Beacon Financial Corp quarterly report, Q2 FY2011

Business context and reporting period

This is Berkshire Hills Bancorp, Inc.’s unaudited Form 10-Q for the quarter and six months ended June 30, 2011—not a filing identified in its text as Beacon Financial Corp. Berkshire provides banking, insurance, and wealth-management services in Massachusetts, New York, and Vermont. The results include Rome Bancorp from its April 1 acquisition; Legacy Bancorp was acquired on July 21, after quarter-end.

Financial performance and condition

Amounts are in millions except per-share data and ratios unless otherwise stated.

• Adjusted results: Management reported Q2 adjusted net income of $5.8 million, or $0.35 per share, excluding after-tax merger-related expenses; adjusted first-half net income was $10.0 million, or $0.66 per share. These are non-GAAP measures. Q2 included $5.3 million in net merger-related expenses; first-half results included $7.0 million.
• Margins and revenue: Q2 net interest margin was 3.52%, compared with 3.25% in Q2 2010 and 3.30% in Q1 2011. Q2 total net revenue rose 22% year over year, with higher net interest income from loan growth, margin improvement, and Rome.
• Balance sheet at June 30: Assets were $3.23 billion, loans $2.45 billion, deposits $2.49 billion, and stockholders’ equity $445.0 million. Since year-end, reported loans grew $309.5 million and deposits $281.4 million, including $258 million of acquired Rome loans and $229 million of Rome deposits.
• Credit quality: Allowance for loan losses was $31.9 million, or 1.30% of total loans. Nonperforming assets were 0.52% of assets; annualized Q2 net charge-offs were 0.24% of average loans. Classified assets relative to Tier 1 capital plus allowance increased to 39% from 36% at year-end.
• Cash flow and liquidity: First-half operating cash flow was $16.7 million; investing cash outflow was $36.6 million; financing cash inflow was $17.7 million. Cash and equivalents ended at $41.9 million, down $2.2 million. Management reported more than $400 million of FHLB borrowing availability. The loan-to-deposit ratio was 99%.
• Debt and capital: Total borrowings were $260.7 million, including $237.4 million of long-term FHLB advances. Berkshire Bank met “well capitalized” regulatory thresholds: total risk-based capital 11.3%, Tier 1 risk-based capital 10.0%, and Tier 1 leverage 8.4%. Equity was 13.8% of assets; tangible equity to tangible assets was 8.3%.

Material changes versus comparable periods

• Reported earnings declined year over year, largely reflecting merger costs and the Rome share issuance. Management said Q2 adjusted EPS increased 40% year over year; adjusted first-half EPS increased 35%.
• Net interest income and margin improved, while provision expense decreased. Operating expenses rose substantially, including merger charges, Rome operations, expansion costs, and $1.3 million of first-half OREO write-down expense.
• The allowance stayed approximately flat despite loan growth, partly because acquired Rome loans were recorded at fair value without a carried-over allowance.
• In Q2, the company corrected an immaterial prior-period accounting error for certain tax-credit investment partnerships. It revised 2010 comparative results and said the cumulative error was immaterial to estimated full-year 2011 income but material to the earnings trend.

Outlook, risks, and unusual items

• No formal earnings guidance is provided. Management cited long-term objectives of return on assets above 1% and return on equity above 10%, and said its operating results were progressing toward them.
• Management expected Rome integration to be substantially complete in Q2 and Legacy integration in Q4 2011. It targeted cost savings equal to about 35% of Rome’s anticipated non-interest expense and 42% of Legacy’s, with full savings expected by year-end.
• Management expected deposit growth to remain the primary funding source and loan growth the primary use of funds. It described the company as moderately asset-sensitive, while noting interest-rate and deposit-pricing uncertainty.
• Legacy’s post-quarter acquisition added reported June 30 assets of $891 million, including $587 million of loans and $660 million of deposits. The company agreed to sell four Legacy branches, with $158 million of deposits, for a 6% deposit premium; closing was expected by October 31, 2011.
• Risks include merger integration and achieving savings, credit deterioration tied to economic conditions and real-estate values, valuation uncertainty in goodwill and securities, and potential effects of the August 2011 U.S. sovereign and agency rating downgrades on securities values and secured funding.
• A $2.6 million pooled trust-preferred investment had a $0.7 million fair value and a $1.9 million unrealized loss; management considered the impairment temporary. Rome shareholder litigation was settled with final court approval in July; the filing said it had no material adverse effect.
• The Bank could not then pay dividends to its parent under Massachusetts law; management expected it to regain eligibility in the second half of 2011. Parent-company cash was $11 million.

Most important facts for investors to verify

• Confirm the registrant identity: the supplied filing is Berkshire Hills Bancorp, Inc., despite the request metadata naming Beacon Financial Corp.
• Reconcile GAAP earnings with management’s adjusted earnings, including the after-tax treatment and nature of merger charges.
• Track Legacy integration, actual cost savings, branch divestiture completion, and the effect of acquired operations on per-share earnings and tangible book value.
• Monitor loan growth, classified and nonperforming exposures, charge-offs, and allowance adequacy—especially given the acquired loans’ lack of a carried-over allowance.
• Assess liquidity, deposit funding, FHLB borrowing capacity, and whether the Bank resumes upstream dividends as management anticipated.
• Review the revised comparative statements and subsequent filings for the tax-credit accounting correction, and monitor securities and funding exposure following the rating downgrades.