Beacon Financial Corp annual report, FY2012

Business context and reporting period

This is Berkshire Hills Bancorp, Inc.’s Form 10-K for the fiscal year ended December 31, 2012, not a filing by Beacon Financial Corp. Berkshire acquired Beacon Federal Bancorp in October 2012. The regional bank and financial-services company also acquired The Connecticut Bank and Trust Company and Greenpark Mortgage operations during 2012. Results include acquired businesses only from their respective acquisition dates.

Financial results and condition

• Revenue rose 39%; net income rose 91%. Management attributed much of the growth to acquisitions, alongside organic growth. Net interest margin improved to 3.62% from 3.57%; return on average assets was 0.73% versus 0.50%, and return on average equity was 5.66% versus 3.64%.
• Non-interest income was $54.1 million, including $13.6 million in mortgage banking fees, compared with $0.4 million in mortgage banking fees in 2011. Non-interest expense rose 21% to $140.8 million and included $18.0 million of merger and conversion costs.
• Net loan charge-offs were $8.8 million, or 0.26% of average loans, versus $7.0 million, or 0.27%, in 2011. The allowance for loan losses was $33.2 million, 0.83% of loans, versus $32.4 million, 1.10%. Non-performing assets were $27.4 million, or 0.52% of assets, versus $26.1 million, or 0.65%.
• Year-end cash and cash equivalents were $98.2 million, compared with $75.4 million. Cash flow from operations was $28.7 million; investing activities used $255.5 million and financing activities provided $249.3 million. The loan-to-deposit ratio increased to 97% from 95%. Management reported $622 million of potential FHLB borrowing capacity. The parent’s $10 million working-capital credit line was fully drawn at year-end.
• The Bank’s regulatory capital ratios exceeded “well capitalized” thresholds: total risk-based capital was 11.79%, Tier 1 risk-based capital 10.01%, and Tier 1 leverage 7.46%. Consolidated equity was $667.3 million; equity-to-assets was 12.6%, down from 13.8%, and tangible common equity-to-tangible assets was 7.82%, down from 8.71%.

Material changes versus the prior comparable period

• Balance-sheet growth largely reflected acquisitions: total loans increased 35% and deposits 32%. Excluding acquired balances, management reported 5% growth in both loans and deposits.
• Acquired businesses contributed $875 million of loans and $834 million of deposits. Acquisitions and merger consideration also contributed to higher goodwill, debt, and share count; common shares outstanding rose 19% during 2012.
• Fee income diversified, especially through mortgage banking. Management cautioned that 2012 mortgage demand and industry margins were unusually strong and could revert toward historical levels.
• Reported EPS increased to $1.49. Management’s non-GAAP adjusted EPS, excluding merger, conversion, and other nonrecurring items, was $1.98 versus $1.54; these measures are not GAAP results.

Outlook, commentary, risks and unusual items

• Management expects to achieve Beacon acquisition cost savings in 2013 after integration and described the new core banking system as an investment intended to improve service, efficiency, analytics, and future growth. The filing gives no specific financial guidance.
• Key risks include commercial real estate and business-loan exposures, local economic conditions, credit-loss estimation and acquired-loan valuations, low interest rates and margin compression, deposit retention and wholesale funding access, and regulatory and capital-rule changes.
• Mortgage banking expansion and the core-system conversion introduce operating, accounting, hedging, vendor, and counterparty risks. Derivative notional value increased to $1.31 billion from $578 million, substantially due to mortgage-related activity; the reported net derivative fair value was a liability of about $10.1 million.
• The company issued $75 million of subordinated notes in September 2012, bearing a fixed 6.875% rate for ten years before switching to a floating rate; proceeds were primarily used for Beacon merger consideration. Dividends depend in part on regulated distributions from the Bank.
• The filing reports a prior-period correction for lease cost escalators, deemed immaterial to previously issued statements; 2011 and 2010 results were revised. Management and the auditor concluded internal control over financial reporting was effective at year-end; PwC gave unqualified opinions on the financial statements and controls. Management reported no pending legal proceedings expected to have a material adverse effect.
• A post-year-end agreement provides for a one-time payment of approximately $2.5 million in 2013 to former Beacon executives.

Important facts for investors to verify

• How much of earnings growth and future cost savings is attributable to acquisitions, and whether Beacon and CBT integration targets are achieved.
• Whether elevated mortgage banking income and margins persist, and how mortgage pipeline hedges perform as rates and refinancing volumes change.
• Credit performance of acquired loans, commercial real estate concentrations, and the adequacy of the allowance; acquired loans are recorded at fair value and some delinquent acquired loans remain accruing.
• Liquidity and funding developments, including the fully drawn parent credit line, increased borrowings, 2013 deposit maturities, and the ability to maintain deposits and regulatory capital.
• The impact of the 2012 lease-accounting revision and the 2013 Beacon executive payment on reported and adjusted results.