and has been highly effective in offsetting changes in the fair value or cash flows of the hedged item. The Company discontinues hedge accounting when it is determined that a derivative is not expected to be or has ceased to be highly effective as a hedge, and then reflects changes in fair value of the derivative in earnings after termination of the hedge relationship.
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The Company has characterized its interest rate swaps that qualify under ASC 815 hedge accounting as cash flow hedges. Cash flow hedges are used to minimize the variability in cash flows of assets or liabilities, or forecasted transactions caused by interest rate fluctuations, and are recorded at fair value in other assets or liabilities within the Company’s balance sheets. Changes in the fair value of these cash flow hedges are initially recorded in accumulated other comprehensive income and subsequently reclassified into earnings when the forecasted transaction affects earnings. Any hedge ineffectiveness assessed as part of the Company’s quarterly analysis is recorded directly to earnings.
The Company enters into commitments to lend with borrowers, and forward commitments to sell loans or to-be-announced mortgage-backed bonds to investors to hedge against the inherent interest rate and pricing risk associated with selling loans. The commitments to lend generally terminate once the loan is funded, the lock period expires or the borrower decides not to contract for the loan. The forward commitments generally terminate once the loan is sold, the commitment period expires or the borrower decides not to contract for the loan. These commitments are considered derivatives which are accounted for by recognizing their estimated fair value on the Consolidated Balance Sheets as either a freestanding asset or liability. See Note 17 to the financial statements for more information on commitments to lend and forward commitments.
Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Company enters into off-balance sheet financial instruments, consisting primarily of credit related financial instruments. These financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received.
The Company groups assets and liabilities that are measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
Level 1 - Valuation is based on quoted prices in active markets for identical assets or liabilities. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2 - Valuation is based on observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3 - Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using unobservable techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.
Employee Benefits
The Company maintains an employer sponsored 401(k) plan to which participants may make contributions in the form of salary deferrals and the Company provides matching contributions in accordance with the terms of the plan. Contributions due under the terms of the defined contribution plans are accrued as earned by employees.
Due to the Rome Bancorp acquisition in 2011, the Company inherited a noncontributory, qualified, defined benefit pension plan for certain employees who met age and service requirements; as well as other post-retirement benefits, principally health care and group life insurance. The Rome pension plan and postretirement benefits that were acquired in connection with the whole-bank acquisition were frozen prior to the close of the transaction. The pension benefit in the form of a life annuity is based on the employee’s combined years of service, age, and compensation. The Company also has a long-term care post-retirement benefit plan for certain executives where upon disability, associated benefits are funded by insurance policies or paid directly by the Company.
In order to measure the expense associated with the Plans, various assumptions are made including the discount rate, expected return on plan assets, anticipated mortality rates, and expected future healthcare costs. The
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assumptions are based on historical experience as well as current facts and circumstances. The Company uses a December 31 measurement date for its Plans. As of the measurement date, plan assets are determined based on fair value, generally representing observable market prices. The projected benefit obligation is primarily determined based on the present value of projected benefit distributions at an assumed discount rate.
Net periodic pension benefit costs include interest costs based on an assumed discount rate, the expected return on plan assets based on actuarially derived market-related values, and the amortization of net actuarial losses. Net periodic postretirement benefit costs include service costs, interest costs based on an assumed discount rate, and the amortization of prior service credits and net actuarial gains. Differences between expected and actual results in each year are included in the net actuarial gain or loss amount, which is recognized in other comprehensive income. The net actuarial gain or loss in excess of a 10 % corridor is amortized in net periodic benefit cost over the average remaining service period of active participants in the Plans. The prior service credit is amortized over the average remaining service period to full eligibility for participating employees expected to receive benefits.
The Company recognizes in its statement of condition an asset for a plan’s overfunded status or a liability for a plan’s underfunded status. The Company also measures the Plans’ assets and obligations that determine its funded status as of the end of the fiscal year and recognizes those changes in other comprehensive income, net of tax.
Due to the SI Financial acquisition in 2019, the Company inherited a tax-qualified defined benefit pension plan. The plan was frozen effective September 6, 2013 and SI Financial recorded a contingent obligation to settle the plan at a future date, which was assumed by the Company. The plan is a single plan under the Internal Revenue Code and, as a result, all of the assets stand behind all of liabilities. Accordingly, contributions made by a participating employer may be used to provide benefits to participants of other participating employers.
Operating Segments
The Company operates as one consolidated reportable segment. The chief operating decision-maker evaluates consolidated results and makes decisions for resource allocation on this same data. Management periodically reviews and redefines its segment reporting as internal reporting practices evolve and components of the business change. The financial statements reflect the financial results of the Company's one reportable operating segment.
Recently Adopted Accounting Principles
Effective January 1, 2019, the following new accounting guidance was adopted by the Company:
• | ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities; |
• | ASU No. 2016-02, Leases (Topic 842)(additional information is disclosed in Note 18 - Leases of the Consolidated Financial Statements) |
In August 2017, the FASB issued ASU No. 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.” The purpose of this updated guidance is to better align a company’s financial reporting for hedging activities with the economic objectives of those activities. ASU No. 2017-12 is effective for public business entities for fiscal years beginning after December 15, 2018, with early adoption, including adoption in an interim period, permitted. ASU 2017-12 requires a modified retrospective transition method in which the Company will recognize the cumulative effect of the change on the opening balance of each affected component of equity in the Consolidated Balance Sheets as of the date of adoption. In April 2019, the FASB issued ASU No. 2019-04 to clarify certain aspects of accounting for hedging activities addressed by ASU No. 2017-12, among other things (ASU No. 2019-04 amendments and pending adoption to FASB ASC Topics 326 and 825 are described in the section below). ASU No. 2017-12 became effective for the Company on January 1, 2019. The adoption was not material to the financial statements.
In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)”. The pronouncement affects all entities that are participants to leasing agreements. From a lessee accounting perspective, the ASU requires a lessee to recognize assets and liabilities on the balance sheet for operating leases and changes many key definitions, including the definition of a lease. The ASU includes a short-term lease exception for leases with a
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term of twelve months or less, in which a lessee can make an accounting policy election not to recognize lease assets and lease liabilities. Lessees will continue to differentiate between finance leases (previously referred to as capital leases) and operating leases, using classification criteria that are substantially similar to the previous guidance. For lessees, the recognition, measurement, and presentation of expenses and cash flows arising from a lease have not significantly changed from previous GAAP. From a lessor accounting perspective, the guidance is largely unchanged, except for targeted improvements to align with new terminology under lessee accounting and with the updated revenue recognition guidance in Topic 606. For sale-leaseback transactions, for a sale to occur the transfer must meet the sale criteria under the new revenue standard, Topic 606. Entities will not be required to reassess transactions previously accounted under then existing guidance.
The ASU includes additional quantitative and qualitative disclosures required by lessees and lessors to help users better understand the amount, timing, and uncertainty of cash flows arising from leases. ASU No. 2016-02 is effective for fiscal years beginning after December 31, 2018, and interim periods within those fiscal years. Lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. In July 2018, the FASB issued ASU No. 2018-11, “Leases (Topic 842) - Targeted Improvements” to provide entities with relief from the costs of implementing certain aspects of the new leasing standard. Specifically, under the amendments in ASU No. 2018-11 entities may elect not to recast the comparative periods presented when transitioning to the new leasing standard, and lessors may elect not to separate lease and non-lease components when certain conditions are met. As the Company elected the transition option provided in ASU No. 2018-11, the modified retrospective approach was applied on January 1, 2019 (as opposed to January 1, 2017). The Company also elected certain practical expedients provided under ASU No. 2016-02 whereby we will not reassess (i) whether any expired or existing contracts are or contain leases, (ii) the lease classification for any expired or existing leases and (iii) initial direct costs for any existing leases. In December 2018, the FASB issued ASU No. 2018-20, “Leases (Topic 842): Narrow-Scope Improvements for Lessors,” which provides targeted improvements and clarification to guidance with FASB ASC Topic 842 specific to lessors. The amendments of ASU No. 2018-20 have the same effective date as ASU 2016-02 and may be applied either retrospectively or prospectively to all new and existing leases. The Company obtained a third-party software application which provides lease accounting under the guidelines of FASB ASC Topic 842. The amendments of ASU No. 2016-02 and subsequently issued ASUs, which provided additional guidance and clarifications to various aspects of FASB ASC Topic 842, became effective for the Company on January 1, 2019. The Company recognized right-of-use lease assets and related lease liabilities totaling $79.6 million and $82.8 million respectively as of January 1, 2019. The right-of-use lease assets and related lease liabilities recognized at January 1, 2019 include right-of-use lease assets and lease liabilities classified as discontinued operations. See Note 18 - Leases for more information.
Future Application of Accounting Pronouncements
In June 2016, the FASB issued ASU No. 2016-13 "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” This ASU improves financial reporting by requiring timelier recording of credit losses on loans and other financial instruments. The ASU requires companies to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Forward-looking information will now be used in credit loss estimates. The ASU requires enhanced disclosures to provide better understanding surrounding significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of a company’s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. Additionally, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration (“PCD assets”). Most debt instruments will require a cumulative-effect adjustment to retained earnings on the statement of financial position as of the beginning of the first reporting period in which the guidance is adopted (modified retrospective approach). However, there is instrument-specific (such as PCD assets) transition guidance requiring a prospective transition approach. For existing purchased credit-impaired assets, upon adoption, the amortized cost basis will be adjusted to reflect the addition of the allowance for credit losses. This transition relief avoids the need to reassess purchased financial assets that exist as of the date of adoption in order to determine whether they would have met, at acquisition, the
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new criteria of ‘more than insignificant’ credit deterioration since origination. The transition relief also allows the remaining accretable discount (based on the revised amortized cost basis) to accrete into interest income over the life of the related asset using the interest method. ASU No. 2016-13 is effective for interim and annual periods beginning after December 15, 2019.
The Company expects the primary changes to be the application of the new expected credit loss model from the incurred model. In addition, the Company expects the guidance to change the presentation of credit losses within the available-for-sale fixed maturities portfolio through an allowance method rather than as a direct write-down. The expected credit loss model will require a financial asset to be presented at the net amount expected to be collected. The allowance method for available-for-sale debt securities will allow the Company to record reversals of credit losses if the estimate of credit losses declines. Management is finalizing the execution of operating and financial processes, controls, and disclosures. The Company has not completed finalizing the results of the CECL estimate as of year-end as we are in process of data and model validation, as well as finalizing qualitative factors and forecast measurement.
In January 2017, the FASB issued ASU No. 2017-04, “Intangibles: Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” The ASU simplifies the test for goodwill impairment by eliminating the second step of the current two-step method. Under the new accounting guidance, entities will compare the fair value of a reporting unit with its carrying amount. If the carrying amount exceeds the reporting unit’s fair value, the entity is required to recognize an impairment charge for this amount. Current guidance requires an entity to proceed to a second step, whereby the entity would determine the fair value of its assets and liabilities. The new method applies to all reporting units. The performance of a qualitative assessment is still allowable. This accounting guidance is effective prospectively for interim and annual reporting periods beginning after December 15, 2019. The Company will adopt the guidance when it performs the annual impairment test and does not expect adoption to have a material effect on its Consolidated Financial Statements.
In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement.” This ASU eliminates, adds, and modifies certain disclosure requirements for fair value measurements. Among the changes, entities will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, but will be required to disclose the range and weighted average used to develop significant unobservable inputs for Level 3 fair value measurements. ASU No. 2018-13 is effective for interim and annual reporting periods beginning after December 15, 2019. Entities are also allowed to elect early adoption for the eliminated or modified disclosure requirements and delay adoption of the new disclosure requirements until their effective date. As ASU No. 2018-13 only revises disclosure requirements, it will not have a material impact on its Consolidated Financial Statements.
In August 2018, the FASB issued ASU No. 2018-14, “Compensation - Retirement Benefits - Defined Benefit Plans - General (Subtopic 715-20): Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans.” This ASU amends and modifies the disclosure requirements for employers that sponsor defined benefit pension or other post-retirement plans. The amendments in this update remove disclosures that no longer are considered cost beneficial, clarify the specific requirements of disclosures, and add disclosure requirements identified as relevant. ASU No. 2018-14 is effective for fiscal years ending after December 15, 2020, with early adoption permitted. As ASU No. 2018-14 only revises disclosure requirements, it will not have a material impact on the Consolidated Financial Statements.
In August 2018, the FASB issued ASU No. 2018-15, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract.” ASU No. 2018-15 clarifies certain aspects of ASU No. 2015-05, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement,” which was issued in April 2015. Specifically, ASU No. 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). ASU No. 2018-15 does not
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affect the accounting for the service element of a hosting arrangement that is a service contract. ASU No. 2018-15 is effective for interim and annual reporting periods beginning after December 15, 2019. The amendments in this ASU should be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. The Company does not expect adoption to have a material impact on the Company's Consolidated Financial Statements.
As mentioned in the previous section in April 2019 the FASB issued ASU No. 2019-04, “Codification Improvements to Topic 326, Financial Instruments - Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments.” With respect to FASB ASC Topic 326, Financial Instruments - Credit Losses, ASU No. 2019-04 clarifies the scope of the credit losses standard and addresses issues related to accrued interest receivable balances, recoveries, variable interest rates and prepayments, among other things. With respect to FASB ASC Topic 825, Financial Instruments, on recognizing and measuring financial instruments, ASU No. 2019-04 addresses the scope of the guidance, the requirement for remeasurement under FASB ASC Topic 820 when using the measurement alternative, certain disclosure requirements and which equity securities have to be remeasured at historical exchange rates. The amendments to FASB ASC Topic 326 have the same effective dates as ASU 2016-13 (i.e., the first quarter of 2020). The Company is currently evaluating the impact of FASB ASC Topic 326 amendments on the Company’s Consolidated Financial Statements. The amendments to FASB ASC Topic 825 are effective for interim and annual reporting periods beginning after December 15, 2019 and are not expected to have a material impact on the Company’s Consolidated Financial Statements.
In May 2019, the FASB issued ASU No. 2019-05, “Financial Instruments - Credit Losses (Topic 326); Targeted Transition Relief.” ASU No. 2019-05 allows entities to irrevocably elect, upon adoption of ASU No. 2016-13, the fair value option on financial instruments that (1) were previously recorded at amortized cost and (2) are within the scope of ASC 326-20 if the instruments are eligible for the fair value option under ASC 825-10. The fair value option election does not apply to held-to-maturity debt securities. Entities are required to make this election on an instrument-by-instrument basis. ASU No. 2019-05 has the same effective date as ASU No. 2016-13 (i.e., the first quarter of 2020). The Company has determined to apply this transition relief to one of the PCI loan asset classes that is currently accounted for under the pooled method under ASC 310-30. Similar to disclosure of the potential impact of ASU No. 2016-13, the Company is in process of finalizing the operational and financial processes and internal controls.
In December 2019, the FASB issued ASU No. 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” ASU No. 2019-12 removes specific exceptions to the general principles in FASB ASC Topic 740. It eliminates the need for an organization to analyze whether the following apply in a given period: (1) exception to the incremental approach for intraperiod tax allocation; (2) exceptions to accounting for basis differences when there are ownership changes in foreign investments; and (3) exception in interim period income tax accounting for year-to-date losses that exceed anticipated losses. ASU 2019-12 also improves financial statement preparers’ application of income tax-related guidance and simplifies: (1) franchise taxes that are partially based on income; (2) transactions with a government that result in a step up in the tax basis of goodwill; (3) separate financial statements of legal entities that are not subject to tax; and (4) enacted changes in tax laws in interim periods. The amendments in this ASU become effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the impact of adopting the new guidance on the Consolidated Financial Statements.
F-23
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2. ACQUISITION
SI Financial Group, Inc.
At the close of business on May 17, 2019, the Company completed the acquisition of SI Financial Group, Inc. (“SIFI”), the parent company of Savings Institute Bank and Trust Company (“Savings Institute”). Savings Institute also merged with and into Berkshire Bank. With this acquisition, the Company increased its market presence with
As established by the merger agreement, each of the 11.858 million outstanding shares of SIFI common stock was converted into the right to receive 0.48 shares of the Company's common stock, plus cash in lieu of fractional shares. As of close of business on May 17, 2019, the Company issued 5.691 million common shares as merger consideration, pursuant to the merger agreement. The value of this consideration was measured at $175.8 million for the common stock based on the $30.89 closing price of the Company’s common stock on the issuance date. SIFI had a stock option plan, and as part of the acquisition agreement, Berkshire agreed to continue the vesting schedules of option holders of SIFI stock with corresponding Berkshire stock with a share conversion ratio of 48 %. The fair value of the vested portion of the options was $0.9 million, and was included as part of consideration paid for SIFI.
The acquisition was accounted for under the acquisition method of accounting in accordance with ASC Topic 805, Business Combinations. Accordingly, the Company recognizes amounts for identifiable assets acquired and liabilities assumed at their estimated acquisition date fair value, with any excess of purchase consideration over the net assets being reported as goodwill. During the year ended December 31, 2019, immaterial adjustments were made to the preliminary valuation of the assets acquired and liabilities assumed. These adjustments affect goodwill, other assets, other liabilities, and deferred tax assets. As of December 31, 2019, the Company finalized its valuation of all assets acquired and liabilities assumed, resulting in no material change to acquisition accounting adjustments.
F-24
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table provides a summary of the assets acquired and liabilities assumed and the associated fair value adjustments as recorded by the Company at acquisition:
(in thousands) | As Acquired | Fair Value Adjustments | As Recorded by the Company | |||||||||
Consideration Paid: | ||||||||||||
Company common stock issued to SIFI common shareholders | $ | |||||||||||
Fair value of SIFI stock options converted to Berkshire options | ||||||||||||
Cash in lieu paid to SIFI shareholders | ||||||||||||
Total consideration paid | $ | |||||||||||
Recognized amounts of identifiable assets acquired and (liabilities) assumed, at fair value: | ||||||||||||
Cash and short-term investments | $ | $ | $ | |||||||||
Investment securities | ( | ) | (a) | |||||||||
Loans held for sale | ||||||||||||
Loans, net | ( | ) | (b) | |||||||||
Premises and equipment | ( | ) | (c) | |||||||||
Core deposit intangibles | (d) | |||||||||||
Deferred tax assets, net | (e) | |||||||||||
Goodwill and other intangibles | ( | ) | (f) | |||||||||
Other assets | ( | ) | ||||||||||
Deposits | ( | ) | ( | ) | (g) | ( | ) | |||||
Borrowings | ( | ) | (h) | ( | ) | |||||||
Other liabilities | ( | ) | ( | ) | (i) | ( | ) | |||||
Total identifiable net assets | $ | $ | ( | ) | $ | |||||||
Goodwill | $ | |||||||||||
_____________________________________
Explanation of Certain Fair Value Adjustments:
(a) | The adjustment represents the write down of the book value of securities to their estimated fair value at the date of acquisition. |
(b) | The adjustment represents the write-off of $ |
(c) | The adjustment represents a decreased fair value based on the appraised value of Savings Institute's owned branches comprised of $ |
(d) | The adjustment represents the value of the core deposit base assumed in the acquisition. The core deposit asset was recorded as an identifiable intangible asset and will be amortized over the estimated useful life of the deposit base ( |
(e) | Represents net deferred tax assets resulting from the fair value adjustments related to the acquired assets and liabilities, identifiable intangibles, and other purchase accounting adjustments. |
(f) | Represents the write-off of goodwill and intangible assets from a prior SIFI acquisition. |
(g) | The adjustment is necessary because the weighted average interest rate of time deposits exceeded the cost of similar funding at the time of acquisition. The amount will be amortized over the estimated useful life of |
(h) | Adjusts borrowings by a reduction of $ |
F-25
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(i) | Adjusts the book value of other liabilities to their estimated fair value at the acquisition date. The adjustment consists of a $ |
Except for collateral dependent loans with deteriorated credit quality, the fair values for loans acquired were estimated using cash flow projections based on the remaining maturity and repricing terms. Cash flows were adjusted by estimating future credit losses and the rate of prepayments. Projected monthly cash flows were then discounted to present value using a risk-adjusted market rate for similar loans. For collateral dependent loans with deteriorated credit quality, the Company estimated fair value by analyzing the value of the underlying collateral of the loans, assuming the fair values of the loans were derived from the eventual sale of the collateral. Those values were discounted using market derived rates of return, with consideration given to the period of time and costs associated with the foreclosure and disposition of the collateral. There was no carryover of the seller’s allowance for credit losses associated with the loans acquired, as the loans were initially recorded at fair value. Information about the Savings Institute acquired loan portfolio subject to ASC 310-30 as of May 17, 2019 is as follows (in thousands):
ASC 310-30 Loans | ||||
Gross contractual receivable amounts at acquisition | $ | |||
Contractual cash flows not expected to be collected (nonaccretable discount) | ( | ) | ||
Expected cash flows at acquisition | ||||
Interest component of expected cash flows (accretable discount) | ( | ) | ||
Fair value of acquired loans | $ | |||
Capitalized goodwill, which is not amortized for book purposes, is not deductible for tax purposes.
Direct acquisition and integration costs of the Savings Institute acquisition were expensed as incurred, and totaled $18.7 million during the year ending December 31, 2019 and $2.8 million for the same period of 2018.
F-26
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Pro Forma Information (unaudited)
The following table presents selected unaudited pro forma financial information reflecting the acquisition of SIFI assuming the acquisition was completed as of January 1, 2018. The valuation of the assets and
liabilities acquired has been used to prepare pro forma adjustments. The unaudited pro forma financial information includes adjustments for scheduled amortization and accretion of fair value adjustments. These adjustments would have been different if they had been recorded on January 1, 2018, and they do not include the impact of prepayments. The unaudited pro forma financial information is presented for illustrative purposes only and is not necessarily indicative of the combined financial results of the Company and the acquisition had the transaction actually been completed at the beginning of the periods presented, nor does it indicate future results for any other interim or full-year period. The unaudited pro forma information is based on the actual financial statements of Berkshire and the acquired business for the periods shown until the dates of acquisition, at which time the acquired business operations became included in Berkshire’s financial statements.
For whole-bank acquisitions, the Company has determined it is impractical to report the amounts of revenue and earnings of each entity since acquisition date. Due to the integration of their operations with those of the organization, the Company does not record revenue and earnings separately. The revenue and earnings of SIFI’s operations are included in the Consolidated Statement of Income.
The unaudited pro forma information, for the years ended December 31, 2019 and 2018, set forth below reflects adjustments related to (a) amortization and accretion of purchase accounting fair value adjustments; (b) amortization of core deposit and customer relationship intangibles; and (c) an estimated tax rate of 27.04 percent. Direct acquisition expenses incurred by the Company during 2019, as noted above, are reversed for the purposes of this unaudited pro forma information. Furthermore, the unaudited pro forma information does not reflect management’s estimate of any revenue-enhancing or anticipated cost-savings that could occur as a result of the
Information in the following table is shown in thousands:
Pro Forma (unaudited) Years Ended December 31, | ||||||||
2019 | 2018 | |||||||
Net interest income | $ | $ | ||||||
Non-interest income | ||||||||
Income available to common shareholders | ||||||||
F-27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3. DISCONTINUED OPERATIONS
During the first quarter of 2019, the Company reached the decision to pursue the sale of the national mortgage banking operations of First Choice Loan Services, Inc. (“FCLS”) – a subsidiary of the Bank. The decision was based on a number of strategic priorities and other factors, including the competitiveness of the mortgage industry. FCLS continues to operate and serve its customers as the Company initiates the process of identifying a buyer. The potential transaction is expected to close within 12 months. As a result of these actions, the Company classified the operations of FCLS as discontinued under ASC 205-20. The Consolidated Balance Sheets, Consolidated Statements of Income, and Consolidated Statements of Cash Flows present discontinued operations retrospectively for current and prior periods.
The following is a summary of the assets and liabilities of the discontinued operations of FCLS at December 31, 2019 and December 31, 2018:
(in thousands) | December 31, 2019 | December 31, 2018 | ||||||
Assets | ||||||||
Loans held for sale, at fair value | $ | $ | ||||||
Premises and equipment, net | ||||||||
Mortgage servicing rights, at fair value | ||||||||
Mortgage banking derivatives | ||||||||
Right-of-use asset | — | |||||||
Deferred tax | ( | ) | ( | ) | ||||
Other assets | ||||||||
Total assets | $ | $ | ||||||
Liabilities | ||||||||
Customer payments in process | $ | $ | ||||||
Lease liability | ||||||||
Other liabilities | ||||||||
Total liabilities | $ | $ | ||||||
FCLS funds its lending operations and maintains working capital through an intercompany line-of-credit with the Bank. Although the sale of FCLS will contemplate settlement of these borrowings, debt was not allocated to discontinued operations due to the intercompany nature of the borrowings. When the transaction closes, the Company will reallocate these funds to various purposes, including but not limited to, pay-down of short-term debt with the Federal Home Loan Bank.
F-28
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following presents operating results of the discontinued operations of FCLS for the years ended December 31, 2019, 2018, and 2017:
Years Ended December 31, | ||||||||||||
(in thousands) | 2019 | 2018 | 2017 | |||||||||
Interest income | $ | $ | $ | |||||||||
Interest expense | ||||||||||||
Net interest income | ||||||||||||
Non-interest income | ||||||||||||
Total net revenue | ||||||||||||
Non-interest expense | ||||||||||||
(Loss)/income from discontinued operations before income taxes | ( | ) | ( | ) | ||||||||
Income tax expense | ( | ) | ( | ) | ||||||||
Net income from discontinued operations | $ | ( | ) | $ | ( | ) | $ | |||||
FCLS also originates mortgages designated as held-for-investment. This component of FCLS’s operations was not considered discontinued, since the Company expects to continue to originate mortgages designated as held-for-investment in its footprint on a small scale through processes considered as continuing operations.
F-29
NOTE 4. CASH AND CASH EQUIVALENTS
Cash and cash equivalents include cash on hand, amounts due from banks, and short-term investments with original maturities of 90 days or less. Short-term investments included $96.3 million and $25.4 million pledged as collateral support for derivative financial contracts at year-end 2019 and 2018, respectively. The Federal Reserve Bank requires the Bank to maintain certain reserve requirements of vault cash and/or deposits. The reserve requirement, included in cash and equivalents, was $18.3 million and $18.0 million at year-end 2019 and 2018, respectively.
NOTE 5. TRADING SECURITY
The Company holds a tax advantaged economic development bond that is being accounted for at fair value. The security had an amortized cost of $9.4 million and $10.1 million and a fair value of $10.8 million and $11.2 million at year-end 2019 and 2018, respectively. Unrealized losses recorded through income on this security totaled $0.3 million, $0.4 million, and $0.3 million for 2019, 2018, and 2017, respectively. As discussed further in Note 17 - Derivative Instruments and Hedging Activities, the Company has entered into a swap contract to swap-out the fixed rate of the security in exchange for a variable rate. The Company does not purchase securities with the intent of selling them in the near term, and there are no other debt securities in the trading portfolio at year-end 2019 and 2018.
F-30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6. SECURITIES
The Company adopted ASU-2016-01 "Recognition and Measurement of Financial Assets and Financial Liabilities" in the first quarter of 2018. Beginning in 2018, all changes in the fair value of marketable equity securities, including other-than-temporary impairment, are immediately recognized in earnings.
The following is a summary of securities available for sale (“AFS”) , held to maturity (“HTM”), and marketable equity securities:
(In thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||
December 31, 2019 | ||||||||||||||||
Securities available for sale | ||||||||||||||||
Debt securities: | ||||||||||||||||
Municipal bonds and obligations | $ | $ | $ | $ | ||||||||||||
Agency collateralized mortgage obligations | ( | ) | ||||||||||||||
Agency mortgage-backed securities | ( | ) | ||||||||||||||
Agency commercial mortgage-backed securities | ( | ) | ||||||||||||||
Corporate bonds | ( | ) | ||||||||||||||
Other bonds and obligations | ( | ) | ||||||||||||||
Total securities available for sale | ( | ) | ||||||||||||||
Securities held to maturity | ||||||||||||||||
Municipal bonds and obligations | ( | ) | ||||||||||||||
Agency collateralized mortgage obligations | ( | ) | ||||||||||||||
Agency mortgage-backed securities | ||||||||||||||||
Agency commercial mortgage-backed securities | ||||||||||||||||
Tax advantaged economic development bonds | ( | ) | ||||||||||||||
Other bonds and obligations | ||||||||||||||||
Total securities held to maturity | ( | ) | ||||||||||||||
Marketable equity securities | ( | ) | ||||||||||||||
Total | $ | $ | $ | ( | ) | $ | ||||||||||
December 31, 2018 | ||||||||||||||||
Securities available for sale | ||||||||||||||||
Debt securities: | ||||||||||||||||
Municipal bonds and obligations | $ | $ | $ | ( | ) | $ | ||||||||||
Agency collateralized mortgage obligations | ( | ) | ||||||||||||||
Agency mortgage-backed securities | ( | ) | ||||||||||||||
Agency commercial mortgage-backed securities | ( | ) | ||||||||||||||
Corporate bonds | ( | ) | ||||||||||||||
Other bonds and obligations | ( | ) | ||||||||||||||
Total securities available for sale | ( | ) | ||||||||||||||
Securities held to maturity | ||||||||||||||||
Municipal bonds and obligations | ( | ) | ||||||||||||||
Agency collateralized mortgage-backed securities | ( | ) | ||||||||||||||
Agency mortgage-backed securities | ( | ) | ||||||||||||||
Agency commercial mortgage-backed securities | ( | ) | ||||||||||||||
Tax advantaged economic development bonds | ( | ) | ||||||||||||||
Other bonds and obligations | ||||||||||||||||
Total securities held to maturity | ( | ) | ||||||||||||||
Marketable equity securities | ( | ) | ||||||||||||||
Total | $ | $ | $ | ( | ) | $ | ||||||||||
F-31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At year-end 2019 and 2018, accumulated net unrealized gains/(losses) on AFS securities included in accumulated other comprehensive income/(loss) were $14.2 million and $(21.6 ) million, respectively. At year-end 2019 and 2018, accumulated net unrealized gains on HTM securities included in accumulated other comprehensive income/(loss) were $5.0 million and $6.4 million respectively. The year-end 2019 and 2018 related income tax (liability)/benefit of $(5.1 ) million and $3.8 million, respectively, was also included in accumulated other comprehensive income/(loss).
The amortized cost and estimated fair value of AFS and HTM securities, segregated by contractual maturity at year-end 2019 are presented below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Mortgage-backed securities and collateralized mortgage obligations are shown in total, as their maturities are highly variable.
Available for sale | Held to maturity | |||||||||||||||
(In thousands) | Amortized Cost | Fair Value | Amortized Cost | Fair Value | ||||||||||||
Within 1 year | $ | $ | $ | $ | ||||||||||||
Over 1 year to 5 years | ||||||||||||||||
Over 5 years to 10 years | ||||||||||||||||
Over 10 years | ||||||||||||||||
Total bonds and obligations | ||||||||||||||||
Mortgage-backed securities | ||||||||||||||||
Total | $ | $ | $ | $ | ||||||||||||
At year-end 2019 and 2018, the Company had pledged securities as collateral for certain municipal deposits and for interest rate swaps with certain counterparties. The total amortized cost and fair values of these pledged securities follows. Additionally, there is a blanket lien on certain securities to collateralize borrowings from the FHLBB, as discussed further in Note 13 - Borrowed Funds.
2019 | 2018 | |||||||||||||||
(In thousands) | Amortized Cost | Fair Value | Amortized Cost | Fair Value | ||||||||||||
Securities pledged to swap counterparties | $ | $ | $ | $ | ||||||||||||
Securities pledged for municipal deposits | ||||||||||||||||
Total | $ | $ | $ | $ | ||||||||||||
Purchases of AFS securities totaled $120 million in 2019 and $258 million in 2018. Proceeds from the sale of AFS securities totaled $136 million in 2019 and $0.5 million in 2018. The amounts for the sale of AFS securities were reclassified out of accumulated other comprehensive income and into earnings. The components of net recognized gains and losses on the sale of AFS securities and the fair value change of marketable equities are as follows:
(In thousands) | 2019 | 2018 | 2017 | |||||||||
Gross recognized gains | $ | $ | $ | |||||||||
Gross recognized losses | ( | ) | ( | ) | ( | ) | ||||||
Net recognized gains/(losses) | $ | $ | ( | ) | $ | |||||||
F-32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Debt securities with unrealized losses, segregated by the duration of their continuous unrealized loss positions, are summarized as follows:
Less Than Twelve Months | Over Twelve Months | Total | ||||||||||||||||||||||
(In thousands) | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | Fair Value | ||||||||||||||||||
December 31, 2019 | ||||||||||||||||||||||||
Securities available for sale | ||||||||||||||||||||||||
Debt securities: | ||||||||||||||||||||||||
Agency collateralized mortgage obligations | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Agency mortgage-backed securities | ||||||||||||||||||||||||
Agency commercial mortgage-back securities | ||||||||||||||||||||||||
Corporate bonds | ||||||||||||||||||||||||
Other bonds and obligations | ||||||||||||||||||||||||
Total securities available for sale | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Securities held to maturity | ||||||||||||||||||||||||
Municipal bonds and obligations | ||||||||||||||||||||||||
Agency collateralized mortgage obligations | ||||||||||||||||||||||||
Tax advantaged economic development bonds | ||||||||||||||||||||||||
Total securities held to maturity | ||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
December 31, 2018 | ||||||||||||||||||||||||
Securities available for sale | ||||||||||||||||||||||||
Debt securities: | ||||||||||||||||||||||||
Municipal bonds and obligations | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Agency collateralized mortgage obligations | ||||||||||||||||||||||||
Agency mortgage-backed securities | ||||||||||||||||||||||||
Agency commercial mortgage-backed securities | ||||||||||||||||||||||||
Corporate bonds | ||||||||||||||||||||||||
Other bonds and obligations | ||||||||||||||||||||||||
Total securities available for sale | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Securities held to maturity | ||||||||||||||||||||||||
Municipal bonds and obligations | ||||||||||||||||||||||||
Agency collateralized mortgage obligations | ||||||||||||||||||||||||
Agency mortgage-backed securities | ||||||||||||||||||||||||
Agency commercial mortgage-back securities | ||||||||||||||||||||||||
Tax advantaged economic development bonds | ||||||||||||||||||||||||
Total securities held to maturity | ||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
F-33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Debt Securities
The Company expects to recover its amortized cost basis on all debt securities in its AFS and HTM portfolios. Furthermore, the Company does not intend to sell nor does it anticipate that it will be required to sell any of its securities in an unrealized loss position as of December 31, 2019, prior to this recovery. The Company’s ability and intent to hold these securities until recovery is supported by the Company’s strong capital and liquidity positions.
The following summarizes, by investment security type, the basis for the conclusion that the debt securities in an unrealized loss position within the Company’s AFS and HTM portfolios did not maintain other-than-temporary impairment ("OTTI") at year-end 2019:
AFS collateralized mortgage obligations
At year-end 2019, 28 out of the total 245 securities in the Company’s portfolio of AFS collateralized mortgage obligations were in unrealized loss positions. Aggregate unrealized losses represented 0.3 % of the amortized cost of securities in unrealized loss positions. The Federal National Mortgage Association ("FNMA"), Federal Home Loan Mortgage Corporation ("FHLMC"), and Government National Mortgage Association ("GNMA") guarantee the contractual cash flows of all of the Company's collateralized residential mortgage obligations. The securities are investment grade rated and there were no material underlying credit downgrades during 2019. All securities are performing.
AFS commercial and residential mortgage-backed securities
At year-end 2019, 39 out of the total 107 securities in the Company’s portfolio of AFS mortgage-backed securities were in unrealized loss positions. Aggregate unrealized losses represented 0.9 % of the amortized cost of securities in unrealized loss positions. The FNMA, FHLMC, and GNMA guarantee the contractual cash flows of the Company’s mortgage-backed securities. The securities are investment grade rated and there were no material underlying credit downgrades during 2019. All securities are performing.
AFS corporate bonds
At year-end 2019, 6 out of the total 23 securities in the Company’s portfolio of AFS corporate bonds were in unrealized loss positions. The aggregate unrealized loss represents 1.4 % of the amortized cost of bonds in unrealized loss positions. The Company reviews the financial strength of these bonds and has concluded that the amortized cost remains supported by the expected future cash flows of these securities.
AFS other bonds and obligations
At year-end 2019, 3 out of the total 8 securities in the Company’s portfolio of other bonds and obligations were in unrealized loss positions. Aggregate unrealized losses represented 0.4 % of the amortized cost of securities in unrealized loss positions. The securities are all investment grade rated, and there were no material underlying credit downgrades during 2019. All securities are performing.
HTM Municipal bonds and obligations
At year-end 2019, 1 out of the total 210 securities in the Company’s portfolio of HTM municipal bonds and obligations were in an unrealized loss position. Aggregate unrealized losses represented 0.6 % of the amortized cost of the security in an unrealized loss position. The Company continually monitors the municipal bond sector of the market carefully and periodically evaluates the appropriate level of exposure to the market. At this time, the Company feels that the bonds in this portfolio carry minimal risk of default and that the Company is appropriately compensated for that risk. There were no material underlying credit downgrades during 2019. All securities are performing.
HTM collateralized mortgage obligations
At year-end 2019, 1 out of the total 9 securities in the Company’s portfolio of HTM collateralized mortgage obligations were in an unrealized loss position. Aggregate unrealized losses represented 0.5 % of the amortized cost of the security in an unrealized loss position. The FNMA, FHLMC, and GNMA guarantee the contractual cash flows of all of the Company's collateralized residential mortgage obligations. The securities are investment grade rated, and there were no material underlying credit downgrades during 2019. All securities are performing.
F-34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
HTM tax-advantaged economic development bonds
At year-end 2019, 1 out of the total 5 securities in the Company’s portfolio of tax advantaged economic development bonds were in an unrealized loss position. Aggregate unrealized losses represented 11.6 % of the amortized cost of the security in an unrealized loss position. The above mentioned tax-advantaged economic bond is a Substandard rated asset. The Company believes that more likely than not all the principal outstanding will be collected. All securities are performing.
F-35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7. LOANS
The Company’s loan portfolio is segregated into the following segments: commercial real estate, commercial and industrial, residential mortgage, and consumer. Commercial real estate loans include construction, single and multi-family, and other commercial real estate classes. Residential mortgage loans include classes for 1-4 family owner occupied and construction loans. Consumer loans include home equity, direct and indirect auto, and other consumer loan classes. These portfolio segments each have unique risk characteristics that are considered when determining the appropriate level for the allowance for loan losses.
A substantial portion of the loan portfolio is secured by real estate in Massachusetts, southern Vermont, northeastern New York, New Jersey, and in the Bank’s other New England lending areas. The ability of many of the Bank’s borrowers to honor their contracts is dependent, among other things, on the specific economy and real estate markets of these areas.
Total loans include business activity loans and acquired loans. Acquired loans are those loans acquired from previous mergers and acquisitions. Once the full integration of the acquired entity is complete, acquired and business activity loans are serviced, managed, and accounted for under the Company's same control environment. During 2019, the Company reclassified $50 million of aircraft loans, $29 million of homeowners association loans, and $29 million of SBA loans from commercial and industrial to held-for-sale. The aircraft loans and homeowners association loans were sold prior to year-end. The SBA loans reclassified to held-for-sale are not contained in the balances below and are accounted for at the lower of carrying value or fair market value.
The following is a summary of total loans:
December 31, 2019 | December 31, 2018 | |||||||||||||||||||||||
(In thousands) | Business Activities Loans | Acquired Loans | Total | Business Activities Loans | Acquired Loans | Total | ||||||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||
Construction | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Other commercial real estate | ||||||||||||||||||||||||
Total commercial real estate | ||||||||||||||||||||||||
Commercial and industrial loans | ||||||||||||||||||||||||
Total commercial loans | ||||||||||||||||||||||||
Residential mortgages: | ||||||||||||||||||||||||
1-4 family | ||||||||||||||||||||||||
Construction | ||||||||||||||||||||||||
Total residential mortgages | ||||||||||||||||||||||||
Consumer loans: | ||||||||||||||||||||||||
Home equity | ||||||||||||||||||||||||
Auto and other | ||||||||||||||||||||||||
Total consumer loans | ||||||||||||||||||||||||
Total loans | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
F-36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Total unamortized net costs and premiums included in the year-end total loans for business activity loans were the following:
(In thousands) | December 31, 2019 | December 31, 2018 | ||||||
Unamortized net loan origination costs | $ | $ | ||||||
Unamortized net premium on purchased loans | ||||||||
Total unamortized net costs and premiums | $ | $ | ||||||
In 2019, the Company purchased loans aggregating $432 million and sold loans aggregating $310 million. In 2018, the Company purchased loans aggregating $567 million and sold loans aggregating $388 million. Net gains on sales of loans were $12.0 million, $9.3 million, and $11.7 million for the years 2019, 2018, and 2017, respectively. These amounts are included in Loan Related Income on the Consolidated Statements of Income.
Most of the Company’s lending activity occurs within its primary markets in Massachusetts, Southern Vermont, and Northeastern New York. Most of the loan portfolio is secured by real estate, including residential mortgages, commercial mortgages, and home equity loans. Year-end loans to operators of non-residential buildings totaled $1.7 billion, or 18.1 %, and $1.4 billion, or 15.6 % of total loans in 2019 and 2018, respectively. There were no other concentrations of loans related to any single industry in excess of 10% of total loans at year-end 2019 or 2018.
At year-end 2019, the Company had pledged loans totaling $285 million to the Federal Reserve Bank of Boston as collateral for certain borrowing arrangements. Also, residential first mortgage loans are subject to a blanket lien for FHLBB advances. See Note 13 - Borrowed Funds.
At year-end 2019 and 2018, the Company’s commitments outstanding to related parties totaled $1.8 million and $52.9 million, respectively, and the loans outstanding against these commitments totaled $1.0 million and $47.8 million, respectively. Related parties include directors and executive officers of the Company and its subsidiaries, as well as their respective affiliates in which they have a controlling interest and immediate family members. For the years 2019 and 2018, all related party loans were performing.
The carrying amount of the acquired loans at December 31, 2019 totaled $2.3 billion. A subset of these loans was determined to have evidence of credit deterioration at acquisition date, which is accounted for in accordance with ASC 310-30. These purchased credit-impaired loans presently maintain a carrying value of $61.4 million and a note balance of $147 million. These loans are evaluated for impairment through the quarterly reforecasting of expected cash flows. Of the $61.4 million, $23.1 million are commercial real estate, $26.7 million are commercial and industrial loans, $10.8 million are residential mortgages, and $0.8 million are consumer loans.
The carrying amount of the acquired loans at December 31, 2018 totaled $1.7 billion. A subset of these loans was determined to have evidence of credit deterioration at acquisition date, which is accounted for in accordance with ASC 310-30. These purchased credit-impaired loans maintained a carrying value of $47.3 million and a note balance of $124 million. Of the $47.3 million, $12.0 million were commercial real estate, $29.5 million were commercial and industrial loans, $4.9 million were residential mortgages, and $0.9 million were consumer loans.
F-37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes activity in the accretable yield for the acquired loan portfolio that falls under the purview of ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality:
(In thousands) | 2019 | 2018 | 2017 | |||||||||
Balance at beginning of period | $ | $ | $ | |||||||||
Accretion | ( | ) | ( | ) | ( | ) | ||||||
Additions | ||||||||||||
Net reclassification from nonaccretable difference | ||||||||||||
Payments received, net | ( | ) | ( | ) | ( | ) | ||||||
Reclassification to TDR | ||||||||||||
Disposals | ( | ) | ||||||||||
Balance at end of period | $ | $ | $ | |||||||||
The following is a summary of past due loans at December 31, 2019 and 2018:
Business Activities Loans
(in thousands) | 30-59 Days Past Due | 60-89 Days Past Due | >90 Days Past Due | Total Past Due | Current | Total Loans | Past Due > 90 days and Accruing | |||||||||||||||||||||
December 31, 2019 | ||||||||||||||||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||||||
Construction | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
Commercial real estate | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Commercial and industrial loans | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Residential mortgages: | ||||||||||||||||||||||||||||
1-4 family | ||||||||||||||||||||||||||||
Construction | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Consumer loans: | ||||||||||||||||||||||||||||
Home equity | ||||||||||||||||||||||||||||
Auto and other | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
F-38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Business Activities Loans
(in thousands) | 30-59 Days Past Due | 60-89 Days Past Due | >90 Days Past Due | Total Past Due | Current | Total Loans | Past Due > 90 days and Accruing | |||||||||||||||||||||
December 31, 2018 | ||||||||||||||||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||||||
Construction | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
Commercial real estate | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Commercial and industrial loans | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Residential mortgages: | ||||||||||||||||||||||||||||
1-4 family | ||||||||||||||||||||||||||||
Construction | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Consumer loans: | ||||||||||||||||||||||||||||
Home equity | ||||||||||||||||||||||||||||
Auto and other | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
Acquired Loans
(in thousands) | 30-59 Days Past Due | 60-89 Days Past Due | >90 Days Past Due | Total Past Due | Acquired Credit Impaired | Total Loans | Past Due > 90 days and Accruing | |||||||||||||||||||||
December 31, 2019 | ||||||||||||||||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||||||
Construction | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
Commercial real estate | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Commercial and industrial loans | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Residential mortgages: | ||||||||||||||||||||||||||||
1-4 family | ||||||||||||||||||||||||||||
Construction | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Consumer loans: | ||||||||||||||||||||||||||||
Home equity | ||||||||||||||||||||||||||||
Auto and other | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
F-39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands) | 30-59 Days Past Due | 60-89 Days Past Due | >90 Days Past Due | Total Past Due | Acquired Credit Impaired | Total Loans | Past Due > 90 days and Accruing | |||||||||||||||||||||
December 31, 2018 | ||||||||||||||||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||||||
Construction | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
Commercial real estate | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Commercial and industrial loans: | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Residential mortgages: | ||||||||||||||||||||||||||||
1-4 family | ||||||||||||||||||||||||||||
Construction | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Consumer loans: | ||||||||||||||||||||||||||||
Home equity | ||||||||||||||||||||||||||||
Auto and other | ||||||||||||||||||||||||||||
Total | ||||||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||
The following is summary information pertaining to non-accrual loans at year-end 2019 and 2018:
December 31, 2019 | December 31, 2018 | |||||||||||||||||||||||
(In thousands) | Business Activities Loans | Acquired Loans | Total | Business Activities Loans | Acquired Loans | Total | ||||||||||||||||||
Commercial real estate: | ||||||||||||||||||||||||
Construction | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Other commercial real estate | ||||||||||||||||||||||||
Total | ||||||||||||||||||||||||
Commercial and industrial loans: | ||||||||||||||||||||||||
Total | ||||||||||||||||||||||||
Residential mortgages: | ||||||||||||||||||||||||
1-4 family | ||||||||||||||||||||||||
Construction | ||||||||||||||||||||||||
Total | ||||||||||||||||||||||||
Consumer loans: | ||||||||||||||||||||||||
Home equity | ||||||||||||||||||||||||
Auto and other | ||||||||||||||||||||||||
Total | ||||||||||||||||||||||||
Total non-accrual loans | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
F-40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Loans evaluated for impairment as of December 31, 2019 and 2018 were as follows:
Business Activities Loans
(In thousands) 2019 | Commercial real estate | Commercial and industrial | Residential mortgages | Consumer | Total | |||||||||||||||
Loans receivable: | ||||||||||||||||||||
Balance at end of year | ||||||||||||||||||||
Individually evaluated for impairment | $ | $ | $ | $ | $ | |||||||||||||||
Collectively evaluated | ||||||||||||||||||||
Total | $ | $ | $ | $ | $ | |||||||||||||||
Business Activities Loans
(In thousands) 2018 | Commercial real estate | Commercial and industrial | Residential mortgages | Consumer | Total | |||||||||||||||
Loans receivable: | ||||||||||||||||||||
Balance at end of year | ||||||||||||||||||||
Individually evaluated for impairment | $ | $ | $ | $ | $ | |||||||||||||||
Collectively evaluated | ||||||||||||||||||||
Total | $ | $ | $ | $ | $ | |||||||||||||||
Acquired Loans
(In thousands) 2019 | Commercial real estate | Commercial and industrial | Residential mortgages | Consumer | Total | |||||||||||||||
Loans receivable: | ||||||||||||||||||||
Balance at end of year | ||||||||||||||||||||
Individually evaluated for impairment | $ | $ | $ | $ | $ | |||||||||||||||
Purchased credit-impaired loans | ||||||||||||||||||||
Collectively evaluated | ||||||||||||||||||||
Total | $ | $ | $ | $ | $ | |||||||||||||||
Acquired Loans
(In thousands) 2018 | Commercial real estate | Commercial and industrial | Residential mortgages | Consumer | Total | |||||||||||||||
Loans receivable: | ||||||||||||||||||||
Balance at end of year | ||||||||||||||||||||
Individually evaluated for impairment | $ | $ | $ | $ | $ | |||||||||||||||
Purchased credit-impaired loans | ||||||||||||||||||||
Collectively evaluated | ||||||||||||||||||||
Total | $ | $ | $ | $ | $ | |||||||||||||||
F-41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of impaired loans at year-end 2019 and 2018 and for the years then ended:
Business Activities Loans
At December 31, 2019 | ||||||||||||
(In thousands) | Recorded Investment (1) | Unpaid Principal Balance (2) | Related Allowance | |||||||||
With no related allowance: | ||||||||||||
Other commercial real estate | $ | $ | $ | — | ||||||||
Other commercial and industrial loans | — | |||||||||||
Residential mortgages - 1-4 family | — | |||||||||||
Consumer - home equity | — | |||||||||||
With an allowance recorded: | ||||||||||||
Other commercial real estate | $ | $ | $ | |||||||||
Other commercial and industrial loans | ||||||||||||
Residential mortgages - 1-4 family | ||||||||||||
Consumer - home equity | ||||||||||||
Consumer - other | ||||||||||||
Total | ||||||||||||
Commercial real estate | $ | $ | $ | |||||||||
Commercial and industrial | ||||||||||||
Residential mortgages | ||||||||||||
Consumer | ||||||||||||
Total impaired loans | $ | $ | $ | |||||||||
(1) The Recorded Investment represents the face amount of the loan increased or decreased by applicable accrued interest, net deferred loan fees and costs, and unamortized premium or discount, and reflects direct charge-offs. These amounts are components of total loans and other assets on the Consolidated Balance Sheets.
(2) The Unpaid Principal Balance represents the customer's legal obligation to the Company.
F-42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Business Activities Loans
At December 31, 2018 | ||||||||||||
(In thousands) | Recorded Investment (1) | Unpaid Principal Balance (2) | Related Allowance | |||||||||
With no related allowance: | ||||||||||||
Other commercial real estate | $ | $ | $ | — | ||||||||
Other commercial and industrial loans | — | |||||||||||
Residential mortgages - 1-4 family | — | |||||||||||
Consumer - home equity | — | |||||||||||
With an allowance recorded: | ||||||||||||
Other commercial real estate | $ | $ | $ | |||||||||
Other commercial and industrial loans | ||||||||||||
Residential mortgages - 1-4 family | ||||||||||||
Consumer - home equity | ||||||||||||
Consumer - other | ||||||||||||
Total | ||||||||||||
Commercial real estate | $ | $ | $ | |||||||||
Commercial and industrial | ||||||||||||
Residential mortgages | ||||||||||||
Consumer | ||||||||||||
Total impaired loans | $ | $ | $ | |||||||||
(1) The Recorded Investment represents the face amount of the loan increased or decreased by applicable accrued interest, net deferred loan fees and costs, and unamortized premium or discount, and reflects direct charge-offs. These amounts are components of total loans and other assets on the Consolidated Balance Sheets.
(2) The Unpaid Principal Balance represents the customer's legal obligation to the Company.
F-43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Acquired Loans
At December 31, 2019 | ||||||||||||
(In thousands) | Recorded Investment (1) | Unpaid Principal Balance (2) | Related Allowance | |||||||||
With no related allowance: | ||||||||||||
Other commercial real estate loans | $ | $ | $ | — | ||||||||
Other commercial and industrial loans | — | |||||||||||
Residential mortgages - 1-4 family | — | |||||||||||
Consumer - home equity | — | |||||||||||
Consumer - other | — | |||||||||||
With an allowance recorded: | ||||||||||||
Other commercial real estate loans | $ | $ | $ | |||||||||
Other commercial and industrial loans | ||||||||||||
Residential mortgages - 1-4 family | ||||||||||||
Consumer - home equity | ||||||||||||
Consumer - other | ||||||||||||
Total | ||||||||||||
Commercial real estate | $ | $ | $ | |||||||||
Commercial and industrial | ||||||||||||
Residential mortgages | ||||||||||||
Consumer | ||||||||||||
Total impaired loans | $ | $ | $ | |||||||||
(1) The Recorded Investment represents the face amount of the loan increased or decreased by applicable accrued interest, net deferred loan fees and costs, and unamortized premium or discount, and reflects direct charge-offs. These amounts are components of total loans and other assets on the Consolidated Balance Sheets.
(2) The Unpaid Principal Balance represents the customer's legal obligation to the Company.
F-44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Acquired Loans
December 31, 2018 | ||||||||||||
(In thousands) | Recorded Investment (1) | Unpaid Principal Balance (2) | Related Allowance | |||||||||
With no related allowance: | ||||||||||||
Other commercial real estate loans | $ | $ | $ | — | ||||||||
Other commercial and industrial loans | — | |||||||||||
Residential mortgages - 1-4 family | — | |||||||||||
Consumer - home equity | — | |||||||||||
Consumer - other | — | |||||||||||
With an allowance recorded: | ||||||||||||
Other commercial real estate loans | $ | $ | $ | |||||||||
Other commercial and industrial loans | ||||||||||||
Residential mortgages - 1-4 family | ||||||||||||
Consumer - home equity | ||||||||||||
Consumer - other | ||||||||||||
Total | ||||||||||||
Commercial real estate | $ | $ | $ | |||||||||
Commercial and industrial | ||||||||||||
Residential mortgages | ||||||||||||
Consumer | ||||||||||||
Total impaired loans | $ | $ | $ | |||||||||
(1) The Recorded Investment represents the face amount of the loan increased or decreased by applicable accrued interest, net deferred loan fees and costs, and unamortized premium or discount, and reflects direct charge-offs. These amounts are components of total loans and other assets on the Consolidated Balance Sheets.
(2) The Unpaid Principal Balance represents the customer's legal obligation to the Company.
F-45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following is a summary of the average recorded investment and interest income recognized on impaired loans as of December 31, 2019, 2018, and 2017:
Business Activities Loans
December 31, 2019 | December 31, 2018 | December 31, 2017 | ||||||||||||||||||||||
(in thousands) | Average Recorded Investment | Cash Basis Interest Income Recognized | Average Recorded Investment | Cash Basis Interest Income Recognized | Average Recorded Investment | Cash Basis Interest Income Recognized | ||||||||||||||||||
With no related allowance: | ||||||||||||||||||||||||
Other commercial real estate | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Other commercial and industrial | ||||||||||||||||||||||||
Residential mortgages - 1-4 family | ||||||||||||||||||||||||
Consumer-home equity | ||||||||||||||||||||||||
Consumer-other | ||||||||||||||||||||||||
With an allowance recorded: | ||||||||||||||||||||||||
Other commercial real estate | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Other commercial and industrial | ||||||||||||||||||||||||
Residential mortgages - 1-4 family | ||||||||||||||||||||||||
Consumer-home equity | ||||||||||||||||||||||||
Consumer - other | ||||||||||||||||||||||||
Total | ||||||||||||||||||||||||
Commercial real estate | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Commercial and industrial | ||||||||||||||||||||||||
Residential mortgages | ||||||||||||||||||||||||
Consumer loans | ||||||||||||||||||||||||
Total impaired loans | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
F-46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Acquired Loans
December 31, 2019 | December 31, 2018 | December 31, 2017 | ||||||||||||||||||||||
(in thousands) | Average Recorded Investment | Cash Basis Interest Income Recognized | Average Recorded Investment | Cash Basis Interest Income Recognized | Average Recorded Investment | Cash Basis Interest Income Recognized | ||||||||||||||||||
With no related allowance: | ||||||||||||||||||||||||
Other commercial real estate | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Other commercial and industrial | ||||||||||||||||||||||||
Residential mortgages - 1-4 family | ||||||||||||||||||||||||
Consumer - home equity | ||||||||||||||||||||||||
Consumer - other | ||||||||||||||||||||||||
With an allowance recorded: | ||||||||||||||||||||||||
Other commercial real estate | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Other commercial and industrial | ||||||||||||||||||||||||
Residential mortgages - 1-4 family | ||||||||||||||||||||||||
Consumer - home equity | ||||||||||||||||||||||||
Consumer - other | ||||||||||||||||||||||||
Total | ||||||||||||||||||||||||
Commercial real estate | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Commercial and industrial | ||||||||||||||||||||||||
Residential mortgages | ||||||||||||||||||||||||
Consumer loans | ||||||||||||||||||||||||
Total impaired loans | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
F-47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Troubled Debt Restructuring Loans
The Company’s loan portfolio also includes certain loans that have been modified in a Troubled Debt Restructuring (TDR), where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions. Certain TDRs are classified as nonperforming at the time of restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a reasonable period, generally six months . TDRs are evaluated individually for impairment and may result in a specific allowance amount allocated to an individual loan.
The following tables include the recorded investment and number of modifications for modified loans identified during the years-ended December 31, 2019, 2018, and 2017 respectively. The tables include the recorded investment in the loans prior to a modification and also the recorded investment in the loans after the loans were restructured. The modifications for the years-ended December 31, 2019, 2018, and 2017 were attributable to interest rate concessions, maturity date extensions, modified payment terms, reamortization, and accelerated maturity.
Modifications by Class For the twelve months ending December 31, 2019 | |||||||||||
Number of Modifications | Pre-Modification Outstanding Recorded Investment (In thousands) | Post-Modification Outstanding Recorded Investment | |||||||||
Troubled Debt Restructurings | |||||||||||
Other commercial real estate | $ | $ | |||||||||
Other commercial and industrial loans | |||||||||||
Residential mortgages - 1-4 family | |||||||||||
Consumer - home equity | |||||||||||
$ | $ | ||||||||||
Modifications by Class For the twelve months ending December 31, 2018 | |||||||||||
Number of Modifications | Pre-Modification Outstanding Recorded Investment (In thousands) | Post-Modification Outstanding Recorded Investment | |||||||||
Troubled Debt Restructurings | |||||||||||
Other commercial real estate | $ | $ | |||||||||
Other commercial and industrial loans | |||||||||||
Residential mortgages - 1-4 family | |||||||||||
Consumer - home equity | |||||||||||
$ | $ | ||||||||||
Modifications by Class For the twelve months ending December 31, 2017 | |||||||||||
Number of Modifications | Pre-Modification Outstanding Recorded Investment (In thousands) | Post-Modification Outstanding Recorded Investment | |||||||||
Troubled Debt Restructurings | |||||||||||
Other commercial real estate | $ | $ | |||||||||
Other commercial and industrial loans | |||||||||||
Residential mortgages - 1-4 family | |||||||||||
Consumer - home equity | |||||||||||
$ | $ | ||||||||||
F-48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table discloses the recorded investments and numbers of modifications for TDRs where a concession has been made within the previous 12 months, that then defaulted in the respective reporting period. For the year ended 2019, there was one loan that was restructured that had subsequently defaulted during the period. For the period ended 2018, there were no loans that were restructured that had subsequently defaulted during the period. For the year ended 2017, there were three loans that were restructured that had subsequently defaulted during the period.
Modifications that subsequently defaulted for the twelve months ending December 31, 2019 | |||||||
Number of Contracts | Recorded Investment | ||||||
Troubled Debt Restructurings | |||||||
Other commercial and industrial loans | $ | ||||||
$ | |||||||
Modifications that subsequently defaulted for the twelve months ending December 31, 2017 | |||||||
Number of Contracts | Recorded Investment | ||||||
Troubled Debt Restructurings | |||||||
Other commercial real estate | $ | ||||||
Other commercial and industrial loans | |||||||
Residential mortgages - 1-4 family | |||||||
$ | |||||||
The following table presents the Company’s TDR activity in 2019 and 2018:
(In thousands) | 2019 | 2018 | 2017 | |||||||||
Balance at beginning of year | $ | $ | $ | |||||||||
Principal payments | ( | ) | ( | ) | ( | ) | ||||||
TDR status change (1) | ||||||||||||
Other reductions (2) | ( | ) | ( | ) | ( | ) | ||||||
Newly identified TDRs | ||||||||||||
Balance at end of year | $ | $ | $ | |||||||||
________________________________
(1) TDR status change classification represents TDR loans with a specified interest rate equal to or greater than the rate that the Company was willing to accept at the time of the restructuring for a new loan with comparable risk and the loan was on current payment status and not impaired based on the terms specified by the restructuring agreement.
(2) Other reductions classification consists of transfer to other real estate owned, charge-offs to loans, and other loan sale payoffs.
The evaluation of certain loans individually for specific impairment includes loans that were previously classified as TDRs or continue to be classified as TDRs.
As of December 31, 2019 and 2018, the Company maintained no foreclosed residential real estate property. Additionally, residential mortgage loans collateralized by real estate property that are in the process of foreclosure as of December 31, 2019 and December 31, 2018 totaled $6.5 million and $3.2 million, respectively, including sold loans serviced by the Company.
F-49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8. LOAN LOSS ALLOWANCE
Activity in the allowance for loan losses for 2019, 2018, and 2017 was as follows:
Business Activities Loans
(In thousands) 2019 | Commercial real estate | Commercial and industrial | Residential mortgages | Consumer | Total | |||||||||||||||
Balance at beginning of year | $ | $ | $ | $ | $ | |||||||||||||||
Charged-off loans | ||||||||||||||||||||
Recoveries on charged-off loans | ||||||||||||||||||||
Provision for loan losses | ( | ) | ||||||||||||||||||
Balance at end of year | $ | $ | $ | $ | $ | |||||||||||||||
Individually evaluated for impairment | ||||||||||||||||||||
Collectively evaluated | ||||||||||||||||||||
Total | $ | $ | $ | $ | $ | |||||||||||||||
Business Activities Loans
(In thousands) 2018 | Commercial real estate | Commercial and industrial | Residential mortgages | Consumer | Total | |||||||||||||||
Balance at beginning of year | $ | $ | $ | $ | $ | |||||||||||||||
Charged-off loans | ||||||||||||||||||||
Recoveries on charged-off loans | ||||||||||||||||||||
Provision for loan losses | ||||||||||||||||||||
Balance at end of year | $ | $ | $ | $ | $ | |||||||||||||||
Individually evaluated for impairment | ||||||||||||||||||||
Collectively evaluated | ||||||||||||||||||||
Total | $ | $ | $ | $ | $ | |||||||||||||||
Business Activities Loans
(In thousands) 2017 | Commercial real estate | Commercial and industrial | Residential mortgages | Consumer | Total | |||||||||||||||
Balance at beginning of year | $ | $ | $ | $ | $ | |||||||||||||||
Charged-off loans | ||||||||||||||||||||
Recoveries on charged-off loans | ||||||||||||||||||||
Provision for loan losses | ||||||||||||||||||||
Balance at end of year | $ | $ | $ | $ | $ | |||||||||||||||
Individually evaluated for impairment | ||||||||||||||||||||
Collectively evaluated | ||||||||||||||||||||
Total | $ | $ | $ | $ | $ | |||||||||||||||
F-50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Acquired Loans
(In thousands) 2019 | Commercial real estate | Commercial and industrial | Residential mortgages | Consumer | Total | |||||||||||||||
Balance at beginning of year | $ | $ | $ | $ | $ | |||||||||||||||
Charged-off loans | ||||||||||||||||||||
Recoveries on charged-off loans | ||||||||||||||||||||
Provision for loan losses | ||||||||||||||||||||
Balance at end of year | $ | $ | $ | $ | $ | |||||||||||||||
Individually evaluated for impairment | ||||||||||||||||||||
Collectively evaluated | ||||||||||||||||||||
Total | $ | $ | $ | $ | $ | |||||||||||||||
Acquired Loans
(In thousands) 2018 | Commercial real estate | Commercial and industrial | Residential mortgages | Consumer | Total | |||||||||||||||
Balance at beginning of year | $ | $ | $ | $ | $ | |||||||||||||||
Charged-off loans | ||||||||||||||||||||
Recoveries on charged-off loans | ||||||||||||||||||||
Provision for loan losses | ||||||||||||||||||||
Balance at end of year | $ | $ | $ | $ | $ | |||||||||||||||
Individually evaluated for impairment | ||||||||||||||||||||
Collectively evaluated | ||||||||||||||||||||
Total | $ | $ | $ | $ | $ | |||||||||||||||
Acquired Loans
(In thousands) 2017 | Commercial real estate | Commercial and industrial | Residential mortgages | Consumer | Total | |||||||||||||||
Balance at beginning of year | $ | $ | $ | $ | $ | |||||||||||||||
Charged-off loans | ||||||||||||||||||||
Recoveries on charged-off loans | ||||||||||||||||||||
Provision for loan losses | ||||||||||||||||||||
Balance at end of year | $ | $ | $ | $ | $ | |||||||||||||||
Individually evaluated for impairment | ||||||||||||||||||||
Collectively evaluated | ||||||||||||||||||||
Total | $ | $ | $ | $ | $ | |||||||||||||||
F-51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Credit Quality Information
Business Activities Loans Credit Quality Analysis
The Company monitors the credit quality of its portfolio by using internal risk ratings that are based on regulatory guidance. Loans that are given a Pass rating are not considered a problem credit. Loans that are classified as Special Mention loans are considered to have potential weaknesses and are evaluated closely by management. Substandard and non-accruing loans are loans for which a definitive weakness has been identified and which may make full collection of contractual cash flows questionable. Doubtful loans are those with identified weaknesses that make full collection of contractual cash flows, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
For commercial credits, the Company assigns an internal risk rating at origination and reviews the rating annual, semiannually, or quarterly depending on the risk rating. The rating is also reassessed at any point in time when management becomes aware of information that may affect the borrower’s ability to fulfill their obligations.
The Company risk rates its residential mortgages, including 1-4 family and residential construction loans, based on a three rating system: Pass, Special Mention, and Substandard. Loans that are current within 59 days are rated Pass. Residential mortgages that are 60 -89 days delinquent are rated Special Mention. Loans delinquent for 90 days or greater are rated Substandard and generally placed on non-accrual status. Home equity loans are risk rated based on the same rating system as the Company’s residential mortgages.
Ratings for other consumer loans, including auto loans, are based on a two rating system. Loans that are current within 119 days are rated Performing while loans delinquent for 120 days or more are rated Non-performing. Other consumer loans are placed on non-accrual at such time as they become Non-performing.
Acquired Loans Credit Quality Analysis
Upon acquiring a loan portfolio, our internal loan review function assigns risk ratings to the acquired loans, utilizing the same methodology as it does with business activities loans. This may differ from the risk rating policy of the predecessor bank. Loans which are rated Substandard or worse according to the rating process outlined below are generally deemed to be credit impaired loans accounted for under ASC 310-30, regardless of whether they are classified as performing or non-performing.
The Bank utilizes a loan risk rating system for acquired loans consistent with loans originated from business activities, as outlined in the Credit Quality Information section of this Note. The ratings system is similar to loans originated through business activities. The Company presented several tables within this footnote separately for business activity loans and acquired loans in order to distinguish the credit performance of the acquired loans from the business activity loans.
F-52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following tables present the Company’s loans by risk rating at year-end 2019 and 2018:
Business Activities Loans
Commercial Real Estate
Credit Risk Profile by Creditworthiness Category
Construction | Real Estate | Total commercial real estate | ||||||||||||||||||||||
(In thousands) | 2019 | 2018 | 2019 | 2018 | 2019 | 2018 | ||||||||||||||||||
Grade: | ||||||||||||||||||||||||
Pass | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Special mention | ||||||||||||||||||||||||
Substandard | ||||||||||||||||||||||||
Doubtful | ||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Commercial and Industrial Loans
Credit Risk Profile by Creditworthiness Category
Total comm. and industrial | ||||||||
(In thousands) | 2019 | 2018 | ||||||
Grade: | ||||||||
Pass | $ | $ | ||||||
Special mention | ||||||||
Substandard | ||||||||
Doubtful | ||||||||
Total | $ | $ | ||||||
Residential Mortgages
Credit Risk Profile by Internally Assigned Grade
1-4 family | Construction | Total residential mortgages | ||||||||||||||||||||||
(In thousands) | 2019 | 2018 | 2019 | 2018 | 2019 | 2018 | ||||||||||||||||||
Grade: | ||||||||||||||||||||||||
Pass | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Special mention | ||||||||||||||||||||||||
Substandard | ||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Consumer Loans
Credit Risk Profile Based on Payment Activity
Home equity | Auto and other | Total consumer | ||||||||||||||||||||||
(In thousands) | 2019 | 2018 | 2019 | 2018 | 2019 | 2018 | ||||||||||||||||||
Performing | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Nonperforming | ||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
F-53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Acquired Loans
Commercial Real Estate
Credit Risk Profile by Creditworthiness Category
Construction | Real Estate | Total commercial real estate | ||||||||||||||||||||||
(In thousands) | 2019 | 2018 | 2019 | 2018 | 2019 | 2018 | ||||||||||||||||||
Grade: | ||||||||||||||||||||||||
Pass | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Special mention | ||||||||||||||||||||||||
Substandard | ||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Commercial and Industrial Loans
Credit Risk Profile by Creditworthiness Category
Total comm. and industrial | ||||||||
(In thousands) | 2019 | 2018 | ||||||
Grade: | ||||||||
Pass | $ | $ | ||||||
Special mention | ||||||||
Substandard | ||||||||
Total | $ | $ | ||||||
Residential Mortgages
Credit Risk Profile by Internally Assigned Grade
1-4 family | Construction | Total residential mortgages | ||||||||||||||||||||||
(In thousands) | 2019 | 2018 | 2019 | 2018 | 2019 | 2018 | ||||||||||||||||||
Grade: | ||||||||||||||||||||||||
Pass | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Special mention | ||||||||||||||||||||||||
Substandard | ||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Consumer Loans
Credit Risk Profile Based on Payment Activity
Home equity | Auto and other | Total consumer | ||||||||||||||||||||||
(In thousands) | 2019 | 2018 | 2019 | 2018 | 2019 | 2018 | ||||||||||||||||||
Performing | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Nonperforming | ||||||||||||||||||||||||
Total | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
F-54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes information about total loans rated Special Mention or lower. The table below includes consumer loans that are Special Mention and Substandard accruing that are classified in the above table as performing based on payment activity.
2019 | 2018 | |||||||||||||||||||||||
(In thousands) | Business Activities Loans | Acquired Loans | Total | Business Activities Loans | Acquired Loans | Total | ||||||||||||||||||
Non-Accrual | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
Substandard Accruing | ||||||||||||||||||||||||
Total Classified | ||||||||||||||||||||||||
Special Mention | ||||||||||||||||||||||||
Total Criticized | $ | $ | $ | $ | $ | $ | ||||||||||||||||||
NOTE 9. PREMISES AND EQUIPMENT
Year-end premises and equipment are summarized as follows:
(In thousands) | 2019 | 2018 | Estimated Useful Life | |||||||
Land | $ | $ | N/A | |||||||
Buildings and improvements | 5 - 39 years | |||||||||
Furniture and equipment (1) | 3 - 7 years | |||||||||
Construction in process (1) | ||||||||||
Premises and equipment, gross | ||||||||||
Accumulated depreciation and amortization (1) | ( | ) | ( | ) | ||||||
Premises and equipment, net | $ | $ | ||||||||
Premises and equipment, net from discontinued operations | ||||||||||
Premises and equipment, net from continuing operations | $ | $ | ||||||||
(1) |
Depreciation and amortization expense including discontinued operations for the years 2019, 2018, and 2017 amounted to $11.8 million, $10.8 million, and $9.9 million, respectively.
F-55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10. GOODWILL AND OTHER INTANGIBLES
Goodwill and other intangible assets are presented in the tables below. The Company had one acquisition during 2019. There was no acquisition during 2018. In accordance with applicable accounting guidance, the Company allocated the amount paid to the fair value of the net assets acquired, with any excess amounts recorded as goodwill. The goodwill balance is allocated to the consolidated Company. The activity impacting goodwill in 2019 and 2018 is as follows:
(In thousands) | 2019 | 2018 | ||||||
Balance, beginning of the period | $ | $ | ||||||
Goodwill acquired and adjusted: | ||||||||
SI Financial Group, Inc. | ||||||||
Adjustments (1) | ( | ) | ( | ) | ||||
Balance, end of the period | $ | $ | ||||||
(1) |
The Company tests goodwill impairment annually as of June 30 using second quarter data. The results of the quantitative assessment indicated it is more likely than not that the reporting unit's fair value exceeds its carrying amount, and accordingly, the two-step impairment test was not performed. When events or changes in circumstances indicate that impairment is possible, the Company performs additional reviews. No impairment was recorded on goodwill for 2019, 2018, and 2017.
The components of other intangible assets are as follows:
(In thousands) | Gross Intangible Assets | Accumulated Amortization | Net Intangible Assets | |||||||||
December 31, 2019 | ||||||||||||
Non-maturity deposits (core deposit intangible) | $ | $ | ( | ) | $ | |||||||
Insurance contracts | ( | ) | ||||||||||
All other intangible assets | ( | ) | ||||||||||
Total | $ | $ | ( | ) | $ | |||||||
December 31, 2018 | ||||||||||||
Non-maturity deposits (core deposit intangible) | $ | $ | ( | ) | $ | |||||||
Insurance contracts | ( | ) | ||||||||||
All other intangible assets | ( | ) | ||||||||||
Total | $ | $ | ( | ) | $ | |||||||
Other intangible assets are amortized on a straight-line or accelerated basis over their estimated lives, which range from four to fifteen years . Amortization expense related to intangibles totaled $5.8 million in 2019, $4.9 million in 2018, and $3.5 million in 2017.
The estimated aggregate future amortization expense for intangible assets remaining at year-end 2019 is as follows: 2020- $6.2 million; 2021- $6.0 million; 2022- $5.9 million; 2023- $5.6 million; 2024- $5.4 million; and thereafter- $16.6 million. For the years 2019, 2018, and 2017, no impairment charges were identified for the Company’s intangible assets.
F-56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11. OTHER ASSETS
Year-end other assets are summarized as follows:
(In thousands) | 2019 | 2018 | ||||||
Capitalized servicing rights (1) | $ | $ | ||||||
Accrued interest receivable | ||||||||
Accrued federal and state tax receivable | ||||||||
Right-of-use assets (1) | ||||||||
Derivative assets (1) | ||||||||
Assets held for sale | ||||||||
Other (1) | ||||||||
Total other assets | $ | $ | ||||||
Total other assets from discontinued operations | ||||||||
Total other assets from continuing operations | $ | $ | ||||||
(1) | Includes other assets classified as discontinued operations. See Note 3 - Discontinued Operations for more information. |
The Bank sells loans in the secondary market and retains the ability to service many of these loans. The Bank earns fees for the servicing provided. Loans sold and serviced for others from continuing operations amounted to $1.7 billion, $1.4 billion, and $1.4 billion at year-end 2019, 2018, and 2017, respectively. Loans sold and serviced for others from discontinued operations amounted to $1.4 billion, $0.8 billion, and $0.3 billion at year-end 2019, 2018, and 2017. Loans serviced for others are not included in the accompanying Consolidated Balance Sheets. The risks inherent in servicing assets relate primarily to changes in prepayments that result from shifts in interest rates. Contractually specified servicing fees from continuing operations were $5.6 million, $4.6 million, and $4.4 million for the years 2019, 2018, and 2017, respectively, and included as a component of loan related fees within non-interest income. Contractually specified servicing fees from discontinued operations were $1.9 million, $1.0 million, and $0.2 million for the years 2019, 2018, and 2017, respectively, and included as a component of other income in Note 3 - Discontinued Operations. Refer to Note 22 - Fair Value Measurements for significant assumptions and inputs used in the valuation at year-end 2019.
Servicing rights activity was as follows:
(In thousands) | 2019 | 2018 | ||||||
Balance at beginning of year | $ | $ | ||||||
Additions | ||||||||
Amortization | ( | ) | ( | ) | ||||
Change in fair value | ( | ) | ||||||
Allowance adjustment | ( | ) | ( | ) | ||||
Balance at end of year (1) | $ | $ | ||||||
(1) | The balances of servicing rights accounted for at fair value as of December 31, 2019 and December 31, 2018 were $ |
Servicing rights activity from discontinued operations during 2019 included $11.1 million of additions, $5.8 million decrease in fair value, and $4.5 million valuation allowance. During 2018, servicing rights activity from discontinued operations included $7.6 million of additions.
F-57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 12. DEPOSITS
A summary of year-end time deposits is as follows:
(In thousands) | 2019 | 2018 | ||||||
Maturity date: | ||||||||
Within 1 year | $ | $ | ||||||
Over 1 year to 2 years | ||||||||
Over 2 years to 3 years | ||||||||
Over 3 years to 4 years | ||||||||
Over 4 years to 5 years | ||||||||
Over 5 years | ||||||||
Total | $ | $ | ||||||
Account balances: | ||||||||
Less than $100,000 | $ | $ | ||||||
$100,000 through $250,000 | ||||||||
$250,000 or more | ||||||||
Total | $ | $ | ||||||
Included in total deposits on the Consolidated Balance Sheets are brokered deposits of $1.2 billion and $1.4 billion at December 31, 2019 and December 31, 2018, respectively. Also included in total deposits are reciprocal deposits of $91.7 million and $84.4 million at December 31, 2019 and December 31, 2018, respectively, as well as related party deposits of $63.9 million and $123.9 million at December 31, 2019 and December 31, 2018, respectively.
F-58
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 13. BORROWED FUNDS
Borrowed funds at December 31, 2019 and 2018 are summarized, as follows:
2019 | 2018 | |||||||||||||
(in thousands, except rates) | Principal | Weighted Average Rate | Principal | Weighted Average Rate | ||||||||||
Short-term borrowings: | ||||||||||||||
Advances from the FHLBB | $ | % | $ | % | ||||||||||
Total short-term borrowings: | ||||||||||||||
Long-term borrowings: | ||||||||||||||
Advances from the FHLBB | ||||||||||||||
Subordinated notes | ||||||||||||||
Junior subordinated borrowing - Trust I | ||||||||||||||
Junior subordinated borrowing - Trust II | ||||||||||||||
Total long-term borrowings: | ||||||||||||||
Total | $ | % | $ | % | ||||||||||
Short-term debt includes Federal Home Loan Bank of Boston (“FHLBB”) advances with an original maturity of less than one year. At year-end 2019, the Company maintained a short-term line-of-credit through a correspondent bank with no balance outstanding. The Bank also maintains a $3.0 million secured line of credit with the FHLBB that bears a daily adjustable rate calculated by the FHLBB. There was no outstanding balance on the FHLBB line of credit for the periods ended December 31, 2019 and December 31, 2018. The Company is in compliance with all debt covenants as of December 31, 2019.
The Bank is approved to borrow on a short-term basis from the Federal Reserve Bank of Boston as a non-member bank. The Bank has pledged certain loans and securities to the Federal Reserve Bank to support this arrangement. No borrowings with the Federal Reserve Bank of Boston took place for the periods ended December 31, 2019 and December 31, 2018.
Long-term FHLBB advances consist of advances with an original maturity of more than one year and are subject to
prepayment penalties. The advances outstanding at December 31, 2019 include callable advances totaling $10 million and amortizing advances totaling $4.4 million. The advances outstanding at December 31, 2018 include no callable advances and amortizing advances totaling $1.7 million. All FHLBB borrowings, including the line of credit, are secured by a blanket security agreement on certain qualified collateral, principally all residential first mortgage loans and certain securities.
A summary of maturities of FHLBB advances at year-end 2019 is as follows:
2019 | |||||||
(In thousands) | Amount | Weighted Average Rate | |||||
Fixed rate advances maturing: | |||||||
2020 | $ | % | |||||
2021 | |||||||
2022 | |||||||
2023 | |||||||
2024 and beyond | |||||||
Total FHLBB advances | $ | % | |||||
F-59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company did no t have variable-rate FHLB advances for the period ended December 31, 2019 and December 31, 2018.
In September 2012, the Company issued fifteen year subordinated notes in the amount of $75.0 million at a discount of 1.15 %. The interest rate is fixed at 6.875 % for the first ten years. After ten years, the notes become callable and convert to an interest rate of three month LIBOR plus 5.113 %. The subordinated note includes reduction to the note principal balance of $338 thousand and $461 thousand for unamortized debt issuance costs as of December 31, 2019 and December 31 2018, respectively.
The Company holds 100 % of the common stock of Berkshire Hills Capital Trust I (“Trust I”) which is included in other assets with a cost of $0.5 million. The sole asset of Trust I is $15.5 million of the Company’s junior subordinated debentures due in 2035. These debentures bear interest at a variable rate equal to LIBOR plus 1.85 % and had a rate of 3.76 % and 4.50 % at December 31, 2019 and December 31, 2018, respectively. The Company has the right to defer payments of interest for up to five years on the debentures at any time, or from time to time, with certain limitations, including a restriction on the payment of dividends to shareholders while such interest payments on the debentures have been deferred. The Company has not exercised this right to defer payments. The Company has the right to redeem the debentures at par value on each quarterly payment date. Trust I is considered a variable interest entity for which the Company is not the primary beneficiary. Accordingly, Trust I is not consolidated into the Company’s financial statements.
The Company holds 100 % of the common stock of SI Capital Trust II (“Trust II”) which is included in other assets
with a cost of $0.2 million. The sole asset of Trust II is $8.2 million of the Company’s junior subordinated
debentures due in 2036. These debentures bear interest at a variable rate equal to LIBOR plus 1.70 % and had a rate
of 3.59 % at December 31, 2019. The Company has the right to defer payments of interest for up to five years on
the debentures at any time, or from time to time, with certain limitations, including a restriction on the payment of
dividends to shareholders while such interest payments on the debentures have been deferred. The Company has not
exercised this right to defer payments. The Company has the right to redeem the debentures at par value. Trust II is
considered a variable interest entity for which the Company is not the primary beneficiary. Accordingly, Trust II is
not consolidated into the Company’s financial statements.
NOTE 14. OTHER LIABILITIES
Year-end other liabilities are summarized as follows:
(In thousands) | 2019 | 2018 | ||||||
Derivative liabilities | $ | $ | ||||||
Capital and financing lease obligations | ||||||||
Asset purchase settlement payable (1) | ||||||||
Employee benefits liability | ||||||||
Operating lease liabilities (1) | ||||||||
Accrued interest payable | ||||||||
Customer transaction clearing accounts | ||||||||
Other (1) | ||||||||
Total other liabilities | $ | $ | ||||||
Total other liabilities from discontinued operations | ||||||||
Total other liabilities from continuing operations | $ | $ | ||||||
(1) | Includes other liabilities classified as discontinued operations. See Note 3 - Discontinued Operations for more information. |
F-60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 15. EMPLOYEE BENEFIT PLANS
Pension Plan
The Company maintains a legacy, employer-sponsored defined benefit pension plan (the “Plan”) for which participation and benefit accruals were frozen on January 1, 2003. The Plan was assumed in connection with the Rome Bancorp acquisition in 2011. Accordingly, no employees are permitted to commence participation in the Plan and future salary increases and years of credited service are not considered when computing an employee’s benefits under the Plan. As of December 31, 2019, all minimum Employee Retirement Income Security Act (“ERISA”) funding requirements have been met.
Information regarding the pension plan is as follows:
December 31, | ||||||||
(In thousands) | 2019 | 2018 | ||||||
Change in projected benefit obligation: | ||||||||
Projected benefit obligation at beginning of year | $ | $ | ||||||
Service Cost | ||||||||
Interest cost | ||||||||
Actuarial loss (gain) | ( | ) | ||||||
Benefits paid | ( | ) | ( | ) | ||||
Settlements | ( | ) | ( | ) | ||||
Projected benefit obligation at end of year | ||||||||
Accumulated benefit obligation | ||||||||
Change in fair value of plan assets: | ||||||||
Fair value of plan assets at plan beginning of year | ||||||||
Actual return on plan assets | ( | ) | ||||||
Contributions by employer | ||||||||
Benefits paid | ( | ) | ( | ) | ||||
Settlements | ( | ) | ( | ) | ||||
Fair value of plan assets at end of year | ||||||||
Underfunded status | $ | $ | ||||||
Amounts Recognized on Consolidated Balance Sheets | ||||||||
Other Liabilities | $ | $ | ||||||
Net periodic pension cost is comprised of the following:
December 31, | ||||||||
(In thousands) | 2019 | 2018 | ||||||
Service Cost | $ | $ | ||||||
Interest Cost | ||||||||
Expected return on plan assets | ( | ) | ( | ) | ||||
Amortization of unrecognized actuarial loss | ||||||||
Net periodic pension costs | $ | $ | ||||||
F-61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Changes in plan assets and benefit obligations recognized in accumulated other comprehensive income are as follows:
December 31, | ||||||||
(In thousands) | 2019 | 2018 | ||||||
Amortization of actuarial (loss) | $ | ( | ) | $ | ( | ) | ||
Actuarial (gain) loss | ( | ) | ||||||
Settlement charge | ( | ) | ||||||
Total recognized in accumulated other comprehensive income | ( | ) | ||||||
Total recognized in net periodic pension cost recognized and other comprehensive income | $ | ( | ) | $ | ||||
The amounts in accumulated other comprehensive income that have not yet been recognized as components of net periodic benefit cost are a net loss of $1.2 million and $1.5 million in 2019 and 2018, respectively.
The Company did not make any cash contributions to the pension trust during 2019. The Company made cash contributions of $907 thousand during 2018, which was equal to the underfunded status of the trust as of December 31, 2017. The Company does no t expect to make any cash contributions in 2020. The amount expected to be amortized from other comprehensive income into net periodic pension cost over the next fiscal year is $93 thousand.
The principal actuarial assumptions used are as follows:
December 31, | ||||||
2019 | 2018 | |||||
Projected benefit obligation | ||||||
Discount rate | % | % | ||||
Net periodic pension cost | ||||||
Discount rate | % | % | ||||
Long term rate of return on plan assets | % | % | ||||
The discount rate that is used in the measurement of the pension obligation is determined by comparing the expected future retirement payment cash flows of the pension plan to the Above Median FTSE Pension Discount Curve as of the measurement date. The expected long-term rate of return on Plan assets reflects long-term earnings expectations on existing Plan assets and those contributions expected to be received during the current plan year. In estimating that rate, appropriate consideration was given to historical returns earned by Plan assets in the fund and the rates of return expected to be available for reinvestment. The rates of return were adjusted to reflect current capital market assumptions and changes in investment allocations.
The Company’s overall investment strategy with respect to the Plan’s assets is primarily for preservation of capital and to provide regular dividend and interest payments. The Plan’s targeted asset allocation is 65 % equity securities via investment in the Long-Term Growth - Equity Portfolio ("LTGE"), 34 % intermediate-term investment grade bonds via investment in the Long-Term Growth - Fixed-Income Portfolio ("LTGFI"), and 1 % in cash equivalents portfolio (for liquidity). Equity securities include investments in a diverse mix of equity funds to gain exposure in the US and international markets. The fixed income portion of the Plan assets is a diversified portfolio that primarily invests in intermediate-term bond funds. The overall rate of return is based on the historical performance of the assets applied against the Plan’s target allocation, and is adjusted for the long-term inflation rate.
The fair values for investment securities are determined by quoted prices in active markets, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).
F-62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair value of the Plan’s assets by category within the fair value hierarchy are as follows at December 31, 2019 and December 31, 2018. The Plan did not hold any assets classified as Level 3, nor were there any transfers.
December 31, 2019 | ||||||||||||
Asset Category (In thousands) | Total | Level 1 | Level 2 | |||||||||
Equity Mutual Funds: | ||||||||||||
Large-Cap | $ | $ | $ | |||||||||
Mid-Cap | ||||||||||||
Small-Cap | ||||||||||||
International | ||||||||||||
Fixed Income - US Core | ||||||||||||
Intermediate Duration | ||||||||||||
Cash Equivalents - money market | ||||||||||||
Total | $ | $ | $ | |||||||||
December 31, 2018 | ||||||||||||
Asset Category (In thousands) | Total | Level 1 | Level 2 | |||||||||
Equity Mutual Funds: | ||||||||||||
Large-Cap | $ | $ | $ | |||||||||
Mid-Cap | ||||||||||||
Small-Cap | ||||||||||||
International | ||||||||||||
Fixed Income - US Core | ||||||||||||
Intermediate Duration | ||||||||||||
Cash Equivalents - money market | ||||||||||||
Total | $ | $ | $ | |||||||||
Estimated benefit payments under the pension plans over the next 10 years at December 31, 2019 are as follows:
Year | Payments (In thousands) | ||
2020 | |||
2021 | |||
2022 | |||
2023 | |||
2024 - 2029 | |||
Multi-Employer Pension Plan
As a result of the Company's acquisition of SI Financial Group, Inc. (“SIFI”), the Company participates in the Pentegra Defined Benefit Plan for Financial Institutions (the “Plan”), a tax-qualified defined benefit pension plan. The Plan operates as a multiple-employer plan under ERISA and the Internal Revenue Code, and as as a multi-employer plan for accounting purposes. The Plan was frozen effective September 6, 2013 and SIFI recorded a contingent obligation to settle the plan at a future date, which was assumed by the Company via acquisition. As of December 31, 2019, the Company's liability related to the Plan totaled $4.8 million. The Company made contributions of $290 thousand in 2019. As of July 1, 2019, the Plan held assets with a market value of $4.3 million and liabilities with a market value of $7.2 million. The funded status (market value of plan assets divided by funding target) of the Plan, was greater than 80% as of July 1, 2019, as required by federal and state regulations. Market value of the Plan's assets reflects contributions received through June 30, 2019. There are no collective bargaining agreements in place that require contributions to the Plan by the Company. The Plan is a single plan under the Internal Revenue Code and, as a result, all of the assets stand behind all of the liabilities. Accordingly, contributions made by a participating employer may be used to provide benefits to participants of other participating employers.
F-63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Postretirement Benefits
The Company maintains an unfunded postretirement medical plan assumed in connection with the Rome Bancorp acquisition in 2011. The postretirement plan has been modified so that participation is closed to those employees who did not meet the retirement eligibility requirements by March 31, 2011. The Company contributes partially to medical benefits and life insurance coverage for retirees. Such retirees and their surviving spouses are responsible for the remainder of the medical benefits, including increases in premiums levels, between the total premium and the Company’s contribution.
The Company also has an executive long-term care (“LTC”) postretirement benefit plan which started August 1, 2014. The LTC plan reimburses executives for certain costs in the event of a future chronic illness. Funding of the plan comes from Company paid insurance policies or direct payments. At plan’s inception, a $558 thousand benefit obligation was recorded against equity representing the prior service cost of plan participants.
Information regarding the postretirement plans is as follows:
December 31, | ||||||||
(In thousands) | 2019 | 2018 | ||||||
Change in accumulated postretirement benefit obligation: | ||||||||
Accumulated post-retirement benefit obligation at beginning of year | $ | $ | ||||||
Service Cost | ||||||||
Interest cost | ||||||||
Participant contributions | ||||||||
Actuarial loss (gain) | ( | ) | ||||||
Benefits paid | ( | ) | ( | ) | ||||
Accumulated post-retirement benefit obligation at end of year | $ | $ | ||||||
Change in plan assets: | ||||||||
Fair value of plan assets at beginning of year | $ | $ | ||||||
Contributions by employer | ||||||||
Contributions by participant | ||||||||
Benefits paid | ( | ) | ( | ) | ||||
Fair value of plan assets at end of year | $ | $ | ||||||
Amounts Recognized on Consolidated Balance Sheets | ||||||||
Other Liabilities | $ | $ | ||||||
Net periodic post-retirement cost is comprised of the following:
December 31, | ||||||||
(In thousands) | 2019 | 2018 | ||||||
Service cost | $ | $ | ||||||
Interest costs | ||||||||
Amortization of net prior service credit | ||||||||
Amortization of net actuarial loss | ||||||||
Net periodic post-retirement costs | $ | $ | ||||||
F-64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Changes in benefit obligations recognized in accumulated other comprehensive income are as follows:
December 31, | ||||||||
(In thousands) | 2019 | 2018 | ||||||
Amortization of prior service credit | $ | ( | ) | $ | ( | ) | ||
Net actuarial loss (gain) | ( | ) | ||||||
Total recognized in accumulated other comprehensive income | ( | ) | ||||||
Accrued post-retirement liability recognized | $ | $ | ||||||
The amounts in accumulated other comprehensive income that have not yet been recognized as components of net periodic benefit cost are as follows:
December 31, | ||||||||
(In thousands) | 2019 | 2018 | ||||||
Net prior service cost (credit) | $ | $ | ||||||
Net actuarial loss (gain) | ( | ) | ||||||
Total recognized in accumulated other comprehensive income | $ | $ | ||||||
The amount expected to be amortized from other comprehensive income into net periodic postretirement cost over the next fiscal year is $83 thousand.
The discount rates used in the measurement of the postretirement plan obligations are determined by comparing the expected future retirement payment cash flows of the plans to the Above Median FTSE Pension Discount Curve as of the measurement date.
The assumed discount rates on a weighted-average basis were 3.06 % and 4.11 % as of December 31, 2019 and December 31, 2018, respectively. The assumed health care cost trend rate used in measuring the accumulated post-retirement benefit medical obligation is expected to be 7.25 % for 2020, and is gradually expected to decrease to 3.84 % by 2075. This assumption may have a significant effect on the amounts reported. However, as noted above, increases in premium levels are the financial responsibility of the plan beneficiary. Thus an increase or decrease in 1% of the health care cost trend rates utilized would have had an immaterial effect on the service and interest cost as well as the accumulated post-retirement benefit obligation for the postretirement plan as of December 31, 2019.
For participants in the LTC plan covered by insurance policies, no increase in annual premiums is assumed based on the history of the corresponding insurance provider.
Estimated benefit payments under the post-retirement benefit plan over the next ten years at December 31, 2019 are as follows:
Year | Payments (In thousands) | ||
2020 | |||
2021 | |||
2022 | |||
2023 | |||
2024 - 2029 | |||
F-65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
401(k) Plan
The Company provides a 401(k) Plan in which most eligible employees participate. Expense related to the plan was $4.1 million in 2019, $3.9 million in 2018, and $3.4 million in 2017.
Employee Stock Ownership Plan (“ESOP”)
As part of the Savings Institute acquisition in 2019, the Company acquired an ESOP plan that was frozen and terminated prior to the completion of the transaction. On acquisition date, all amounts in the plan were vested and the loan under the plans was repaid from the sale proceeds of unallocated shares.
Other Plans
The Company maintains supplemental executive retirement plans (“SERPs”) for select current and former executives. Benefits generally commence no earlier than age sixty-two and are payable either as an annuity or as a lump sum at the executive’s option. Most of these SERPs were assumed in connection with acquisitions. At year-end 2019 and 2018, the accrued liability for these SERPs was $20.3 million and $3.4 million, respectively. SERP expense was $928 thousand in 2019, $638 thousand in 2018, and $968 thousand in 2017, and is recognized over the required service period.
During 2018, the Company released $5.4 million of accrued SERP liability, following a transition in the Company's Chief Executive Officer position. The separation agreement did not entitle the former executive to any future benefits, including the associated SERP, other than those described in the agreement.
The Company has endorsement split-dollar arrangements pertaining to certain current and former executives and directors. Under these arrangements, the Company purchased policies insuring the lives of the executives and directors, and separately entered into agreements to split the policy benefits with the individuals. There are no post-retirement benefits associated with these policies. The Company also assumed split-dollar life insurance agreements from multiple prior acquisitions. The accrued liability for these split-dollar arrangements was $7.1 million as of year-end 2019 and $4.6 million as of year-end 2018.
F-66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16. INCOME TAXES
Provision for Income Taxes
The components of the Company’s provision for income taxes for the years ended December 31, 2019, 2018, and 2017 were, as follows:
(In thousands) | 2019 | 2018 | 2017 | |||||||||
Current: | ||||||||||||
Federal tax expense | $ | $ | $ | |||||||||
State tax expense | ||||||||||||
Total current tax expense | ||||||||||||
Deferred: | ||||||||||||
Federal tax expense | ||||||||||||
State tax (benefit)/expense | ( | ) | ||||||||||
Total deferred tax expense (1) | ||||||||||||
Change in valuation allowance | ||||||||||||
Income tax expense from continuing operations | $ | $ | $ | |||||||||
Income tax (benefit)/expense from discontinued operations | ( | ) | ( | ) | ||||||||
Total | $ | $ | $ | |||||||||
(1) | 2017 deferred tax expense of $ |
Effective Tax Rate
The following is a reconciliation of the statutory federal income tax rate to the Company’s effective tax rate for the years ended December 31, 2019, 2018, and 2017:
2019 | 2018 | 2017 | |||||||||||||||||||
(In thousands, except rates) | Amount | Rate | Amount | Rate | Amount | Rate | |||||||||||||||
Statutory tax rate | $ | % | $ | % | $ | % | |||||||||||||||
Increase (decrease) resulting from: | |||||||||||||||||||||
State taxes, net of federal tax benefit | |||||||||||||||||||||
Tax exempt income - investments, net | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | |||||||||
Bank-owned life insurance | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | |||||||||
Non-deductible merger costs | |||||||||||||||||||||
Tax credits, net of basis reduction | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | |||||||||
Change in valuation allowance | |||||||||||||||||||||
Impact of federal tax reform enactment | |||||||||||||||||||||
Other, net | |||||||||||||||||||||
Effective tax rate | $ | % | $ | % | $ | % | |||||||||||||||
F-67
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Deferred Tax Assets and Liabilities
As of December 31, 2019 and 2018, significant components of the Company’s deferred tax assets and liabilities were, as follows:
(In thousands) | 2019 | 2018 | ||||||
Deferred tax assets: | ||||||||
Allowance for loan losses | $ | $ | ||||||
Unrealized capital loss on tax credit investments | ||||||||
Net unrealized loss on securities available for sale and pension in OCI | ||||||||
Employee benefit plans | ||||||||
Purchase accounting adjustments | ||||||||
Net operating loss carryforwards | ||||||||
Lease liability | — | |||||||
Premises and equipment | ||||||||
Other | ||||||||
Deferred tax assets, net before valuation allowances | ||||||||
Valuation allowance | ( | ) | ( | ) | ||||
Deferred tax assets, net of valuation allowances | $ | $ | ||||||
Deferred tax liabilities: | ||||||||
Net unrealized gain on securities available for sale and pension in OCI | $ | ( | ) | $ | ||||
Premises and equipment | ( | ) | ||||||
Loan servicing rights | ( | ) | ( | ) | ||||
Deferred loan fees | ( | ) | ( | ) | ||||
Intangible amortization | ( | ) | ( | ) | ||||
Unamortized tax credit reserve | ( | ) | ( | ) | ||||
Right-of-use asset | ( | ) | — | |||||
Deferred tax liabilities | $ | ( | ) | $ | ( | ) | ||
Deferred tax assets, net | $ | $ | ||||||
Deferred tax liabilities from discontinued operations | $ | ( | ) | $ | ( | ) | ||
Deferred tax assets, net from continuing operations | $ | $ | ||||||
The Company’s net deferred tax asset increased by $8.6 million during 2019, including $17.9 million from the acquisition of SIFI.
Deferred tax assets, net of valuation allowances, are expected to be realized through the reversal of existing taxable temporary differences and future taxable income.
F-68
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Valuation Allowances
The components of the Company’s valuation allowance on its deferred tax asset, net as of December 31, 2019 and 2018 were, as follows:
(in thousands) | 2019 | 2018 | ||||||
State tax basis difference, net of Federal tax benefit | $ | ( | ) | $ | ( | ) | ||
Valuation allowances | $ | ( | ) | $ | ( | ) | ||
The state tax basis difference, net of Federal tax benefit was originally recorded in 2012, due to management’s assessment that it is more likely than not that certain deferred tax assets recorded for the difference between the book basis and the state tax basis in certain tax credit limited partnership investments (LPs) will not be realized. Management anticipates that the remaining excess state tax basis will be realized as a capital loss upon disposition, and that it is unlikely that the Company will have capital gains against which to offset such capital losses.
There was no change in the valuation allowance during 2019. The valuation allowance as of December 31, 2019 is subject to change in the future as the Company continues to periodically assess the likelihood of realizing its deferred tax assets.
Tax Attributes
At December 31, 2019, the Company has $4.5 million of federal net operating loss carryforwards, the utilization of which are limited under Internal Revenue Code Section 382. These net operating losses begin to expire in 2024. The related deferred tax asset is $1.0 million.
Unrecognized Tax Benefits
On a periodic basis, the Company evaluates its income tax positions based on tax laws and regulations and financial reporting considerations, and records adjustments as appropriate. This evaluation takes into consideration the status of taxing authorities’ current examinations of the Company’s tax returns, recent positions taken by the taxing authorities on similar transactions, if any, and the overall tax environment in relation to uncertain tax positions.
The following table presents changes in unrecognized tax benefits for the years ended December 31, 2019, 2018, and 2017:
(In thousands) | 2019 | 2018 | 2017 | |||||||||
Unrecognized tax benefits at January 1 | $ | $ | $ | |||||||||
Increase in gross amounts of tax positions related to prior years | ||||||||||||
Decrease in gross amounts of tax positions related to prior years | ( | ) | ( | ) | ||||||||
Decrease due to settlement with taxing authority | ( | ) | ||||||||||
Increase in gross amounts of tax positions related to current year | ||||||||||||
Decrease due to lapse in statute of limitations | ( | ) | ||||||||||
Unrecognized tax benefits at December 31 | $ | $ | $ | |||||||||
It is reasonably possible that over the next twelve months the amount of unrecognized tax benefits may change from the reevaluation of uncertain tax positions arising in examinations, in appeals, or in the courts, or from the closure of tax statutes. The Company does not expect any significant changes in unrecognized tax benefits during the next twelve months.
All of the Company’s unrecognized tax benefits, if recognized, would be recorded as a component of income tax expense, therefore, affecting the effective tax rate. The Company recognizes interest and penalties, if any, related to the liability for uncertain tax positions as a component of income tax expense. The accrual for interest and penalties was not material for all years presented.
F-69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company and its subsidiaries file income tax returns in the U.S. federal jurisdiction as well as in various states. In the normal course of business, the Company is subject to U.S. federal, state, and local income tax examinations by tax authorities. The Company is no longer subject to examination for tax years prior to 2016 including any related income tax filings from its recent acquisitions. The Company has been selected for audit in the state of New York for tax years 2015-2017.
F-70
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
At year-end 2019, the Company held derivatives with a total notional amount of $4.1 billion. The Company had economic hedges and non-hedging derivatives totaling $3.9 billion and $169 million, respectively, which are not designated as hedges for accounting purposes and are therefore recorded at fair value with changes in fair value recorded directly through earnings. Economic hedges included interest rate swaps totaling $3.3 billion, risk participation agreements with dealer banks of $315 million, and $237 million in forward commitment contracts. Forward sale commitments and commitments to lend are included in discontinued operations. See Note 3 - Discontinued Operations for more information on assets and liabilities classified as discontinued operations.
As part of the Company’s risk management strategy, the Company enters into interest rate swap agreements to mitigate the interest rate risk inherent in certain of the Company’s assets and liabilities. Interest rate swap agreements involve the risk of dealing with both Bank customers and institutional derivative counterparties and their ability to meet contractual terms. The agreements are entered into with counterparties that meet established credit standards and contain master netting and collateral provisions protecting the at-risk party. The derivatives program is overseen by the Risk Management Committee of the Company’s Board of Directors. Based on adherence to the Company’s credit standards and the presence of the netting and collateral provisions, the Company believes that the credit risk inherent in these contracts was not significant at December 31, 2019.
The Company pledged collateral to derivative counterparties in the form of cash totaling $96.3 million and securities with an amortized cost of $25.7 million and a fair value of $25.8 million at year-end 2019. At December 31, 2018, the Company pledged cash collateral of $25.4 million and securities with an amortized cost of $13.1 million and a fair value of $12.8 million. The Company does not typically require its commercial customers to post cash or securities as collateral on its program of back-to-back economic hedges. However certain language is written into the International Swaps Dealers Association, Inc. (“ISDA”) and loan documents where, in default situations, the Bank is allowed to access collateral supporting the loan relationship to recover any losses suffered on the derivative asset or liability. The Company may need to post additional collateral in the future in proportion to potential increases in unrealized loss positions.
Information about interest rate swap agreements and non-hedging derivative assets and liabilities at December 31, 2019 follows:
Notional Amount | Weighted Average Maturity | Weighted Average Rate | Estimated Fair Value Asset (Liability) | |||||||||||||
December 31, 2019 | Received | Contract pay rate | ||||||||||||||
(In thousands) | (In years) | (In thousands) | ||||||||||||||
Economic hedges: | ||||||||||||||||
Interest rate swap on tax advantaged economic development bond | $ | % | % | $ | ( | ) | ||||||||||
Interest rate swaps on loans with commercial loan customers | % | % | ||||||||||||||
Reverse interest rate swaps on loans with commercial loan customers | % | % | ( | ) | ||||||||||||
Risk participation agreements with dealer banks | ||||||||||||||||
Forward sale commitments (1) | ( | ) | ||||||||||||||
Total economic hedges | ( | ) | ||||||||||||||
Non-hedging derivatives: | ||||||||||||||||
Commitments to lend (1) | ||||||||||||||||
Total non-hedging derivatives | ||||||||||||||||
Total | $ | $ | ( | ) | ||||||||||||
(1) Includes the impact of discontinued operations.
F-71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Information about interest rate swap agreements and non-hedging derivative asset and liabilities at December 31, 2018 follows:
Notional Amount | Weighted Average Maturity | Weighted Average Rate | Estimated Fair Value Asset (Liability) | |||||||||||||
December 31, 2018 | Received | Contract pay rate | ||||||||||||||
(In thousands) | (In years) | (In thousands) | ||||||||||||||
Economic hedges: | ||||||||||||||||
Interest rate swap on tax advantaged economic development bond | $ | % | % | $ | ( | ) | ||||||||||
Interest rate swaps on loans with commercial loan customers | % | % | ||||||||||||||
Reverse interest rate swaps on loans with commercial loan customers | % | % | ( | ) | ||||||||||||
Risk participation agreements with dealer banks | ||||||||||||||||
Forward sale commitments (1) | ( | ) | ||||||||||||||
Total economic hedges | ( | ) | ||||||||||||||
Non-hedging derivatives: | ||||||||||||||||
Commitments to lend (1) | ||||||||||||||||
Total non-hedging derivatives | ||||||||||||||||
Total | $ | $ | ||||||||||||||
(1) Includes the impact of discontinued operations.
F-72
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cash Flow Hedges
In the first quarter of 2017, the Company maintained six interest rate swap contracts with an aggregate notional value of $300 million with original durations of three years . This hedge strategy converted one month rolling FHLB borrowings based on the FHLB’s one month fixed interest rate to fixed interest rates, thereby protecting the Company from floating interest rate variability.
On February 7, 2017, the Company terminated all of its interest rate swaps associated with FHLB borrowings with 1-month LIBOR based floating interest rates of an aggregate notional amount of $300 million. As of March 31, 2017, the Company no longer held the FHLB borrowings associated with the interest rate swaps. As a result, the Company reclassified $6.6 million of losses from the effective portion of the unrealized changes in the fair value of the terminated derivatives from other comprehensive income to non-interest income as the forecasted transactions to the related FHLB advances will not occur.c
Prior to the termination, the effective portion of unrealized changes in the fair value of derivatives accounted for as cash flow hedges was reported in other comprehensive income. Each quarter, the Company assessed the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged item or transaction. For the years ended December 31, 2019 and 2018, there was no hedge ineffectiveness on interest rate swaps designated as cash flow hedges.
Amounts included in the Consolidated Statements of Income and in the other comprehensive income section of the Consolidated Statements of Comprehensive Income (related to interest rate derivatives designated as hedges of cash flows), were as follows:
Years Ended December 31, | ||||||||||||
(In thousands) | 2019 | 2018 | 2017 | |||||||||
Interest rate swaps on FHLB borrowings: | ||||||||||||
Unrealized (loss) recognized in accumulated other comprehensive loss | $ | $ | $ | ( | ) | |||||||
Less: Reclassification of unrealized (loss) from accumulated other comprehensive loss to interest expense | ( | ) | ||||||||||
Less: reclassification of unrealized (loss) from accumulated other comprehensive income to other non-interest expense | ( | ) | ||||||||||
Net tax effect on items recognized in accumulated other comprehensive income | ( | ) | ||||||||||
Other comprehensive income recorded in accumulated other comprehensive income, net of reclassification adjustments and tax effects | $ | $ | $ | |||||||||
F-73
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Economic hedges
As of December 31, 2019 the Company has an interest rate swap with a $9.4 million notional amount to swap out the fixed rate of interest on an economic development bond bearing a fixed rate of 5.09 %, currently within the Company’s trading portfolio under the fair value option, in exchange for a LIBOR-based floating rate. The intent of the economic hedge is to improve the Company’s asset sensitivity to changing interest rates in anticipation of favorable average floating rates of interest over the 21 -year life of the bond. The fair value changes of the economic development bond are mostly offset by fair value changes of the related interest rate swap.
The Company also offers certain derivative products directly to qualified commercial borrowers. The Company economically hedges derivative transactions executed with commercial borrowers by entering into mirror-image, offsetting derivatives with third-party financial institutions. The transaction allows the Company’s customer to convert a variable-rate loan to a fixed rate loan. Because the Company acts as an intermediary for its customer, changes in the fair value of the underlying derivative contracts mostly offset each other in earnings. Credit valuation loss adjustments arising from the difference in credit worthiness of the commercial loan and financial institution counterparties totaled $1.2 million at year-end 2019. The interest income and expense on these mirror image swaps exactly offset each other.
The Company has risk participation agreements with dealer banks. Risk participation agreements occur when the Company participates on a loan and a swap where another bank is the lead. The Company earns a fee to take on the risk associated with having to make the lead bank whole on Berkshire’s portion of the pro-rated swap should the borrower default.
The Company utilizes forward sale commitments to hedge interest rate risk and the associated effects on the fair value of interest rate lock commitments and loans held for sale. The forward sale commitments are accounted for as derivatives with changes in fair value recorded in current period earnings. Forward sale commitments are
included in discontinued operations. See Note 3 - Discontinued Operations for more information on assets and
liabilities classified as discontinued operations.
The company uses the following types of forward sale commitments contracts:
• | Best efforts loan sales, |
• | Mandatory delivery loan sales, and |
• | To be announced (TBA) mortgage-backed securities sales. |
A best efforts contract refers to a loan sales agreement where the Company commits to deliver an individual mortgage loan of a specified principal amount and quality to an investor if the loan to the underlying borrower closes. The Company may enter into a best efforts contract once the price is known, which is shortly after the potential borrower’s interest rate is locked.
A mandatory delivery contract is a loan sales agreement where the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. Generally, the Company may enter into mandatory delivery contracts shortly after the loan closes with a customer.
The Company may sell to-be-announced mortgage-backed securities to hedge the changes in fair value of interest rate lock commitments and held for sale loans, which do not have corresponding best efforts or mandatory delivery contracts. These security sales transactions are closed once mandatory contracts are written. On the closing date the price of the security is locked-in, and the sale is paired-off with a purchase of the same security. Settlement of the security purchase/sale transaction is done with cash on a net-basis.
F-74
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Non-hedging derivatives
The Company enters into commitments to lend for residential mortgage loans, which commit the Company to lend funds to a potential borrower at a specific interest rate and within a specified period of time. Commitments that relate to the origination of mortgage loans that will be held for sale are considered derivative financial instruments under applicable accounting guidance. Outstanding commitments expose the Company to the risk that the price of the mortgage loans underlying the commitments may decline due to increases in mortgage interest rates from inception of the rate lock to the funding of the loan. The commitments are free-standing derivatives which are carried at fair value with changes recorded in non-interest income in the Company’s Consolidated Statements of Income. Changes in the fair value of commitments subsequent to inception are based on changes in the fair value of the underlying loan resulting from the fulfillment of the commitment and changes in the probability that the loan will fund within the terms of the commitment, which is affected primarily by changes in interest rates and the passage of time. Commitments to lend are included in discontinued operations. See Note 3 - Discontinued Operations for more information on assets and liabilities classified as discontinued operations.
Amounts included in the Consolidated Statements of Income related to economic hedges and non-hedging derivatives were as follows:
Years Ended December 31, | ||||||||||||
(In thousands) | 2019 | 2018 | 2017 | |||||||||
Economic hedges | ||||||||||||
Interest rate swap on industrial revenue bond: | ||||||||||||
Unrealized (loss)/gain recognized in other non-interest income | $ | ( | ) | $ | $ | |||||||
Interest rate swaps on loans with commercial loan customers: | ||||||||||||
Unrealized gain/(loss) recognized in other non-interest income | ( | ) | ||||||||||
(Unfavorable)/Favorable change in credit valuation adjustment recognized in other non-interest income | ( | ) | ( | ) | ( | ) | ||||||
Reverse interest rate swaps on loans with commercial loan customers: | ||||||||||||
Unrealized (loss)/gain recognized in other non-interest income | ( | ) | ( | ) | ||||||||
Risk Participation Agreements: | ||||||||||||
Unrealized gain/(loss) recognized in other non-interest income | ( | ) | ||||||||||
Forward Commitments: | ||||||||||||
Unrealized gain/(loss) recognized in discontinued operations | ( | ) | ( | ) | ||||||||
Realized (loss) in discontinued operations | ( | ) | ( | ) | ( | ) | ||||||
Non-hedging derivatives | ||||||||||||
Commitments to lend: | ||||||||||||
Unrealized (loss)/gain recognized in discontinued operations | $ | ( | ) | $ | $ | |||||||
Realized gain in discontinued operations | ||||||||||||
F-75
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Assets and Liabilities Subject to Enforceable Master Netting Arrangements
Interest Rate Swap Agreements (“Swap Agreements”)
The Company enters into swap agreements to facilitate the risk management strategies for commercial banking customers. The Company mitigates this risk by entering into equal and offsetting swap agreements with highly rated third party financial institutions. The swap agreements are free-standing derivatives and are recorded at fair value in the Company’s Consolidated Balance Sheets. The Company is party to master netting arrangements with its financial institution counterparties; however, the Company does not offset assets and liabilities under these arrangements for financial statement presentation purposes. The master netting arrangements provide for a single net settlement of all swap agreements, as well as collateral, in the event of default on, or termination of, any one contract. Collateral generally in the form of marketable securities is received or posted by the counterparty with net liability positions, respectively, in accordance with contract thresholds.
The Company had net asset positions with its financial institution counterparties totaling $0.6 million and $5.9 million as of December 31, 2019 and December 31, 2018, respectively. The Company had net asset positions with its commercial banking counterparties totaling $76.4 million and $21.2 million as of December 31, 2019 and December 31, 2018, respectively.
The Company had net liability positions with its financial institution counterparties totaling $78.8 million and $18.8 million as of December 31, 2019 and December 31, 2018, respectively. At December 31, 2019, the Company had net liability positions with its commercial banking counterparties totaling $1.1 million and $9.7 million as of December 31, 2019 and December 31, 2018, respectively. The collateral posted by the Company that covered liability positions was $122.1 million and $38.2 million as of December 31, 2019 and December 31, 2018, respectively.
The following table presents the assets and liabilities subject to an enforceable master netting arrangement as of December 31, 2019 and December 31, 2018 :
Offsetting of Financial Assets and Derivative Assets
Gross Amounts of Recognized Assets | Gross Amounts Offset in the Statements of Condition | Net Amounts of Assets Presented in the Statements of Condition | Gross Amounts Not Offset in the Statements of Condition | |||||||||||||||||||||
Financial Instruments | Cash Collateral Received | |||||||||||||||||||||||
(in thousands) | Net Amount | |||||||||||||||||||||||
As of December 31, 2019 | ||||||||||||||||||||||||
Interest Rate Swap Agreements: | ||||||||||||||||||||||||
Institutional counterparties | $ | $ | ( | ) | $ | $ | $ | $ | ||||||||||||||||
Commercial counterparties | ( | ) | ||||||||||||||||||||||
Total | $ | $ | ( | ) | $ | $ | $ | $ | ||||||||||||||||
Offsetting of Financial Liabilities and Derivative Liabilities
Gross Amounts of Recognized Liabilities | Gross Amounts Offset in the Statements of Condition | Net Amounts of Liabilities Presented in the Statement of Condition | Gross Amounts Not Offset in the Statements of Condition | |||||||||||||||||||||
Financial Instruments | Cash Collateral Received | |||||||||||||||||||||||
(in thousands) | Net Amount | |||||||||||||||||||||||
As of December 31, 2019 | ||||||||||||||||||||||||
Interest Rate Swap Agreements: | ||||||||||||||||||||||||
Institutional counterparties | $ | ( | ) | $ | $ | ( | ) | $ | $ | $ | ||||||||||||||
Commercial counterparties | ( | ) | ( | ) | ( | ) | ||||||||||||||||||
Total | $ | ( | ) | $ | $ | ( | ) | $ | $ | $ | ||||||||||||||
F-76
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Offsetting of Financial Assets and Derivative Assets
Gross Amounts of Recognized Assets | Gross Amounts Offset in the Statements of Condition | Net Amounts of Assets Presented in the Statements of Condition | Gross Amounts Not Offset in the Statements of Condition | |||||||||||||||||||||
Financial Instruments | Cash Collateral Received | |||||||||||||||||||||||
(in thousands) | Net Amount | |||||||||||||||||||||||
As of December 31, 2018 | ||||||||||||||||||||||||
Interest Rate Swap Agreements: | ||||||||||||||||||||||||
Institutional counterparties | $ | $ | ( | ) | $ | $ | $ | $ | ||||||||||||||||
Commercial counterparties | ( | ) | ||||||||||||||||||||||
Total | $ | $ | ( | ) | $ | $ | $ | $ | ||||||||||||||||
Offsetting of Financial Liabilities and Derivative Liabilities
Gross Amounts of Recognized Liabilities | Gross Amounts Offset in the Statements of Condition | Net Amounts of Liabilities Presented in the Statement of Condition | Gross Amounts Not Offset in the Statements of Condition | ||||||||||||||||||||
Financial Instruments | Cash Collateral Received | ||||||||||||||||||||||
(in thousands) | Net Amount | ||||||||||||||||||||||
As of December 31, 2018 | |||||||||||||||||||||||
Interest Rate Swap Agreements: | |||||||||||||||||||||||
Institutional counterparties | $ | ( | ) | $ | $ | ( | ) | $ | $ | $ | |||||||||||||
Commercial counterparties | ( | ) | ( | ) | ( | ) | |||||||||||||||||
Total | $ | ( | ) | $ | $ | ( | ) | $ | $ | $ | |||||||||||||
F-77
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18. LEASES
A lease is defined as a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. On January 1, 2019, the Company adopted ASU No. 2016-02, “Leases (Topic 842)” and all subsequent ASUs that modified Topic 842. For the Company, Topic 842 primarily affected the accounting treatment for operating lease agreements in which the Company is the lessee. See Note 1 - Summary of Significant Accounting Policies to the Consolidated Financial Statements regarding transition guidance related to the new standard.
Substantially all of the leases in which the Company is the lessee are comprised of real estate property for branches, ATM locations, and office space. Most of the Company’s leases are classified as operating leases, and therefore, were previously not recognized on the Company’s Consolidated Balance Sheets. With the adoption of Topic 842, operating lease agreements are required to be recognized on the Consolidated Balance Sheets as a right-of-use (“ROU”) asset and a corresponding lease liability. The Company’s finance leases (previously referred to as a capital lease) was previously required to be recorded on the Company’s Consolidated Balance Sheets. As these leases were previously required to be recorded on the Company’s Consolidated Balance Sheets, Topic 842 did not materially impact the accounting for the leases.
ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the obligation to make lease payments arising from the lease. ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. In determining the present value of lease payments, the Company utilized the implicit lease rate when readily determinable. As most of the Company’s leases do not provide an implicit rate, the Company used our incremental borrowing rate based on the information available at commencement date. The incremental borrowing rate is the rate of interest that the Company would have to pay to borrow on a collateralized basis over a similar term in an amount equal to the lease payments in a similar economic environment. The weighted average discount rate used to discount operating lease liabilities and finance lease liabilities at December 31, 2019 was 3.36 % and 5.00 %, respectively.
The Company made a policy election to exclude the recognition requirements of Topic 842 to all classes of leases with original terms of 12 months or less. Instead, the short-term lease payments are recognized in profit or loss on a straight-line basis over the lease term. At December 31, 2019 lease expiration dates ranged from 1 month to 21 years. The weighted average remaining lease term for operating and finance leases at December 31, 2019 was 10.3 years and 14.8 years, respectively.
The following table represents the Consolidated Balance Sheets classification of the Company’s ROU assets and lease liabilities:
(In thousands) | December 31, 2019 | |||||
Lease Right-of-Use Assets | Classification | |||||
Operating lease right-of-use assets (1) | Other assets | $ | ||||
Finance lease right-of-use assets | Premises and equipment, net | |||||
Total Lease Right-of-Use Assets | $ | |||||
Lease Liabilities | ||||||
Operating lease liabilities (1) | Other liabilities | $ | ||||
Finance lease liabilities | Other liabilities | |||||
Total Lease Liabilities | $ | |||||
(1) Includes $3.5 million of operating lease right-of-use assets and $3.5 million of operating lease liabilities classified as discontinued operations.
F-78
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company has lease agreements with lease and non-lease components, which are generally accounted for separately. For real estate leases, non-lease components and other non-components, such as common area maintenance charges, real estate taxes, and insurance are not included in the measurement of the lease liability since they are generally able to be segregated.
The Company does not have any material sub-lease agreements.
Lease expense for operating leases for the year ended December 31, 2019 was $14.4 million, of which $2.8 million was related to FCLS and is reported as discontinued operations. Variable lease components, such as consumer price index adjustments, are expensed as incurred and not included in ROU assets and operating lease liabilities.
Supplemental cash flow information related to leases was as follows:
Year Ended | ||||
(In thousands) | December 31, 2019 | |||
Cash paid for amounts included in the measurement of lease liabilities: | ||||
Operating cash flows from operating leases (1) | $ | |||
Operating cash flows from finance leases | ||||
Financing cash flows from finance leases | ||||
Right-of-use assets obtained in exchange for lease obligations: | ||||
Operating leases (1) | ||||
Finance leases | ||||
(1) Includes operating cash flows from operating leases of $2.8 million related to discontinued operations.
The following table presents a maturity analysis of the Company’s lease liability by lease classification at December 31, 2019:
(In thousands) | Operating Leases | Finance Leases | ||||||
2020 | $ | $ | ||||||
2021 | ||||||||
2022 | ||||||||
2023 | ||||||||
2024 | ||||||||
Thereafter | ||||||||
Total undiscounted lease payments (1) | ||||||||
Less amounts representing interest (1) | ( | ) | ( | ) | ||||
Lease liability (1) | $ | $ | ||||||
(1) Includes $3.5 million of discontinued operations.
F-79
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 19. OTHER COMMITMENTS, CONTINGENCIES, AND OFF-BALANCE SHEET ACTIVITIES
Credit Related Financial Instruments. The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit, and interest rate risk in excess of the amount recognized in the accompanying Consolidated Balance Sheets.
The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument is represented by the contractual amount of these commitments. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments. A summary of financial instruments outstanding whose contract amounts represent credit risk is as follows at year-end:
(In thousands) | 2019 | 2018 | ||||||
Commitments to originate new loans (1) | $ | $ | ||||||
Unused funds on commercial and other lines of credit | ||||||||
Unadvanced funds on home equity lines of credit | ||||||||
Unadvanced funds on construction and real estate loans | ||||||||
Standby letters of credit | ||||||||
Total | $ | $ | ||||||
(1) Includes discontinued operations of $132.7 million and $134.5 million for 2019 and 2018, respectively.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These letters of credit are primarily issued to support borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company considers standby letters of credit to be guarantees and the amount of the recorded liability related to such guarantees was not material at year-end 2019 and 2018.
Employment and Change in Control Agreements. The Company and the Bank have change in control agreements with several officers which provide a severance payment in the event employment is terminated in conjunction with a defined change in control.
Legal Claims. Various legal claims arise from time to time in the normal course of business. As of December 31, 2019, neither the Company nor the Bank was involved in any pending legal proceedings believed by management to be material, that are not accrued for, to the Company’s financial condition or results of operations. As of December 31, 2019, the Company had litigation accrual of $2.0 million. As of December 31, 2018, the Company had litigation accrual of $3.0 million.
F-80
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 20. SHAREHOLDERS’ EQUITY AND EARNINGS PER COMMON SHARE
Minimum Regulatory Capital Requirements
The Company and Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if imposed, could have a direct material impact on the Company’s Consolidated Financial Statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital to average assets (as defined). As of year-end 2019 and 2018, the Bank and the Company met the capital adequacy requirements. Regulators may set higher expected capital requirements in some cases based on their examinations.
Effective January 1, 2015, the Company and the Bank became subject to the Basel III rule that requires the Company and the Bank to assess their Common equity tier 1 capital to risk weighted assets and the Company and the Bank each exceed the minimum to be well capitalized. In addition, the final capital rules added mechanism for the maintenance of a conservation buffer, composed of Common equity tier 1 capital, of 2.5% of risk-weighted assets, to be phased in over three years and applied to the Common equity tier 1 risk-based capital ratio, the Tier 1 risk-based capital ratio and the Total risk-based capital ratio. Accordingly, banking organizations, on a fully phased in basis no later than January 1, 2019, must maintain a minimum Common equity tier 1 risk-based capital ratio of 7.0%, a minimum Tier 1 risk-based capital ratio of 8.5%, and a minimum Total risk-based capital ratio of 10.5%. The required minimum conservation buffer began to be phased in incrementally, starting at 0.625% on January 1, 2016, increased to 1.25% on January 1, 2017, increased to 1.875% on January 1, 2018 and increased to 2.5% on January 1, 2019. The final capital rules impose restrictions on capital distributions and certain discretionary cash bonus payments if the minimum capital conservation buffer is not met.
At December 31, 2019, the capital levels of both the Company and the Bank exceeded all regulatory capital requirements and their regulatory capital ratios were above the minimum levels. The capital levels of both the Company and the Bank at December 31, 2018 also exceeded the minimum capital requirements including the currently applicable capital conservation buffer of 1.875%.
As of year-end 2019 and 2018, the Bank met the conditions to be classified as “well capitalized” under the relevant regulatory framework. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following tables.
F-81
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company and Bank’s actual and required capital amounts were as follows:
Minimum Capital Requirement | Minimum to be Well Capitalized Under Prompt Corrective Action Provisions | ||||||||||||||||||||
Actual | |||||||||||||||||||||
(Dollars in thousands) | Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||
December 31, 2019 | |||||||||||||||||||||
Company (Consolidated) | |||||||||||||||||||||
Total capital to risk-weighted assets | $ | % | $ | % | N/A | N/A | |||||||||||||||
Common Equity Tier 1 Capital to risk weighted assets | N/A | N/A | |||||||||||||||||||
Tier 1 capital to risk-weighted assets | N/A | N/A | |||||||||||||||||||
Tier 1 capital to average assets | N/A | N/A | |||||||||||||||||||
Bank | |||||||||||||||||||||
Total capital to risk-weighted assets | $ | % | $ | % | $ | % | |||||||||||||||
Common Equity Tier 1 Capital to risk weighted assets | |||||||||||||||||||||
Tier 1 capital to risk-weighted assets | |||||||||||||||||||||
Tier 1 capital to average assets | |||||||||||||||||||||
December 31, 2018 | |||||||||||||||||||||
Company (Consolidated) | |||||||||||||||||||||
Total capital to risk-weighted assets | $ | % | $ | % | N/A | N/A | |||||||||||||||
Common Equity Tier 1 Capital to risk weighted assets | N/A | N/A | |||||||||||||||||||
Tier 1 capital to risk-weighted assets | N/A | N/A | |||||||||||||||||||
Tier 1 capital to average assets | N/A | N/A | |||||||||||||||||||
Bank | |||||||||||||||||||||
Total capital to risk-weighted assets | $ | % | $ | % | $ | % | |||||||||||||||
Common Equity Tier 1 Capital to risk weighted assets | |||||||||||||||||||||
Tier 1 capital to risk-weighted assets | |||||||||||||||||||||
Tier 1 capital to average assets | |||||||||||||||||||||
F-82
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Common stock
The Bank is subject to dividend restrictions imposed by various regulators, including a limitation on the total of all dividends that the Bank may pay to the Company in any calendar year. The total of all dividends shall not exceed the Bank’s net income for the current year (as defined by statute), plus the Bank’s net income retained for the two previous years, without regulatory approval. Dividends from the Bank are an important source of funds to the Company to make dividend payments on its common and preferred stock, to make payments on its borrowings, and for its other cash needs. The ability of the Company and the Bank to pay dividends is dependent on regulatory policies and regulatory capital requirements. The ability to pay such dividends in the future may be adversely affected by new legislation or regulations, or by changes in regulatory policies relating to capital, safety and soundness, and other regulatory concerns.
The payment of dividends by the Company is subject to Delaware law, which generally limits dividends to an amount equal to an excess of the net assets of a company (the amount by which total assets exceed total liabilities) over statutory capital, or if there is no excess, to the Company’s net profits for the current and/or immediately preceding fiscal year.
Preferred stock
The Company previously issued Series B Non-Voting Preferred Stock. Each preferred share is convertible into two shares of the Company's common stock under specified conditions. The shares are considered participating, but do not maintain preferential treatment over common shares. Proportional dividends on the preferred shares are not payable unless also declared for common shares. As of year-end 2019, 522 thousand preferred shares were issued and outstanding.
Accumulated other comprehensive income
Year-end components of accumulated other comprehensive (loss)/income are as follows:
(In thousands) | 2019 | 2018 | ||||||
Other accumulated comprehensive income/(loss), before tax: | ||||||||
Net unrealized holding gain/(loss) on AFS securities | $ | $ | ( | ) | ||||
Net unrealized holding (loss) on pension plans | ( | ) | ( | ) | ||||
Income taxes related to items of accumulated other comprehensive (loss)/income: | ||||||||
Net unrealized holding (gain)/loss on AFS securities | ( | ) | ||||||
Net unrealized holding loss on pension plans | ||||||||
Accumulated other comprehensive income/(loss) | $ | $ | ( | ) | ||||
F-83
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the components of other comprehensive (loss)/income for the years ended December 31, 2019, 2018, and 2017:
(In thousands) | Before Tax | Tax Effect | Net of Tax | |||||||||
Year Ended December 31, 2019 | ||||||||||||
Net unrealized holding gain on AFS securities: | ||||||||||||
Net unrealized gain arising during the period | $ | $ | ( | ) | $ | |||||||
Less: reclassification adjustment for gains realized in net income | ( | ) | ||||||||||
Net unrealized holding gain on AFS securities | ( | ) | ||||||||||
Net unrealized holding (loss) on pension plans | ||||||||||||
Net unrealized (loss) arising during the period | ( | ) | ( | ) | ||||||||
Less: reclassification adjustment for (losses) realized in net income | ||||||||||||
Net unrealized holding (loss) on pension plans | ( | ) | ( | ) | ||||||||
Other comprehensive gain | $ | $ | ( | ) | $ | |||||||
(In thousands) | Before Tax | Tax Effect | Net of Tax | |||||||||
Year Ended December 31, 2018 | ||||||||||||
Net unrealized holding (loss) on AFS securities: | ||||||||||||
Net unrealized (loss) arising during the period | $ | ( | ) | $ | $ | ( | ) | |||||
Less: reclassification adjustment for gains realized in net income | ( | ) | ||||||||||
Net unrealized holding (loss) on AFS securities | ( | ) | ( | ) | ||||||||
Net unrealized holding (loss) on pension plans | ||||||||||||
Net unrealized gain arising during the period | ( | ) | ||||||||||
Less: reclassification adjustment for (losses) realized in net income | ( | ) | ( | ) | ||||||||
Net unrealized holding gain on pension plans | ( | ) | ||||||||||
Other comprehensive (loss) | $ | ( | ) | $ | $ | ( | ) | |||||
Less: reclassification related to adoption of ASU 2016-01 | ( | ) | ||||||||||
Less: reclassification related to adoption of ASU 2018-02 | ( | ) | ( | ) | ||||||||
Total change to accumulated other comprehensive (loss) | $ | ( | ) | $ | $ | ( | ) | |||||
(In thousands) | Before Tax | Tax Effect | Net of Tax | |||||||||
Year Ended December 31, 2017 | ||||||||||||
Net unrealized holding gain on AFS securities: | ||||||||||||
Net unrealized (loss) arising during the period | $ | ( | ) | $ | $ | ( | ) | |||||
Less: reclassification adjustment for gains realized in net income | ( | ) | ||||||||||
Net unrealized holding gain on AFS securities | ( | ) | ( | ) | ||||||||
Net (loss) on cash flow hedging derivatives: | ||||||||||||
Net unrealized (loss) arising during the period | ( | ) | ( | ) | ||||||||
Less: reclassification adjustment for (losses) realized in net income | ( | ) | ( | ) | ||||||||
Net gain on cash flow hedging derivatives | ( | ) | ||||||||||
Net unrealized holding (loss) on pension plans | ||||||||||||
Net unrealized (loss) arising during the period | ( | ) | ( | ) | ||||||||
Less: reclassification adjustment for (losses) realized in net income | ( | ) | ( | ) | ||||||||
Net unrealized holding (losses) on pension plans | ( | ) | ( | ) | ||||||||
Other comprehensive (loss) | $ | ( | ) | $ | $ | ( | ) | |||||
F-84
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the changes in each component of accumulated other comprehensive (loss)/income, for the years ended December 31, 2019, 2018, and 2017:
(in thousands) | Net unrealized holding gain (loss) on AFS Securities | Net loss on effective cash flow hedging derivatives | Net unrealized holding gain (loss) on pension plans | Total | ||||||||||||
Year Ended December 31, 2019 | ||||||||||||||||
Balance at Beginning of Year | $ | ( | ) | $ | $ | ( | ) | $ | ( | ) | ||||||
Other comprehensive gain/(loss) before reclassifications | ( | ) | ||||||||||||||
Amounts reclassified from accumulated other comprehensive income | ||||||||||||||||
Total other comprehensive (loss)/income | ( | ) | ||||||||||||||
Balance at End of Period | $ | $ | $ | ( | ) | $ | ||||||||||
Year Ended December 31, 2018 | ||||||||||||||||
Balance at Beginning of Year | $ | $ | $ | ( | ) | $ | ||||||||||
Other comprehensive gain/(loss) before reclassifications | ( | ) | ( | ) | ||||||||||||
Amounts reclassified from accumulated other comprehensive income | ( | ) | ( | ) | ||||||||||||
Total other comprehensive (loss)/income | ( | ) | ( | ) | ||||||||||||
Less: amounts reclassified from accumulated other comprehensive income (loss) related to adoption of ASU 2016-01 and ASU 2018-02 | ||||||||||||||||
Balance at End of Period | $ | ( | ) | $ | $ | ( | ) | $ | ( | ) | ||||||
Year Ended December 31, 2017 | ||||||||||||||||
Balance at Beginning of Year | $ | $ | ( | ) | $ | ( | ) | $ | ||||||||
Other comprehensive gain/(loss) Before reclassifications | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||
Amounts reclassified from accumulated other comprehensive income | ( | ) | ( | ) | ||||||||||||
Total other comprehensive income | ( | ) | ( | ) | ( | ) | ||||||||||
Balance at End of Period | $ | $ | $ | ( | ) | $ | ||||||||||
F-85
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table presents the amounts reclassified out of each component of accumulated other comprehensive (loss)/income for the years ended December 31, 2019, 2018, and 2017:
Affected Line Item in the Statement Where Net Income Is Presented | ||||||||||||||
Years Ended December 31, | ||||||||||||||
(in thousands) | 2019 | 2018 | 2017 | |||||||||||
Realized gains/(losses) on AFS securities: | ||||||||||||||
$ | $ | $ | Non-interest income | |||||||||||
( | ) | ( | ) | ( | ) | Tax expense | ||||||||
Realized (losses) on cash flow hedging derivatives: | ||||||||||||||
( | ) | Interest expense | ||||||||||||
( | ) | Non-interest income | ||||||||||||
Non-interest expense | ||||||||||||||
Tax benefit | ||||||||||||||
( | ) | |||||||||||||
Realized (losses) on pension plans | ||||||||||||||
( | ) | ( | ) | Non-interest expense | ||||||||||
Tax expense | ||||||||||||||
( | ) | ( | ) | |||||||||||
Total reclassifications for the period | $ | $ | ( | ) | $ | |||||||||
F-86
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Earnings Per Common Share
Basic earnings per common share (“EPS”) excludes dilution and is computed by dividing net income applicable to common stock by the weighted average number of common shares outstanding for the year. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock (such as stock options) were exercised or converted into additional common shares that would then share in the earnings of the entity. Diluted EPS is computed by dividing net income applicable to common stock by the weighted average number of common shares outstanding for the year, plus an incremental number of common-equivalent shares computed using the treasury stock method.
Earnings per common share has been computed based on the following (average diluted shares outstanding is calculated using the treasury stock method):
Years Ended December 31, | ||||||||||||
(In thousands, except per share data) | 2019 | 2018 | 2017 | |||||||||
Net income from continuing operations | $ | $ | $ | |||||||||
Net (loss)/income from discontinued operations | ( | ) | ( | ) | ||||||||
Net income | $ | $ | $ | |||||||||
Average number of common shares issued | ||||||||||||
Less: average number of treasury shares | ||||||||||||
Less: average number of unvested stock award shares | ||||||||||||
Plus: average participating preferred shares | ||||||||||||
Average number of basic common shares outstanding | ||||||||||||
Plus: dilutive effect of unvested stock award shares | ||||||||||||
Plus: dilutive effect of stock options outstanding | ||||||||||||
Average number of diluted common shares outstanding | ||||||||||||
Basic earnings per share: | ||||||||||||
Continuing Operations | $ | $ | $ | |||||||||
Discontinued operations | ( | ) | ( | ) | ||||||||
Basic earning per common share | $ | $ | $ | |||||||||
Diluted earnings per share: | ||||||||||||
Continuing Operations | $ | $ | $ | |||||||||
Discontinued operations | ( | ) | ( | ) | ||||||||
Diluted earnings per common share | $ | $ | $ | |||||||||
For the year ended 2019, 61 thousand options were anti-dilutive and therefore excluded from the earnings per share calculations. For the year ended 2018, 38 thousand options were anti-dilutive and therefore excluded from the earnings per share calculations. For the year ended 2017, 55 thousand options were anti-dilutive and therefore excluded from the earnings per share calculations.
F-87
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 21. STOCK-BASED COMPENSATION PLANS
The 2018 Equity Incentive Plan (the “2018 Plan”) permits the granting of a combination of Restricted Stock awards and incentive and non-qualified stock options (“Stock Options”) to employees and directors. A total of 1.0 million shares was authorized under the Plan. Awards may be granted as either Restricted Stock or Stock Options provided that any shares that are granted as Restricted Stock are counted against the share limit set forth as (1) three for every one share of Restricted Stock granted and (2) one for every one share of Stock Option granted. As of the 2018 Plan's effective date, all expired, canceled, and forfeited shares under the 2013 Plan are included in the 2018 Plan's available shares. As of year-end 2019, the Company had the ability to grant approximately 1.1 million shares under this plan.
A summary of activity in the Company’s stock compensation plans is shown below:
Non-vested Stock Awards Outstanding | Stock Options Outstanding | |||||||||||||
(Shares in thousands) | Number of Shares | Weighted- Average Grant Date Fair Value | Number of Shares | Weighted- Average Exercise Price | ||||||||||
Balance, December 31, 2018 | $ | $ | ||||||||||||
Granted | ||||||||||||||
Acquired | — | — | ||||||||||||
Stock options exercised | — | — | ( | ) | ||||||||||
Stock awards vested | ( | ) | — | — | ||||||||||
Forfeited | ( | ) | ||||||||||||
Expired | — | — | ||||||||||||
Balance, December 31, 2019 | $ | $ | ||||||||||||
Stock Awards
The total compensation cost for stock awards recognized as expense was $4.8 million, $4.8 million, and $5.3 million, in the years 2019, 2018, and 2017, respectively. The total recognized tax benefit associated with this compensation cost was $1.3 million, $1.3 million, and $2.0 million, respectively.
The weighted average fair value of stock awards granted was $29.47 , $37.87 , and $35.84 in 2019, 2018, and 2017, respectively. Stock awards vest over periods up to five years and are valued at the closing price of the stock on the grant date. Certain awards vest based on the Company's performance over established measurement periods. The total fair value of stock awards vested during 2019, 2018, and 2017 was $4.8 million, $4.8 million, and $4.4 million respectively. The unrecognized stock-based compensation expense related to unvested stock awards was $8.5 million as of year-end 2019. This amount is expected to be recognized over a weighted average period of two years .
F-88
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Option Awards
Option awards are granted with an exercise price equal to the market price of the Company’s stock at the date of grant, and vest over periods up to five years . The options grant the holder the right to acquire a share of the Company’s common stock for each option held, and have a contractual life of ten years . As of year-end 2019, the weighted average remaining contractual term for options outstanding is two years .
The Company generally issues shares from treasury stock as options are exercised. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model. The expected dividend yield and expected term are based on management estimates. The expected volatility is based on historical volatility. The risk-free interest rates for the expected term are based on the U.S. Treasury yield curve in effect at the time of the grant. The Company acquired options in the SI Financial Group transaction in 2019, but did not grant additional options during the year. The Company did not grant options during 2018 or 2017.
The total intrinsic value of options exercised was $149 thousand, $855 thousand, and $363 thousand for the years 2019, 2018, and 2017, respectively. During 2019, the expense pertaining to options vesting was $93 thousand. There was no expense pertaining to options vesting in 2018 or 2017. The tax benefit associated with stock option expense in 2019 was $25 thousand. There was no tax benefit associated with stock option expense in 2018 or 2017. The unrecognized stock-based compensation expense related to unvested stock options as of year-end 2019 was $124 thousand. There was no unrecognized stock-based compensation expense related to unvested stock options as of year-ends 2018 and 2017.
F-89
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 22. FAIR VALUE MEASUREMENTS
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of the Company’s financial assets and financial liabilities that are carried at fair value, including assets classified as discontinued operations on the consolidated balance sheets. See Note 3 - Discontinued Operations for more information on assets and liabilities classified as discontinued operations.
Recurring Fair Value Measurements of Financial Instruments
The following table summarizes assets and liabilities measured at fair value on a recurring basis as of year-end 2019 and 2018 segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
December 31, 2019 | ||||||||||||||||
(In thousands) | Level 1 Inputs | Level 2 Inputs | Level 3 Inputs | Total Fair Value | ||||||||||||
Trading security | $ | $ | $ | $ | ||||||||||||
Available-for-sale securities: | ||||||||||||||||
Municipal bonds and obligations | ||||||||||||||||
Agency collateralized mortgage obligations | ||||||||||||||||
Agency residential mortgage-backed securities | ||||||||||||||||
Agency commercial mortgage-backed securities | ||||||||||||||||
Corporate bonds | ||||||||||||||||
Other bonds and obligations | ||||||||||||||||
Marketable equity securities | ||||||||||||||||
Loans held for sale (1) | ||||||||||||||||
Derivative assets (1) | ||||||||||||||||
Capitalized servicing rights (1) | ||||||||||||||||
Derivative liabilities (1) | ||||||||||||||||
(1) Includes assets and liabilities classified as discontinued operations.
December 31, 2018 | ||||||||||||||||
(In thousands) | Level 1 Inputs | Level 2 Inputs | Level 3 Inputs | Total Fair Value | ||||||||||||
Trading security | $ | $ | $ | $ | ||||||||||||
Available-for-sale securities: | ||||||||||||||||
Municipal bonds and obligations | ||||||||||||||||
Agency collateralized mortgage obligations | ||||||||||||||||
Agency residential mortgage-backed securities | ||||||||||||||||
Agency commercial mortgage-backed securities | ||||||||||||||||
Corporate bonds | ||||||||||||||||
Other bonds and obligations | ||||||||||||||||
Marketable equity securities | ||||||||||||||||
Loans held for sale (1) | ||||||||||||||||
Derivative assets (1) | ||||||||||||||||
Capitalized servicing rights (1) | ||||||||||||||||
Derivative liabilities (1) | ||||||||||||||||
(1) Includes assets and liabilities classified as discontinued operations.
F-90
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
During the year ended December 31, 2019, the Company had four transfers totaling $44.0 million in corporate bonds from Level 2 to Level 3 based on recent inactivity in the market related to pricing information for similar bonds. There were no transfers between Level 1, 2, and 3 during the years ended December 31, 2018 and 2017.
Trading Security at Fair Value. The Company holds one security designated as a trading security. It is a tax advantaged economic development bond issued to the Company by a local nonprofit which provides wellness and health programs. The determination of the fair value for this security is determined based on a discounted cash flow methodology. Certain inputs to the fair value calculation are unobservable and there is little to no market activity in the security; therefore, the security meets the definition of a Level 3 security. The discount rate used in the valuation of the security is sensitive to movements in the 3-month LIBOR rate.
Securities Available for Sale and Marketable Equity Securities. Marketable equity securities classified as Level 1 consist of publicly-traded equity securities for which the fair values can be obtained through quoted market prices in active exchange markets. Marketable equity securities classified as Level 2 consist of securities with infrequent trades in active exchange markets, and pricing is primarily sourced from third party pricing services. AFS securities classified as Level 2 include most of the Company’s debt securities. The pricing on Level 2 and Level 3 was primarily sourced from third party pricing services, overseen by management, and is based on models that consider standard input factors such as dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bond’s terms and condition, among other things. Level 3 pricing includes inputs unobservable to market participants.
Loans held for sale. The Company elected the fair value option for all mortgage loans originated for sale (HFS) that were originated for sale on or after May 1, 2012. Loans HFS are classified as Level 2 as the fair value is based on input factors such as quoted prices for similar loans in active markets.
Aggregate Fair Value | Aggregate Unpaid Principal | Aggregate Fair Value Less Aggregate Unpaid Principal | ||||||||||
December 31, 2019 (In thousands) | ||||||||||||
Loans held for sale - continuing operations | $ | $ | $ | |||||||||
Loans held for sale - discontinued operations | ||||||||||||
Loans Held for Sale | $ | $ | $ | |||||||||
Aggregate Fair Value | Aggregate Unpaid Principal | Aggregate Fair Value Less Aggregate Unpaid Principal | ||||||||||
December 31, 2018 (In thousands) | ||||||||||||
Loans held for sale - continuing operations | $ | $ | $ | |||||||||
Loans held for sale - discontinued operations | ||||||||||||
Loans Held for Sale | $ | $ | $ | |||||||||
The changes in fair value of loans held for sale for years ended December 31, 2019, were gains of $97 thousand from continuing operations and losses of $138 thousand from discontinued operations. The changes in fair value of loans held for sale for years ended December 31, 2018, were losses of $61 thousand from continuing operations and $1.3 million from discontinued operations. During 2019, originations of loans held for sale from continuing operations totaled $67 million and sales of loans originated for sale from continuing operations totaled $62 million. During 2019, originations of loans held for sale from discontinued operations totaled $2.9 billion and sales of loans originated for sale from discontinued operations totaled $2.8 billion. During 2018, originations of loans held for sale from continuing operations totaled $55 million and sales of loans originated for sale from continuing operations totaled $55 million. During 2018, originations of loans held for sale from discontinued operations totaled $1.9 billion and sales of loans originated for sale from discontinued operations totaled $2.0 billion.
Interest Rate Swaps. The valuation of the Company’s interest rate swaps is obtained from a third-party pricing service and is determined using a discounted cash flow analysis on the expected cash flows of each derivative. The pricing analysis is based on observable inputs for the contractual terms of the derivatives, including the period to maturity and interest rate curves.
F-91
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings.
Although the Company has determined that the majority of the inputs used to value its interest rate derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of year-end 2019, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.
Commitments to Lend. The Company enters into commitments to lend for residential mortgage loans intended for sale, which commit the Company to lend funds to a potential borrower at a certain interest rate and within a specified period of time. The estimated fair value of commitments to originate residential mortgage loans for sale is based on quoted prices for similar loans in active markets. However, this value is adjusted by a factor which considers the likelihood that the loan commitment will ultimately close, and by the non-refundable costs of originating the loan. The closing ratio is derived from the Bank’s internal data and is adjusted using significant management judgment. The costs to originate are primarily based on the Company’s internal commission rates that are not observable. As such, these commitments to lend are classified as Level 3 measurements. Commitments to lend are included in discontinued operations. See Note 3 - Discontinued Operations for more information on assets and liabilities classified as discontinued operations.
Forward Sale Commitments. The Company utilizes forward sale commitments as economic hedges against potential changes in the values of the commitments to lend and loans originated for sale. To be announced (TBA) mortgage-backed securities forward commitment sales are used as hedging instruments, are classified as Level 1, and consist of publicly-traded debt securities for which identical fair values can be obtained through quoted market prices in active exchange markets. The fair values of the Company’s best efforts and mandatory delivery loan sale commitments are determined similarly to the commitments to lend using quoted prices in the market place that are observable. However, costs to originate and closing ratios included in the calculation are internally generated and are based on management’s judgment and prior experience, which are considered factors that are not observable. As such, best efforts and mandatory forward sale commitments are classified as Level 3 measurements. Forward sale commitments are included in discontinued operations. See Note 3 - Discontinued Operations for more information on assets and liabilities classified as discontinued operations.
Capitalized Servicing Rights. The Company accounts for certain capitalized servicing rights at fair value in its Consolidated Financial Statements, as the Company is permitted to elect the fair value option for each specific instrument. A loan servicing right asset represents the amount by which the present value of the estimated future net cash flows to be received from servicing loans exceed adequate compensation for performing the servicing. The fair value of servicing rights is estimated using a present value cash flow model. The most important assumptions used in the valuation model are the anticipated rate of the loan prepayments and discount rates. Although some assumptions in determining fair value are based on standards used by market participants, some are based on unobservable inputs and therefore are classified in Level 3 of the valuation hierarchy. Capitalized servicing rights
held at fair value are included in discontinued operations on the consolidated balance sheet. See Note 3 -
Discontinued Operations for more information on assets and liabilities classified as discontinued operations.
F-92
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The table below presents the changes in Level 3 assets that were measured at fair value on a recurring basis at year-end 2019 and 2018:
Assets (Liabilities) | ||||||||||||||||||||
(In thousands) | Trading Security | Securities Available for Sale | Commitments to Lend (1) | Forward Commitments (1) | Capitalized Servicing Rights (1) | |||||||||||||||
Balance as of December 31, 2017 | $ | $ | $ | $ | $ | |||||||||||||||
Unrealized (loss), net recognized in other non-interest income | ( | ) | — | |||||||||||||||||
Unrealized gain/(loss), net recognized in discontinued operations | — | — | ( | ) | ||||||||||||||||
Paydown of trading security | ( | ) | — | — | — | — | ||||||||||||||
Transfers to loans held for sale | — | — | ( | ) | — | — | ||||||||||||||
Additions to servicing rights | ||||||||||||||||||||
Balance as of December 31, 2018 | $ | $ | $ | $ | $ | |||||||||||||||
Unrealized (loss) gain, net recognized in other non-interest income | — | |||||||||||||||||||
Unrealized gain/(loss), net recognized in discontinued operations | — | — | — | ( | ) | |||||||||||||||
Unrealized (loss) included in accumulated other comprehensive loss | — | ( | ) | — | — | — | ||||||||||||||
Transfers to Level 3 | — | — | — | — | ||||||||||||||||
Paydown of trading security | ( | ) | — | — | — | — | ||||||||||||||
Transfers to loans held for sale | — | — | ( | ) | — | — | ||||||||||||||
Additions to servicing rights | — | — | — | — | ||||||||||||||||
Balance as of December 31, 2019 | $ | $ | $ | $ | $ | |||||||||||||||
Unrealized gains/(losses) relating to instruments still held at December 31, 2019 | $ | $ | ( | ) | $ | $ | $ | |||||||||||||
Unrealized gains/(losses) relating to instruments still held at December 31, 2018 | $ | $ | $ | $ | $ | |||||||||||||||
(1) Classified as assets from discontinued operations on the consolidated balance sheets.
F-93
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Quantitative information about the significant unobservable inputs within Level 3 recurring assets/(liabilities) as of December 31, 2019 and 2018 are as follows:
Fair Value | Significant Unobservable Input Value | |||||||||||
(In thousands) | December 31, 2019 | Valuation Techniques | Unobservable Inputs | |||||||||
Assets | ||||||||||||
Trading Security | $ | Discounted Cash Flow | Discount Rate | % | ||||||||
Securities Available for Sale | Indication from Market Maker | Price | 97.00 - 100.00 | |||||||||
Commitments to Lend (1) | Historical Trend | Closing Ratio | % | |||||||||
Pricing Model | Origination Costs, per loan | $ | ||||||||||
Capitalized Servicing Rights (1) | Discounted cash flow | Constant prepayment rate (CPR) | % | |||||||||
Discount rate | % | |||||||||||
Total | $ | |||||||||||
(1) Classified as assets from discontinued operations on the consolidated balance sheets.
Fair Value | Significant Unobservable Input Value | |||||||||||
(In thousands) | December 31, 2018 | Valuation Techniques | Unobservable Inputs | |||||||||
Assets | ||||||||||||
Trading Security | $ | Discounted Cash Flow | Discount Rate | % | ||||||||
Commitments to Lend (1) | Historical Trend | Closing Ratio | % | |||||||||
Pricing Model | Origination Costs, per loan | $ | ||||||||||
Capitalized Servicing Rights (1) | Discounted cash flow | Constant prepayment rate (CPR) | % | |||||||||
Discount rate | % | |||||||||||
Total | $ | |||||||||||
(1) Classified as assets from discontinued operations on the consolidated balance sheets.
F-94
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Non-Recurring Fair Value Measurements
The Company is required, on a non-recurring basis, to adjust the carrying value or provide valuation allowances for certain assets using fair value measurements in accordance with GAAP. The following is a summary of applicable non-recurring fair value measurements. There are no liabilities measured on a non-recurring basis.
December 31, 2019 | Fair Value Measurements as of December 31, 2018 | ||||||
(In thousands) | Level 3 Inputs | Level 3 Inputs | |||||
Assets | |||||||
Impaired loans | $ | December 2019 | |||||
Capitalized servicing rights | December 2019 | ||||||
Total | $ | ||||||
December 31, 2018 | Fair Value Measurements as of December 31, 2017 | ||||||
(In thousands) | Level 3 Inputs | Level 3 Inputs | |||||
Assets | |||||||
Impaired loans | $ | December 2018 | |||||
Capitalized servicing rights | December 2018 | ||||||
Total | $ | ||||||
Quantitative information about the significant unobservable inputs within Level 3 non-recurring assets as of December 31, 2019 and 2018 are as follows:
(in thousands) | December 31, 2019 | Valuation Techniques | Unobservable Inputs | Range (Weighted Average) (a) | ||||||
Assets | ||||||||||
Impaired loans | $ | Fair value of collateral | Loss severity | 15.72% to 0.12% (4.50%) | ||||||
Appraised value | $8.2 to $1,548 ($736.1) | |||||||||
Capitalized servicing rights | Discounted cash flow | Constant prepayment rate (CPR) | 9.44% to 14.12% (12.25%) | |||||||
Discount rate | 10.00% to 13.50% (11.78%) | |||||||||
Total Assets | $ | |||||||||
(a) Where dollar amounts are disclosed, the amounts represent the lowest and highest fair value of the respective assets in the population except for adjustments for market/property conditions, which represents the range of adjustments to individuals properties.
F-95
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands) | December 31, 2018 | Valuation Techniques | Unobservable Inputs | Range (Weighted Average) (a) | ||||||
Assets | ||||||||||
Impaired loans | $ | Fair value of collateral | Loss severity | 51.16% to 0.00% (6.75%) | ||||||
Appraised value | $0.3 to $877 ($363) | |||||||||
Capitalized servicing rights | Discounted cash flow | Constant prepayment rate (CPR) | 7.74% to 11.29% (9.74%) | |||||||
Discount rate | 10.00% to 14.13% (11.99%) | |||||||||
Total Assets | $ | |||||||||
(a) Where dollar amounts are disclosed, the amounts represent the lowest and highest fair value of the respective assets in the population except for adjustments for market/property conditions, which represents the range of adjustments to individuals properties.
There were no Level 1 or Level 2 nonrecurring fair value measurements for year-end 2019 and 2018.
Impaired Loans. Loans are generally not recorded at fair value on a recurring basis. Periodically, the Company records non-recurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Non-recurring adjustments can also include certain impairment amounts for collateral-dependent loans calculated when establishing the allowance for credit losses. Such amounts are generally based on the fair value of the underlying collateral supporting the loan and, as a result, the carrying value of the loan less the calculated valuation does not necessarily represent the fair value of the loan. Real estate collateral is typically valued using appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace. However, the choice of observable data is subject to significant judgment, and there are often adjustments based on judgment in order to make observable data comparable and to consider the impact of time, the condition of properties, interest rates, and other market factors on current values. Additionally, commercial real estate appraisals frequently involve discounting of projected cash flows, which relies inherently on unobservable data. Therefore, real estate collateral related nonrecurring fair value measurement adjustments have generally been classified as Level 3. Estimates of fair value for other collateral that supports commercial loans are generally based on assumptions not observable in the marketplace and therefore such valuations have been classified as Level 3.
Capitalized loan servicing rights. A loan servicing right asset represents the amount by which the present value of the estimated future net cash flows to be received from servicing loans exceed adequate compensation for performing the servicing. The fair value of servicing rights is estimated using a present value cash flow model. The most important assumptions used in the valuation model are the anticipated rate of the loan prepayments and discount rates. Adjustments are only recorded when the discounted cash flows derived from the valuation model are less than the carrying value of the asset. Although some assumptions in determining fair value are based on standards used by market participants, some are based on unobservable inputs and therefore are classified in Level 3 of the valuation hierarchy.
F-96
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Summary of Estimated Fair Values of Financial Instruments
The following tables summarize the estimated fair values, which represent exit price, and related carrying amounts, of the Company’s financial instruments. Certain financial instruments and all non-financial instruments are excluded from disclosure requirements. Accordingly, the aggregate fair value amounts presented herein may not necessarily represent the underlying fair value of the Company. Certain assets and liabilities in the following disclosures include balances classified as discontinued operations. See Note 3 - Discontinued Operations for more information on assets and liabilities classified as discontinued operations.
December 31, 2019 | ||||||||||||||||||||
Carrying Amount | Fair Value | |||||||||||||||||||
(In thousands) | Level 1 | Level 2 | Level 3 | |||||||||||||||||
Financial Assets | ||||||||||||||||||||
Cash and cash equivalents | $ | $ | $ | $ | $ | |||||||||||||||
Trading security | ||||||||||||||||||||
Marketable equity securities | ||||||||||||||||||||
Securities available for sale | ||||||||||||||||||||
Securities held to maturity | ||||||||||||||||||||
FHLB stock and restricted equity securities | N/A | N/A | N/A | N/A | ||||||||||||||||
Net loans | ||||||||||||||||||||
Loans held for sale (1) | ||||||||||||||||||||
Accrued interest receivable | ||||||||||||||||||||
Derivative assets (1) | ||||||||||||||||||||
Financial Liabilities | ||||||||||||||||||||
Total deposits | ||||||||||||||||||||
Short-term debt | ||||||||||||||||||||
Long-term FHLB advances | ||||||||||||||||||||
Subordinated notes | ||||||||||||||||||||
Derivative liabilities (1) | ||||||||||||||||||||
(1) Includes assets and liabilities classified as discontinued operations.
December 31, 2018 | ||||||||||||||||||||
Carrying Amount | Fair Value | |||||||||||||||||||
(In thousands) | Level 1 | Level 2 | Level 3 | |||||||||||||||||
Financial Assets | ||||||||||||||||||||
Cash and cash equivalents | $ | $ | $ | $ | $ | |||||||||||||||
Trading security | ||||||||||||||||||||
Marketable equity securities | ||||||||||||||||||||
Securities available for sale | ||||||||||||||||||||
Securities held to maturity | ||||||||||||||||||||
FHLB stock and restricted equity securities | N/A | N/A | N/A | N/A | ||||||||||||||||
Net loans | ||||||||||||||||||||
Loans held for sale (1) | ||||||||||||||||||||
Accrued interest receivable | ||||||||||||||||||||
Derivative assets (1) | ||||||||||||||||||||
Financial Liabilities | ||||||||||||||||||||
Total deposits | ||||||||||||||||||||
Short-term debt | ||||||||||||||||||||
Long-term FHLB advances | ||||||||||||||||||||
Subordinated notes | ||||||||||||||||||||
Derivative liabilities (1) | ||||||||||||||||||||
(1) Includes assets and liabilities classified as discontinued operations.
F-97
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 23. CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Condensed financial information pertaining only to the Parent, Berkshire Hills Bancorp, is as follows. During 2018, the Company converted a $35 million intercompany subordinated note from the Bank into equity at the Bank.
CONDENSED BALANCE SHEETS
December 31, | ||||||||
(In thousands) | 2019 | 2018 | ||||||
Assets | ||||||||
Cash due from Berkshire Bank | $ | $ | ||||||
Investment in subsidiaries | ||||||||
Marketable equity securities, at fair value | ||||||||
Other assets | ||||||||
Total assets | $ | $ | ||||||
Liabilities and Shareholders’ Equity | ||||||||
Subordinated notes | $ | $ | ||||||
Accrued expenses | ||||||||
Shareholders’ equity | ||||||||
Total liabilities and shareholders’ equity | $ | $ | ||||||
CONDENSED STATEMENTS OF INCOME
Years Ended December 31, | ||||||||||||
(In thousands) | 2019 | 2018 | 2017 | |||||||||
Income: | ||||||||||||
Dividends from subsidiaries | $ | $ | $ | |||||||||
Other | ||||||||||||
Total income | ||||||||||||
Interest expense | ||||||||||||
Non-interest expenses | ||||||||||||
Total expense | ||||||||||||
Income before income taxes and equity in undistributed income of subsidiaries | ||||||||||||
Income tax benefit | ( | ) | ( | ) | ( | ) | ||||||
Income before equity in undistributed income of subsidiaries | ||||||||||||
Equity in undistributed results of operations of subsidiaries | ( | ) | ||||||||||
Net income | ||||||||||||
Preferred stock dividend | ||||||||||||
Income available to common shareholders | $ | $ | $ | |||||||||
Comprehensive income | $ | $ | $ | |||||||||
F-98
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31, | ||||||||||||
(In thousands) | 2019 | 2018 | 2017 | |||||||||
Cash flows from operating activities: | ||||||||||||
Net income | $ | $ | $ | |||||||||
Adjustments to reconcile net income to net cash (used) provided by operating activities: | ||||||||||||
Equity in undistributed results of operations of subsidiaries | ( | ) | ( | ) | ||||||||
Other, net | ( | ) | ( | ) | ||||||||
Net cash provided by operating activities | ||||||||||||
Cash flows from investing activities: | ||||||||||||
Advances to subsidiaries | ( | ) | ( | ) | ||||||||
Purchase of securities | ( | ) | ( | ) | ||||||||
Sale of securities | ||||||||||||
Other, net | ||||||||||||
Net cash (used) in investing activities | ( | ) | ( | ) | ||||||||
Cash flows from financing activities: | ||||||||||||
Proceed from issuance of short term debt | ||||||||||||
Proceed from repayment of long term debt | ||||||||||||
Repayment of short term debt | ( | ) | ||||||||||
Net proceeds from common stock | ||||||||||||
Payment to repurchase common stock | ( | ) | ||||||||||
Common stock cash dividends paid | ( | ) | ( | ) | ( | ) | ||||||
Preferred stock cash dividends paid | ( | ) | ( | ) | ( | ) | ||||||
Other, net | ||||||||||||
Net cash provided provided/(used) by financing activities | ( | ) | ( | ) | ||||||||
Net change in cash and cash equivalents | ( | ) | ||||||||||
Cash and cash equivalents at beginning of year | ||||||||||||
Cash and cash equivalents at end of year | $ | $ | $ | |||||||||
F-99
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 24. QUARTERLY DATA (UNAUDITED)
Quarterly results of operations were as follows:
2019 | 2018 | |||||||||||||||||||||||||||||||
(In thousands, except per share data) | Fourth Quarter | Third Quarter | Second Quarter | First Quarter | Fourth Quarter | Third Quarter | Second Quarter | First Quarter | ||||||||||||||||||||||||
Interest and dividend income | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Interest expense | ||||||||||||||||||||||||||||||||
Net interest income | ||||||||||||||||||||||||||||||||
Non-interest income | ||||||||||||||||||||||||||||||||
Total revenue | ||||||||||||||||||||||||||||||||
Provision for loan losses | ||||||||||||||||||||||||||||||||
Non-interest expense | ||||||||||||||||||||||||||||||||
Income from continuing operations before income taxes | ||||||||||||||||||||||||||||||||
Income tax expense | ||||||||||||||||||||||||||||||||
Net income from continuing operations | ||||||||||||||||||||||||||||||||
(Loss)/income from discontinued operations, net of tax | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||
Net income | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Basic earnings/(loss) per share: | ||||||||||||||||||||||||||||||||
Continuing operations | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Discontinued operations | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||
Basic earnings per common share | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Diluted earnings/(loss) per share: | ||||||||||||||||||||||||||||||||
Continuing operations | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Discontinued operations | ( | ) | ( | ) | ( | ) | ( | ) | ||||||||||||||||||||||||
Diluted earnings per share | $ | $ | $ | $ | $ | $ | $ | $ | ||||||||||||||||||||||||
Weighted average common shares outstanding: | ||||||||||||||||||||||||||||||||
Basic | ||||||||||||||||||||||||||||||||
Diluted | ||||||||||||||||||||||||||||||||
F-100
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 25. NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
Presented below is net interest income after provision for loan losses for the three years ended 2019, 2018, and 2017, respectively:
Years Ended December 31, | ||||||||||||
(In thousands) | 2019 | 2018 | 2017 | |||||||||
Net interest income | $ | $ | $ | |||||||||
Provision for loan losses | ||||||||||||
Net interest income after provision for loan losses | ||||||||||||
Total non-interest income | ||||||||||||
Total non-interest expense | ||||||||||||
Income from continuing operations before income taxes | ||||||||||||
Income tax expense | ||||||||||||
Net income from continuing operations | ||||||||||||
(Loss) income from discontinued operations before income taxes | ( | ) | ( | ) | ||||||||
Income tax (benefit)/expense | ( | ) | ( | ) | ||||||||
Net (loss) income from discontinued operations | ( | ) | ( | ) | ||||||||
Net income | $ | $ | $ | |||||||||
F-101
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 26. REVENUE
Revenue from contracts with customers in the scope of Topic 606 is recognized within noninterest income. The Company does not have any material significant payment terms as payment is received at or shortly after the satisfaction of the performance obligation. The value of unsatisfied performance obligations for contracts with an original expected length of one year or less are not disclosed. The Company recognizes incremental costs of obtaining contracts as an expense when incurred for contracts with a term of one year or less.
Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain non-interest income streams such as fees associated with mortgage servicing rights, financial guarantees, derivatives, and certain credit card fees are also not in scope of Topic 606. Topic 606 is applicable to non-interest revenue streams such as wealth management fees, insurance commissions and fees, administrative services for customer deposit accounts, interchange fees, and sale of owned real estate properties.
The following presents non-interest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the years ended 2019, 2018, and 2017, respectively.
Years Ended December 31, | ||||||||||||
(In thousands) | 2019 | 2018 | 2017 | |||||||||
Non-interest income | ||||||||||||
In-scope of Topic 606: | ||||||||||||
Service charges on deposit accounts | $ | $ | $ | |||||||||
Insurance commissions and fees | ||||||||||||
Wealth management fees | ||||||||||||
Interchange income | ||||||||||||
Non-interest income (in-scope of Topic 606) | $ | $ | $ | |||||||||
Non-interest income (out-of-scope of Topic 606) | ||||||||||||
Total non-interest income from continuing operations | $ | $ | $ | |||||||||
Non-interest income streams in-scope of Topic 606 are discussed below.
Service Charges on Deposit Accounts. Service charges on deposit accounts consist of monthly service fees (i.e. business analysis fees and consumer service charges) and other deposit account related fees. The Company's performance obligation for monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Other deposit account related fees are largely transactional based, and therefore, the Company's performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts. The Company may, from time to time, waive certain fees (e.g., NSF fee) for customers but generally do not reduce the transaction price to reflect variability for future reversals due to the insignificance of the amounts. Waiver of fees reduces the revenue in the period the waiver is granted to the customer.
Insurance Commissions and Fees. Commission revenue is recognized as of the effective date of the insurance policy or the date the customer is billed, whichever is later, net of return commissions related to policy cancellations. Policy cancellation is a variable consideration that is not deemed significant and thus, does not impact the amount of revenue recognized.
In addition, the Company may receive additional performance commissions based on achieving certain sales and loss experience measures. Such commissions are recognized when determinable, which is generally when such commissions are received or when the Company receives data from the insurance companies that allows the reasonable estimation of these amounts.
F-102
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Wealth Management Fees. Wealth management fees is primarily comprised of fees earned from consultative investment management, trust administration, tax return preparation, and financial planning. The Company’s performance obligation is generally satisfied over time and the resulting fees are recognized monthly, based on the daily accrual of the market value of the investment accounts and the applicable fee rate.
Interchange Fees. Interchange fees are transaction fees paid to the card-issuing bank to cover handling costs, fraud and bad debt costs, and the risk involved in approving the payment. Due to the day-to-day nature of these fees they are settled on a daily basis and are accounted for as they are received.
Gains/Losses on Sales of OREO. The sale of OREO and other nonfinancial assets are accounted for with the derecognition of the asset in question once a contract exists and control of the asset has been transferred to the buyer. The gain or loss on the sale is calculated as the difference between the carrying value of the asset and the transaction price.
F-103