BEACON FEDERAL BANCORP 10-K 2012
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission File No. 001-33713
Securities Registered Pursuant to Section 12(g) of the Act:None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES o NO x
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Act. YES o NO x
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such requirements for the past 90 days. YES x NO o.
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). YES x NO o.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendments to this Form 10-K. x.
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO x
As of March 9, 2012, 6,195,330 shares of the Registrant’s common stock, $0.01 par value, were issued and outstanding. The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the last sale price as reported on the Nasdaq Global Market on June 30, 2011, was $75.2 million.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement to be used in connection with the 2012 Annual Meeting of Stockholders of the Registrant, which is intended to be filed within 120 days of the Registrant’s fiscal year end, are incorporated by reference into Part III.
TABLE OF CONTENTS
PRIVATE SECURITIES LITIGATION REFORM ACT SAFE HARBOR STATEMENT
This Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may” and words of similar meaning. These forward-looking statements include, but are not limited to:
These forward-looking statements are based on our current beliefs and expectations and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. We are under no duty to and do not take any obligation to update any forward-looking statements after the date of this Form 10-K.
The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:
Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.
As used in this Form 10-K, unless we specify otherwise, “we,” “us,” “our” and similar terms refer to Beacon Federal Bancorp, Inc., a Maryland corporation, or Beacon Federal, the wholly owned savings association subsidiary of Beacon Federal Bancorp, Inc., as indicated by the context.
Beacon Federal Bancorp, Inc.
Beacon Federal Bancorp, Inc. (the “Company”) was incorporated in the State of Maryland in 2007. We have not engaged in any significant business to date, other than owning all of the issued and outstanding stock of Beacon Federal (the “Bank”), a federally chartered savings association that converted to a stock savings association in connection with our initial public offering of common stock in October 2007. In the future, Beacon Federal Bancorp, Inc., as the holding company of Beacon Federal, is authorized to pursue other business activities permitted by applicable laws and regulations, which may include the acquisition of banking and financial services companies. See “—Supervision and Regulation—Holding Company Regulation” for a discussion of the activities that are permitted for savings and loan holding companies. We currently have no understandings or agreements to acquire other financial institutions. We may also borrow funds for reinvestment in Beacon Federal.
We completed our initial public offering of common stock in October 2007. In that offering, Beacon Federal Bancorp, Inc. sold 7,396,431 shares of common stock at $10.00 per share. After costs of $1.8 million directly attributable to the offering, net proceeds excluding the ESOP loan amounted to $66.2 million. Beacon Federal Bancorp, Inc. contributed $36.1 million of the net proceeds of the offering to Beacon Federal. In November 2008, Beacon Federal Bancorp, Inc. contributed an additional $10.0 million to Beacon Federal.
We receive substantially all our revenue from dividends from the Bank. Beacon Federal Bancorp, Inc. neither owns nor leases any property, but instead pays a fee to Beacon Federal for the use of its premises, equipment and furniture. At the present time, we employ only persons who are officers of Beacon Federal to serve as officers of Beacon Federal Bancorp, Inc. We do, however, use the support staff of Beacon Federal from time to time. We pay a fee to Beacon Federal for the time devoted to Beacon Federal Bancorp, Inc. by employees of Beacon Federal. However, these persons are not separately compensated by Beacon Federal Bancorp, Inc. Beacon Federal Bancorp, Inc. may hire additional employees, as appropriate, to the extent it expands its business in the future.
Our executive offices are located at 6611 Manlius Center Road, East Syracuse, New York 13057. Our telephone number at this address is (315) 433-0111. The Company also maintains a website at www.beaconfederal.com that includes important information on our Company, including a list of our products and services, branch locations, and current financial information. In addition, we make available, without charge, through our website a link to our filings with the SEC, including copies of annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these filings, if any. Information on our website should not be considered a part of this annual report.
We are a federally chartered savings association headquartered in East Syracuse, New York. We were organized in 1953 as the Carrier Employees Federal Credit Union, serving the employees of Carrier Corporation in Syracuse, New York. During the 1980s, we grew through mergers with a number of smaller credit unions operating at Carrier Corporation production facilities throughout the United States, including credit unions in Collierville, Tennessee; Tyler, Texas; and McMinnville, Tennessee.
In 1986, we changed our name to Beacon Federal Credit Union to enhance growth and diversify our membership by adding select employer groups. In the period through 1996, we added over 150 select employer groups to our membership. We also acquired by merger credit unions in Tyler, Texas; Syracuse, New York; and Concord, Massachusetts. As a result of these mergers, our total assets grew from $28 million in 1985 to over $133 million in 1996.
In July 1999, we converted our credit union charter to a federal mutual savings association charter and changed our name to Beacon Federal. The purpose of our charter conversion was to facilitate our ability to grow by removing the field-of-membership constraints associated with the credit union charter and to allow us to diversify our loan portfolio to include more commercial loans and mortgage loans. As a federal savings association, we have continued to grow, merging with two credit unions in McMinnville, Tennessee in 2000 and 2001, one credit union in Syracuse, New York in 2003, and one credit union in Marcy, New York in 2006. In 2011, we made the strategic decision to sell our one Texas branch in Tyler to MidSouth Bank, NA., a subsidiary of MidSouth Bancorp, Inc., (“MidSouth”) to better focus our resources within our geographic markets of New York, Massachusetts and Tennessee.
MidSouth assumed $79.4 million of deposits associated with the branch for a premium of 4%, based upon deposits of $73.9 million as of July 31, 2011 and purchased $23.8 million of loans, or 99% of the principal loan balances, as well as premises and equipment and accrued interest.
As a result of our acquisitions, we now serve a variety of market areas in economically diverse parts of the country. Moreover, since the completion of our acquisitions, we have expanded our lending and deposit-generating operations in these market areas. The following table shows the loan (excluding allowance for loan losses) and deposit balances associated with each of our branch offices at December 31, 2011.
We intend to continue to seek to grow by acquisitions of other financial institutions, including credit unions, and branch additions and acquisitions to the extent attractive acquisition opportunities are available, and subject to regulatory constraints.
By operating in geographically and economically diverse market areas, we hope to reduce the negative impact on our overall operations of adverse economic conditions in any one of the market areas we serve. Further, because demand for our deposit products often differs in our various market areas, we often reduce our overall funding costs by concentrating our deposit generating efforts in markets where demand is high. However, operating in geographically diverse markets does increase management time and expense.
Our principal business consists of originating one-to four-family residential mortgage loans, consumer loans, home equity loans, commercial real estate loans, multi-family mortgage loans and commercial business loans. These loans are originated from our corporate office in East Syracuse, New York, and from our six full-service branch offices located in East Syracuse, Marcy and Rome, New York; Smartt and Smyrna, Tennessee; and Chelmsford, Massachusetts. All loans originated in our branch offices are centrally underwritten in our corporate office.
We attract retail deposits from the general public in the areas surrounding our main office and our branch offices. We also utilize our internet website to generate loan applications and to attract retail deposits. We retain in our portfolio all adjustable-rate loans that we originate as well as some fixed-rate one- to four-family residential mortgage loans. While we also retain in our portfolio a portion of the long-term, fixed-rate one- to four-family residential mortgage loans that we originate, we also sell a portion of such loans into the secondary mortgage market for interest rate risk management purposes. We currently retain the servicing rights on all loans that we sell.
Our revenues are derived primarily from interest on loans and investment securities. We also generate revenues from fees and service charges, as well as from commissions on the sale of investment, tax preparation and insurance products offered by our subsidiary, Beacon Comprehensive Services, Inc. Our primary sources of funds are deposits, principal and interest payments on securities and loans, and borrowings.
We conduct operations from our corporate headquarters and six retail branch offices located in New York, Massachusetts and Tennessee. Our original office facility was located in East Syracuse, New York, which was formerly home to the headquarters of Carrier Corporation, a large industrial company specializing in heating and air conditioning equipment, which was our original sponsor company while operating as a credit union. Two of the Tennessee branches are located in central Tennessee, one in Smyrna, a suburb of Nashville, and one in Smartt, a small town outside of McMinnville, Tennessee. Two of our offices are the former offices of the Marcy Federal Credit Union, which was acquired in late 2006 and which is located in the Rome, New York area. We operate a network of 10 free-standing ATMs in Onondaga and contiguous counties in New York and one ATM in Tennessee. We are also a member of the Allpoint network, which provides our customers surcharge-free access to over 43,000 ATMs worldwide and we currently have an agreement with a Central New York convenient store, providing members access to several surcharge-free ATMs. Our branch offices serve diverse market areas with different employment and economic characteristics. Altogether, our office network provides us access to a relatively large population base for our products and services.
Our primary market area consists of the five counties in which we have our offices — Onondaga and Oneida Counties, New York, Middlesex County, Massachusetts, Rutherford and Warren Counties, Tennessee, and to a lesser extent contiguous counties. The five counties had a total population of approximately 2.7 million in 2010. Our corporate and branch offices in Onondaga County, New York are located in the Syracuse metropolitan area. Onondaga County had a 2010 population of approximately 456,000, a median household income in 2010 of approximately $53,000, and a December 2011 unemployment rate of 7.3%. Our Rome, New York offices are located in Oneida County, directly east of Onondaga County. Oneida County had a 2010 population of approximately 232,000, a median household income in 2010 of approximately $47,000 and a December 2011 unemployment rate of 7.9%. Onondaga County and Oneida County are both older, slow growth counties with urban populations in the larger cities (Syracuse, Rome and Utica, New York), and extensive rural areas. Population growth in Onondaga and Oneida Counties was (0.47)% and (1.34)%, respectively, during the 2000 to 2010 period. While traditionally manufacturing based, these two counties have experienced manufacturing job losses and a slow diversification of their economies over the past several decades. The largest employers in Onondaga County include Upstate University Health System, Syracuse University, Wegmans Food Markets, Inc. and St. Joseph’s Hospital Health Center. Currently, the largest private employer in Oneida County is the Turning Stone Casino Resort, which is a gambling enterprise of the Oneida Indian Nation of New York.
Our Chelmsford, Massachusetts office is located in Middlesex County, Massachusetts, which is near Boston. Middlesex County had a 2010 population of approximately 1,502,000, a median household income in 2010 of approximately $84,000, and a December 2011 unemployment rate of 5.1%. Population growth in Middlesex County was 2.5% from 2000 to 2010. Middlesex County contains a relatively large, diversified economy, with higher incomes and educational characteristics typical of the Boston metropolitan area.
Our Smyrna, Tennessee office is located within the Nashville metropolitan area in Rutherford County. Rutherford County had a 2010 population of approximately 266,000, a median household income in 2010 of approximately $63,000, and a December 2011 unemployment rate of 6.7%. Rutherford County had population growth of 46.4% from 2000 to 2010. The largest employers in Rutherford County include Nissan North American, Inc., Rutherford County Government, Middle Tennessee State University, Bridgestone/Firestone Inc., Ingram Book Company and the State Farm Insurance Company.
Our office in Smartt, Tennessee, is located in Warren County, which is approximately 50 miles southeast of Smyrna. Warren County had a 2010 population of approximately 40,000, a median household income in 2010 of approximately $38,000, and a December 2011 unemployment rate of 9.6%. Population growth in Warren County was 4.8% from 2000 to 2010. Warren County is a rural market area with a single population center of McMinnville. This market area has a small overall population base, and a large manufacturing component. The largest employer in Warren County is Bridgestone, a tire manufacturer in the central Tennessee region. Warren County also has a large employment base in the nursery and related industries.
We face strong competition from other savings institutions, commercial banks, credit unions and finance companies in originating real estate and consumer loans and in attracting deposits.
We attract deposits through our branch office system. Competition for deposits is principally from other savings institutions, commercial banks and credit unions located in our market areas, as well as mutual funds, internet banking and other alternative investments. We compete for these deposits by offering superior service and a variety of deposit accounts at competitive rates. Based on branch deposit data provided by the Federal Deposit Insurance Corporation (“FDIC”), at June 30, 2011, our share of deposits was 4.16% in Warren County, Tennessee and 5.38% in Onondaga County, New York. Our market share was less than 3.0% in all other counties in our market areas.
Our principal lending activity is the origination of real estate mortgage loans to purchase or refinance one- to four-family residential real estate. We also originate a significant number of indirect automobile loans and other consumer loans, along with commercial business loans, commercial real estate loans, multi-family real estate mortgage loans and home equity loans. At December 31, 2011, one- to four-family residential mortgage loans totaled $185.5 million, or 23.5% of our loan portfolio, consumer loans totaled $160.2 million, or 20.3% of our loan portfolio, home equity loans totaled $128.4 million, or 16.3% of our loan portfolio, commercial business loans totaled $82.4 million, or 10.5% of our loan portfolio, commercial real estate loans totaled $182.9 million, or 23.2% of our loan portfolio, construction loans totaled $13.0 million, or 1.7% of our loan portfolio, and multi-family real estate mortgage loans totaled $35.8 million, or 4.5% of our loan portfolio.
Loan Portfolio Composition. >The following table sets forth the composition of our loan portfolio, excluding loans held for sale, by type of loan at the dates indicated.
Loan Portfolio Maturities and Yields. >The following table summarizes the scheduled repayments of our loan portfolio at December 31, 2011. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.
The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at December 31, 2011 that are contractually due after December 31, 2012.
One- to Four-Family Residential Mortgage Loans.> A substantial part of our lending is the origination of one- to four-family residential mortgage loans. At December 31, 2011, $185.5 million, or 23.5% of our total loan portfolio, consisted of these loans. We offer residential mortgage loans that conform to Freddie Mac underwriting standards (conforming loans) and non-conforming loans. Our loans have fixed-rates and adjustable-rates, with maturities of up to 30 years, and maximum loan amounts generally of up to $1.0 million.
We currently offer fixed-rate conventional mortgage loans with terms of up to 30 years that are fully amortizing with monthly or bi-weekly (for 15-year mortgages) loan payments, and adjustable-rate mortgage loans that provide an initial fixed interest rate for one, three or five years and that amortize over a period up to 30 years.
Our one-to four-family residential mortgage loans are generally conforming loans, underwritten according to Freddie Mac guidelines. We generally originate both fixed- and adjustable-rate mortgage loans in amounts up to the maximum conforming loan limits as established by the Office of Federal Housing Enterprise Oversight, which is currently $417,000 for single-family homes. We also originate loans above the lending limit for conforming loans, which we refer to as “jumbo loans.” We only originate fixed-rate jumbo loans with terms of 15 years or greater, and adjustable-rate jumbo loans with an initial fixed-rate period of one, three or five years.
We will originate loans with loan-to-value ratios in excess of 80%, up to and including a loan-to-value ratio of 95%. We require private mortgage insurance for all loans with loan-to-value ratios in excess of 80%, except we will waive private mortgage insurance on loans with a loan-to-value ratio up to 90% for borrowers who agree to an extra 25 basis points on their loan rate. In addition, we will originate loans with a combined loan-to-value ratio of 95%, based on an 80% loan-to-value first lien and a 15% loan-to-value home equity loan. As of December 31, 2011, $27.5 million, or 14.8%, of our residential loan portfolio had loan-to-value ratios in excess of 80%.
We actively monitor our interest rate risk position to determine the desirable level of investment in fixed-rate mortgages. Depending on market interest rates and our capital and liquidity position, we may retain all of our newly originated longer-term fixed-rate residential mortgage loans or we may sell all or a portion of such loans in the secondary mortgage market to government sponsored entities, including Federal Home Loan Bank of New York and Freddie Mac, or other purchasers. We currently retain the servicing rights on all loans sold in order to generate fee income and reinforce our commitment to customer service. For the year ended December 31, 2011, we received servicing fees of $389,000. As of December 31, 2011, the principal balance of loans serviced for others totaled $138.0 million.
We currently offer several adjustable-rate mortgage loans secured by residential properties with interest rates that are fixed for an initial period ranging from one year to five years. We offer adjustable-rate mortgage loans that are fully amortizing. After the initial fixed period, the interest rate on adjustable-rate mortgage loans is generally reset every year based upon a contractual spread or margin above the average yield on U.S. Treasury securities, adjusted to a constant maturity of one year, as published weekly by the Federal Reserve Board, subject to periodic and lifetime limitations on interest rate changes. All of our adjustable-rate mortgage loans with initial fixed-rate periods of one, three and five years have initial and periodic caps of two percentage points on interest rate changes, with a cap of six percentage points for the life of the loan. We offer fully amortizing convertible adjustable-rate mortgage loans with principal and interest payments due on the note’s first payment date. The convertible adjustable-rate mortgage loans have an option for the borrower to convert the variable interest rate to a fixed interest rate on specified rate change dates, for a conversion fee.
Many of the borrowers who select these loans have shorter-term credit needs than those who select long-term, fixed-rate mortgage loans. We underwrite convertible adjustable-rate mortgage loan applications on the basis of the applicant’s qualifications assuming a two-percentage point increase to the initial note rate on loans fixed for an initial period of one year, and at the initial note rate for loans fixed for an initial period of three or five years.
Adjustable-rate mortgage loans generally present different credit risks than fixed-rate mortgage loans, primarily because the underlying debt service payments of the borrowers increase as interest rates increase, thereby increasing the potential for default.
We require title insurance on all of our one- to four-family residential mortgage loans, and we also require that borrowers maintain fire and extended coverage casualty insurance (and, if appropriate, flood insurance) in an amount at least equal to the lesser of the loan balance or the replacement cost of the improvements. We do not conduct environmental testing on residential mortgage loans unless specific concerns for hazards are identified by the appraiser used in connection with the origination of the loan.
Multi-Family Mortgage Loans.> Loans secured by multi-family real estate totaled $35.8 million, or 4.5% of our total loan portfolio, at December 31, 2011. Multi-family real estate mortgage loans generally are secured by multi-family rental properties, such as apartment buildings. At December 31, 2011, we had 43 multi-family mortgage loans with an average loan balance during 2011 of approximately $834,000. The majority of these loans have adjustable interest rates.
In underwriting multi-family mortgage loans, we consider a number of factors, which include the projected net cash flow to the loan’s debt service requirement (generally requiring a minimum ratio of 115%), the age and condition of the collateral, the financial resources and income level of the borrower and the borrower’s experience in owning or managing similar properties. Multi-family mortgage loans are originated in amounts up to 80% of the appraised value of the property securing the loan. Personal guarantees are usually obtained from multi-family mortgage borrowers.
Loans secured by multi-family real estate generally involve a greater degree of credit risk than one- to four-family residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income-producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family mortgages typically depends upon the successful operation of the related real estate property. If the cash flow from the project is reduced, the borrower’s ability to repay the loan may be impaired. At December 31, 2011, our largest multi-family residential mortgage loan had an outstanding balance of $5.6 million and was secured by an apartment complex in Dewit, New York. At December 31, 2011 the loan was performing in accordance with its terms.
Commercial Real Estate Loans. >We originate commercial real estate loans secured primarily by office buildings. As of December 31, 2011, we had two commercial real estate loan participations. Loans secured by commercial real estate totaled $182.9 million, or 23.2% of our total loan portfolio, at December 31, 2011, and consisted of 241 loans outstanding with an average loan balance during 2011 of approximately $759,000, although there are a large number of loans with balances substantially greater than this average. A majority of our commercial real estate loans are secured by properties located in upstate New York and in the Nashville, Tennessee area.
Our commercial real estate loans are primarily written as 5- or 10-year adjustable-rate mortgages. Amortization of these loans can reach up to 20- to 25-year payout schedules. Periodically we originate 10- to 15-year fixed-rate, fully amortizing loans. Margins generally range from 200 basis points to 500 basis points above the applicable Federal Home Loan Bank advance rate.
In the underwriting of commercial real estate loans, we generally lend up to 75% of the property’s appraised value. We base our decisions to lend on the economic viability of the property and the creditworthiness of the borrower. In evaluating a proposed commercial real estate loan, we emphasize the ratio of the property’s projected net cash flow to the loan’s debt service requirement (generally requiring a minimum ratio of 115%), computed after deduction for a vacancy factor and property expenses we deem appropriate. Personal guarantees are obtained from commercial real estate borrowers. We require title insurance insuring the priority of our lien, fire and extended coverage casualty insurance, and, if appropriate, flood insurance, in order to protect our security interest in the underlying property.
Commercial real estate loans generally carry higher interest rates and have shorter terms than one- to four-family residential mortgage loans. Commercial real estate loans, however, entail significant additional credit risks compared to one- to four-family residential mortgage loans, as they typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment of loans secured by income-producing properties typically depends on the successful operation of the related real estate project and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy. At December 31, 2011, our largest commercial real estate loan had an outstanding balance of $7.8 million, was secured by a property located in East Syracuse, NY, and was performing in accordance with its terms.
Construction Loans. >We originate a limited number of construction loans primarily for the purchase of developed lots and raw land. At December 31, 2011, construction loans totaled $13.0 million, or 1.7% of total loans. At December 31, 2011, the commitment to advance additional portions of these construction loans totaled $2.4 million. At December 31, 2011, our largest construction loan had an outstanding balance of $3.5 million, was secured by real estate in Dewitt, NY, and was performing in accordance with its terms.
We grant construction loans to area builders, often in conjunction with development loans. In the case of residential subdivisions, these loans finance the cost of completing homes on the improved property. Advances on construction loans are made in accordance with a schedule reflecting the cost of construction, but are generally limited to 80% of actual construction costs and a 75% loan-to-completed-appraised-value ratio. Repayment of construction loans on residential subdivisions is normally expected from the sale of units to individual purchasers. In the case of income-producing property, repayment is usually expected from permanent financing upon completion of construction. We commit to provide the permanent mortgage financing on most of our construction loans on income-producing property.
Before making a commitment to fund a construction loan, we require an appraisal of the property by an independent licensed appraiser. We generally also review and inspect each property before disbursement of funds during the term of the construction loan.
Construction financing generally involves greater credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost (including interest) of construction and other assumptions. If the estimate of construction cost proves to be inaccurate, we may be required to advance additional funds beyond the amount originally committed in order to protect the value of the property. Moreover, if the estimated value of the completed project proves to be inaccurate, the borrower may hold a property with a value that is insufficient to assure full repayment of the construction loan upon the sale of the property. In the event we make a land acquisition loan on property that is not yet approved for the planned development, there is the risk that approvals will not be granted or will be delayed. Construction loans also expose us to the risk that improvements will not be completed on time in accordance with specifications and projected costs. In addition, the ultimate sale or rental of the property may not occur as anticipated.
Commercial Business Loans. >We make various types of secured and unsecured commercial business loans to customers in our market area for the purpose of acquiring equipment and other general business purposes. The terms of these loans generally range from less than one year to a maximum of ten years. The loans are either negotiated on a fixed-rate basis or carry adjustable interest rates indexed to a lending rate that is determined internally, or a short-term market rate index such as the prime rate or 90-day LIBOR rate. At December 31, 2011, we had 360 commercial loans outstanding with an aggregate balance of $82.4 million, or 10.5% of our total loans. For the year ended December 31, 2011, the average commercial business loan balance was approximately $229,000, although there are a large number of loans with balances substantially greater than this average. At December 31, 2011, we had $19.7 million in unsecured commercial business loans. Substantially all of our commercial business loans are made to borrowers located in upstate New York and the Nashville, Tennessee area.
Commercial credit decisions are based upon our credit assessment of the loan applicant. We determine the applicant’s ability to repay in accordance with the proposed terms of the loans and we assess the risks involved. An evaluation is made of the applicant to determine character and capacity to manage. Personal guarantees of the principals are obtained. In addition to evaluating the loan applicant’s financial statements, we consider the adequacy of the primary and secondary sources of repayment for the loan. Credit agency reports of the applicant’s credit history supplement our analysis of the applicant’s creditworthiness. We may also check with other banks and conduct trade investigations. Collateral supporting a secured transaction is analyzed to determine its marketability. Commercial business loans generally have higher interest rates than residential loans of like duration because they have a higher risk of default since their repayment generally depends on the successful operation of the borrower’s business and the sufficiency of any collateral. Our pricing of commercial business loans is based primarily on the credit risk of the borrower, with due consideration given to borrowers with appropriate deposit relationships. At December 31, 2011, our largest commercial business loan was made to a borrower located in Syracuse, NY. This loan had an outstanding balance of $5.0 million and was performing in accordance with its terms at December 31, 2011.
Home Equity Loans>. We offer home equity loans, which are primarily secured by first or second mortgages on one- to four-family residences. At December 31, 2011, home equity loans totaled $128.4 million, or 16.3% of total loans. Additionally, at December 31, 2011, our home equity lines of credit committed to be advanced totaled $39.7 million. We offer home equity loan products, including both installment loans and revolving credit loans.
The underwriting standards for home equity loans include a title review, a determination of the applicant’s credit history, an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan, and the value of the collateral securing the loan. The combined loan-to-value ratio (first and second mortgage liens) for home equity loans can be as high as 95%. A home equity loan originated along with a home purchase loan requires the borrower to pay closing costs. Home equity loans are offered with both fixed and variable interest rates, and installment fixed home equity loans have repayment terms of up to 20 years. At December 31, 2011, our largest home equity loan had an outstanding balance of $1.0 million, and was performing in accordance with its terms.
Home equity loans secured by second mortgages have greater risk than residential mortgage loans secured by first mortgages. We face the risk that the collateral will be insufficient to compensate us for loan losses. When customers default on their loans, we attempt to foreclose on the property or seize the collateral securing the loan. However, the value of the collateral may not be sufficient to compensate us for the amount of the unpaid loan and we may be unsuccessful in recovering the remaining balance from those customers. Particularly with respect to our home equity loan activities, decreases in real estate values could adversely affect the value of property used as collateral for our loans.
Consumer Loans.> As a former credit union, we have traditionally originated a large volume of consumer loans, primarily direct automobile loans. In March 2006, we began to originate indirect automobile loans and we have established relationships with a number of automobile dealers in Central New York. While direct automobile loans as a percentage of our total loans have decreased in recent years and are expected to continue to decrease, indirect automobile loans are expected to increase as a percentage of our total loans. For new automobiles, our lending policy provides that the amount financed can be up to 100% of the value of the vehicle, plus applicable taxes and dealer charges (i.e., warranty and insurance charges). For used automobiles, our lending policy provides that the amount of the loan should not exceed the “loan value” of the vehicle, as established by industry guides. The interest rates offered on automobile loans are generally the same for new and late-model used automobiles. Full insurance coverage must be maintained on the financed vehicle, and Beacon Federal must be named loss payee on the policy. At December 31, 2011, we had $134.5 million of automobile loans, which amounted to 17.1% of our total loans, including indirect automobile loans of $115.7 million.
We offer a variety of other consumer loans, principally to customers with acceptable credit ratings residing in our primary market area. Our other consumer loans generally consist of secured and unsecured personal loans, motorcycle and motor home loans and boat loans. Other consumer loans totaled $25.7 million, or 3.3% of our total loans at December 31, 2011. Unsecured personal loans totaled $6.8 million at December 31, 2011.
Consumer loans have greater risk than residential mortgage loans, particularly in the case of loans that are unsecured or secured by rapidly depreciating assets such as automobiles, motorcycles, motor homes and boats. In these cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections depend on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.
Loan Originations, Purchases, Sales, Participations and Servicing. >Lending activities are conducted primarily by our loan personnel operating at our corporate and branch office locations. All loans that we originate are underwritten pursuant to our policies and procedures, which incorporate Freddie Mac underwriting guidelines to the extent applicable. We originate both adjustable-rate and fixed-rate loans. Our ability to originate fixed- or adjustable-rate loans is dependent upon the relative customer demand for such loans, which is affected by current market interest rates as well as anticipated future market interest rates. Our loan origination and sales activity may be adversely affected by a rising interest rate environment that typically results in decreased loan demand. Most of our commercial real estate, multi-family real estate and commercial business loans are generated by referrals from accountants and other professional contacts. Most of our one- to four-family residential mortgage loan, consumer loan and home equity loan originations are generated by mortgage brokers, mortgage banker correspondents, retail loan originators, walk-in business, our internet website, and from automobile dealers participating in our indirect auto loan program. We also advertise extensively throughout our market areas.
We decide whether to retain the loans that we originate or sell loans in the secondary market after evaluating current and projected market interest rates, our interest rate risk objectives, our liquidity needs and other factors. We sold $22.9 million of residential mortgage loans (all fixed-rate loans, with terms of 20 years or longer) during the year ended December 31, 2011. We had $1.3 million in loans held for sale in the secondary market at December 31, 2011.
At December 31, 2011, we were servicing loans owned by others with a principal balance of $138.0 million. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent borrowers, supervising foreclosures and property dispositions in the event of unremedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans. We retain a portion of the interest paid by the borrower on the loans we service as consideration for our servicing activities.
Loan Approval Procedures and Authority>. Our lending activities follow written, non-discriminatory underwriting standards and loan origination procedures established by Beacon Federal’s Board of Directors. The loan approval process is intended to assess the borrower’s ability to repay the loan and value of the property that will secure the loan. To assess the borrower’s ability to repay, we review the borrower’s employment and credit history and information on the historical and projected income and expenses of the borrower.
Beacon Federal’s policies and loan approval limits are established by the Board of Directors. Aggregate lending relationships in amounts up to $500,000 that are secured by real estate, and in amounts up to $200,000 if unsecured, may be approved by specified loan officers. All loans in excess of the individual officer limits must be approved by the Officers’ Loan Committee, consisting of Beacon Federal’s Chief Executive Officer and Senior Vice Presidents. All loans in excess of the Officers’ Loan Committee limit ($500,000) and less than $1.0 million must be approved by the Executive Committee of the Board of Directors. Loans in excess of $1.0 million are approved by the full Board of Directors.
We require appraisals by independent, licensed, third-party appraisers of all real property securing loans. All appraisers are approved by the Board of Directors annually.
Nonperforming and Problem Assets
When a loan is 15 days past due, we send the borrower a delinquency notice. When a non-commercial loan is 30 days past due, we mail the borrower a letter reminding the borrower of the delinquency, and we attempt to contact the borrower directly to determine the reason for the delinquency in order to ensure that the borrower understands the terms of the loan and the importance of making payments on or before the due date. If necessary, subsequent late charges and delinquency notices are issued and the account will be monitored on a regular basis thereafter. By the 90th day of delinquency, we will send the borrower a final demand for payment and we may recommend foreclosure. Any of our officers can accelerate these time frames in consultation with certain of our executive officers. Commercial loans, once delinquent, are closely monitored by a loan officer who provides individual attention to the borrower in order to resolve the delinquency or elevate the collection efforts when necessary. A summary report of all loans 30 days or more past due is provided monthly to the Board of Directors of Beacon Federal.
Effective December 31, 2011, loans are automatically placed on nonaccrual status when payment of principal or interest is more than 90 days delinquent. Prior to December 31, 2011, loans were placed on non-accrual status when payment of principal or interest was more than 120 days delinquent. Loans, including restructured loans, are also placed on nonaccrual status if collection of principal or interest in full is in doubt. Collateral-dependent loans can be placed on nonaccrual status if the estimated proceeds, less costs to sell, of the collateral is less than the carrying value of the loan. When loans are placed on nonaccrual status, unpaid accrued interest is fully reversed, and further income is recognized only to the extent received. Loans are returned to accrual status when all the principal and interest amounts are brought current and future payments are reasonably assured.
The Bank does not generally offer modification programs for collateral-dependent loans. Only in a situation where the collateral was not expected to be sufficient to recover the Bank’s investment in the loan would a modification be considered for a collateral-dependent loan, and in those cases the loan would be subject to the Bank’s modification programs. A loan may be modified when the Bank determines that a borrower’s financial condition has deteriorated to an extent that the borrower’s ability to meet the original repayment terms are in question and where the Bank believes the borrower will eventually overcome those circumstances and repay the loan in full. When deemed appropriate, short-term payment plans have been developed that enable borrowers to bring their loans current, generally within six to twelve months. The most prevalent modification the Bank has offered is on commercial real estate and commercial business loans. The Bank offers to place these loans on interest only payments at a market interest rate for a short period of time, generally six to twelve months, effectively extending the term of the original loan.
The Bank monitors the modified loans reviewing for delinquencies under the modified terms. If a payment is missed under the modified terms, the Bank will contact the customer to inquire as to the reason for delay. If the customer is experiencing further financial difficulties the Bank will reassess whether the customer can perform under the modified terms.
At the conclusion of the interest only period, a review of the debtors’ financial statements is completed to determine the viability of returning the loans to scheduled principal and interest payments according to the original terms.
For loans that accrue interest at the time the loan is modified, we do not generally charge-off a portion of the loan. Factors we consider in concluding that the repayment of interest and principal contractually due on the entire debt is reasonably assured include modifying at an interest rate we anticipate payments can be made and offering interest-only periods of a duration that will allow debtors to improve their financial condition. Additionally, we review the collateral position and any guarantees associated with the loan to determine the likelihood of collecting the contractually due interest and principal.
Based on the underwriting at the time of the modification, the Bank makes a determination whether or not the loan is a troubled debt restructuring (“TDR”). Modified loans are not considered TDRs when the loan terms are consistent with the Bank’s current product offerings and the borrowers meet the Bank’s current underwriting standards with regard to financial condition, payment history and collateral.
The Bank considers a TDR to be any modified loan where a debtor’s financial difficulties leads to a concession being granted in order to maximize the probability of repayment that would not otherwise have been considered. The modified terms must be of a nature that the debtor could not obtain similar funds with a source other than the Bank, or could only obtain similar funds at effective rates so high that it could not afford to pay them.
At December 31, 2011, the Bank had the following modified loans (including TDRs) by type of concession made:
The Bank has been offering commercial loan products since 1999. However, the majority of the Bank’s commercial portfolio is less than six years old and many of the restructured loans surfaced in the past three years. Due to the Bank’s short history of modified loans we do not have complete information regarding the success or re-default rates for commercial modified loans through disposition. None of the Bank’s 10 loans that were placed on interest only payments as of December 31, 2011 have performed under their modified terms. All commercial loans that had their terms extended and interest rates reduced (reduced to a market rate for performing loans) were performing under their modified terms at December 31, 2011.
The residential one- to four-family loans that had their terms extended and interest rates reduced to below market rates are being accounted for as troubled debt restructurings and have been performing under their modified terms. The Bank does not have any second/junior liens held where the first loan has been modified.
The Bank had 16 TDRs totaling $15.9 million as of December 31, 2011. TDRs of $3.7 million were included in impaired and nonaccrual loans, while the remaining $12.2 million in TDRs were included in impaired loans on accrual status. There are no commitments to lend additional funds to customers with outstanding loans that are classified as troubled debt restructurings as of December 31, 2011. As of December 31, 2010, there were two TDRs totaling $2.4 million. A TDR of $1.5 million was included in impaired and nonaccrual loans, while the remaining $900,000 TDR was included in impaired loans on accrual status.
Restructured loans that are considered impaired are measured based on the present value of expected future cash flows with the difference between the present value of future cash flows and carrying amount recorded through the provision for loan losses. There was allocated $2.0 million and $5,000 of specific allowance to TDRs as of December 31, 2011 and 2010, respectively.
We believe the allowance related to modified loans that were not considered TDRs would not have been materially different if calculated pursuant to paragraph 22 of ASC 310-10-35, primarily due to the modifications being relatively short interest-only periods not having a significant impact on expected cash flows.
The terms of certain other loans were modified during the year ended December 31, 2011 that did not meet the definition of a troubled debt restructuring. These loans have a total recorded investment as of December 31, 2011 of $1.8 million. The modification of these loans involved either a modification of the terms of a loan to borrowers who were not experiencing financial difficulties or a delay in a payment that was considered to be insignificant.
Nonperforming Assets. >The table below sets forth the amounts and categories of our nonperforming assets at the dates indicated. All TDRs are included in total nonperforming loans.
At December 31, 2011, Beacon Federal had no loans that were not classified as nonaccrual, 90 days past due or impaired but where known information about possible credit problems of borrowers caused management to have serious concerns as to the ability of the borrowers to comply with present loan repayment terms and that may result in disclosure as nonaccrual, 90 days past due or impaired.
Total nonperforming assets were $45.6 million, or 4.44% of total assets at December 31, 2011, compared to $14.3 million or 1.38% of total assets at December 31, 2010. During the fourth quarter of 2011, the Company downgraded several commercial relationships as a result of a review of all loans over $75,000 in the commercial loan portfolio. The increase in nonperforming loans was primarily attributable to the Company downgrading two commercial real estate relationships, totaling $8.2 million, and seven commercial business loan relationships totaling $16.4 million. Of the $16.4 million of commercial business loans, $4.0 million were unsecured and $11.4 million were secured by a lien on the Company’s assets. Foreclosed and repossessed assets increased $1.7 million compared to the year-ended December 31, 2010. The Company foreclosed four residential properties and two commercial properties in 2011.
Interest income that would have been recorded for the year ended December 31, 2011, had nonaccruing loans been current according to their original terms amounted to $1.8 million. Interest of $1.1 million was recognized on these loans and is included in net income for the year ended December 31, 2011.
Delinquent Loans>. The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated.
Foreclosed and Repossessed Assets>. Real estate acquired by us as a result of foreclosure or by deed in lieu of foreclosure is classified as foreclosed real estate until sold. When property is acquired it is recorded at the lower of cost or estimated fair value at the date of foreclosure, establishing a new cost basis. Estimated fair value generally represents the sale price a buyer would be willing to pay on the basis of current market conditions, including normal terms from other financial institutions, less the estimated costs to sell the property. Holding costs and declines in estimated fair value result in charges to expense after acquisition. In addition, we periodically repossess certain collateral, including automobiles and other titled vehicles. At December 31, 2011, we had $1.9 million in foreclosed real estate and $71,000 in repossessed assets.
Classification of Assets. >Our policies, consistent with regulatory guidelines, provide for the classification of loans and other assets that are considered to be of lesser quality as substandard or doubtful. An asset is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Substandard assets include those assets characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have all of the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Assets that do not expose us to risk sufficient to warrant classification in one of the aforementioned categories, but which possess potential weaknesses that deserve our close attention, are required to be designated as special mention. As of December 31, 2011, we had $32.6 million of assets designated as special mention.
When we classify assets as either substandard or doubtful, we allocate a portion of the related general loss allowances to such assets as we deem prudent. The allowance for loan losses is the amount estimated by management as necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. Our determination as to the classification of our assets and the amount of our loss allowances are subject to review by our principal federal regulator, the OCC, which can require that we establish additional loss allowances. We regularly review our asset portfolio to determine whether any assets require classification in accordance with applicable regulations. On the basis of our review of our assets at December 31, 2011, classified assets consisted of substandard assets of $53.8 million and doubtful assets of $9.3 million. As of December 31, 2011, our largest substandard asset was secured by numerous properties in Massachusetts and New Hampshire, with a principal balance of $6.7 million.
We provide for loan losses based on the allowance method. Accordingly, all loan losses are charged to the related allowance and all recoveries are credited to it. Additions to the allowance for loan losses are provided by charges to income based on various factors which, in our judgment, deserve current recognition in estimating probable losses. We regularly review the loan portfolio and make provisions for loan losses in order to maintain the allowance for loan losses in accordance with U.S. generally accepted accounting principles. The allowance for loan losses consists of two components:
The adjustments to historical loss experience are based on our evaluation of several factors, including:
We evaluate the allowance for loan losses based upon the combined total of the specific and general components. Generally, when the loan portfolio increases, absent other factors, the allowance for loan loss methodology results in a higher dollar amount of estimated probable losses than would be the case without the increase. In contrast, when the loan portfolio decreases, absent other factors, the allowance for loan loss methodology results in a lower dollar amount of estimated probable losses than would be the case without the decrease. We originate one- to four-family residential mortgage loans with loan-to-value ratios in excess of 80%, up to and including a loan-to-value ratio of 95%. We require private mortgage insurance for all loans with loan-to-value ratios in excess of 80%, except we will waive private mortgage insurance on loans with a loan-to-value ratio up to 90% for borrowers who agree to an extra 25 basis points on their loan rate. In addition, we will originate loans with a combined loan-to-value ratio of 95%, based on an 80% loan-to-value first lien and a 15% loan-to-value home equity loan. As of December 31, 2011, $27.5 million, or 14.8%, of our residential loan portfolio had loan-to-value ratios in excess of 80%. These loans are reviewed on a regular basis by management to determine whether any probable losses exist, if any, as a result of declines in collateral value.
Commercial real estate loans generally have greater credit risks compared to one- to four-family residential mortgage loans, as they typically involve large loan balances concentrated with single borrowers or groups of related borrowers. In addition, the payment experience on loans secured by income-producing properties typically depends on the successful operation of the related real estate project and thus may be subject to a greater extent to adverse conditions in the real estate market and in the general economy.
Commercial business loans involve a higher risk of default than residential loans of like duration since their repayment generally depends on the successful operation of the borrower’s business and the sufficiency of collateral, if any. Loans secured by multi-family residential mortgages generally involve a greater degree of credit risk than one- to four-family residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family mortgages typically depends upon the successful operation of the related real estate property. If the cash flow from the project is reduced, the borrower’s ability to repay the loan may be impaired.
Construction loans generally have greater credit risk than traditional one- to four-family residential mortgage loans. The repayment of these loans depends upon the sale of the property to third parties or the availability of permanent financing upon completion of all improvements. In the event we make a loan on property that is not yet approved for the planned development, there is the risk that approvals will not be granted or will be delayed. These events may adversely affect the borrower and the collateral value of the property. Construction loans also expose us to the risk that improvements will not be completed on time in accordance with specifications and projected costs. In addition, the ultimate sale or rental of the property may not occur as anticipated.
We periodically evaluate through internal and external loan reviews, the carrying value of loans and the allowance is adjusted accordingly. While we use the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the information used in making the evaluations. In addition, as an integral part of their examination process, the OCC periodically reviews the allowance for loan losses. The OCC may require us to recognize additions to the allowance based on their analysis of information available to them at the time of their examination. In response to their regulatory examination completed on January 12, 2012, the Company has reflected all OCC recommendations in the allowance for loan losses at December 31, 2011.
Effective December 31, 2011, interest income on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Consumer loans are typically charged off no later than 90 days past due. Prior to December 31, 2011, loans were placed on non-accrual status when payment of principal or interest was more than 120 days delinquent. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
All interest accrued, but not received for loans placed on nonaccrual status, is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status if unpaid principal and interest amounts are repaid so that the loan is less than 90 days delinquent. We do not presently originate any loans with terms that allow for minimum payments less than the interest accrued on the loan.
The following table sets forth activity in our allowance for loan losses for the years indicated.