10-Q 1 t73455_10q.htm FORM 10-Q t73455_10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
For the quarterly period ended March 31, 2012
   
 
OR
   
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
For the transition period from ______________to______________
 
Commission file number 001-33713
 
BEACON FEDERAL BANCORP, INC.
(Exact name of registrant as specified in its charter)

 
Maryland
     
26-0706826
 
(State or other jurisdiction of
 
(I.R.S. Employer Identification No.)
incorporation or organization)
   

 
6611 Manlius Center Road, East Syracuse, New York
   
13057
 
 
(Address of principal executive office)
 
(Zip Code)
 
Registrant’s telephone number, including area code (315) 433-0111
   
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
 
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T 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 whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer “, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer o Accelerated filer x Non-accelerated filer o Smaller reporting company o
 
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
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
     
Class
 
Outstanding May 7, 2012
Common Stock, par value $0.01 per share
 
           6,198,751
 
 
 

 
 
BEACON FEDERAL BANCORP, INC.
 
FORM 10-Q
 
FOR THE QUARTER ENDED MARCH 31, 2012
 
TABLE OF CONTENTS
         
     
PAGE NO.
PART I – FINANCIAL INFORMATION
     
         
Item 1.
Financial Statements (Unaudited)
 
3
 
         
 
Consolidated Balance Sheets
 
3
 
         
 
Consolidated Statements of Income
 
4
 
         
 
Consolidated Statements of Comprehensive Income
 
5
 
         
 
Consolidated Statement of Changes in Stockholders’ Equity
 
6
 
         
 
Consolidated Statements of Cash Flows
 
7
 
         
 
Notes to Consolidated Financial Statements
 
9
 
         
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
41
 
         
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
 
51
 
         
Item 4.
Controls and Procedures
 
54
 
         
PART II – OTHER INFORMATION
     
         
Item 1.
Legal Proceedings
 
54
 
         
Item 1A.
Risk Factors
 
55
 
         
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
55
 
         
Item 3.
Defaults Upon Senior Securities
 
55
 
         
Item 4.
Mine Safety Disclosures
 
55
 
         
Item 5.
Other Information
 
55
 
         
Item 6.
Exhibits
 
55
 
         
Signatures
 
57
 
         
Certifications
     

 
2

 
 
BEACON FEDERAL BANCORP, INC.
 
PART 1.  FINANCIAL INFORMATION
Item 1.  Financial Statements
 
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
             
   
March 31,
   
December 31,
 
 
 
2012
   
2011
 
   
(Unaudited)
 
ASSETS
               
                 
Cash and cash equivalents - cash and due from financial institutions
  $ 39,393     $ 43,724  
Securities available for sale
    171,925       144,896  
Securities held to maturity (fair value of $6,875 and $7,207, respectively)
    6,591       6,975  
Loans held for sale
    4,438       1,350  
Loans, net of allowance for loan losses of $13,831 and $19,150, respectively
    744,109       773,341  
Federal Home Loan Bank (FHLB) of New York stock and other restricted stock
    13,112       12,605  
Premises and equipment, net
    12,456       12,755  
Accrued interest receivable
    3,016       3,174  
Foreclosed and repossessed assets
    2,827       1,946  
Bank-owned life insurance (BOLI)
    11,074       10,994  
Other assets
    15,802       15,069  
      Total assets
  $ 1,024,743     $ 1,026,829  
                 
LIABILITIES AND STOCKHOLDERS EQUITY
               
                 
Deposits
  $ 677,264     $ 680,856  
Federal Home Loan Bank advances
    148,427       148,427  
Securities sold under agreement to repurchase and other short-term borrowings
    73,000       73,000  
Accrued interest payable and other liabilities
    4,367       4,733  
Capital lease obligation
    7,743       7,743  
      Total liabilities
    910,801       914,759  
Commitments and contingencies
               
Preferred stock, $.01 par value, 50,000,000 shares authorized;
         
none issued or outstanding
               
Common stock, $.01 par value, 100,000,000 shares authorized; 7,677,017 and
7,670,993 shares issued; 6,198,751 and 6,192,727 shares outstanding, respectively
    76       76  
Additional paid-in capital
    75,919       75,555  
Retained earnings-substantially restricted
    56,470       55,616  
Unearned Employee Stock Ownership Plan (ESOP) shares
    (2,380 )     (2,568 )
Accumulated other comprehensive loss, net
    (2,024 )     (2,490 )
Treasury stock, 1,478,266 and 1,478,266 shares at cost, respectively
    (14,119 )     (14,119 )
      Total stockholders’ equity
    113,942       112,070  
      Total liabilities and stockholders equity
  $ 1,024,743     $ 1,026,829  
                 
See accompanying notes to consolidated unaudited financial statements.
         

 
3

 
 
BEACON FEDERAL BANCORP, INC.
 
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per share data)
 
   
Three Months Ended
 
   
March 31,
 
   
2012
   
2011
 
Interest and dividend income:
 
(Unaudited)
 
   Loans, including fees
  $ 9,901     $ 10,887  
   Securities
    1,258       1,478  
   FHLB stock
    120       150  
   Federal funds sold and other
    12       3  
      Total interest income
    11,291       12,518  
Interest expense:
               
   Deposits
    1,846       2,162  
   FHLB advances
    1,611       1,710  
   Securities sold under agreement to repurchase
    675       668  
   Lease obligation
    196       196  
      Total interest expense
    4,328       4,736  
      Net interest income
    6,963       7,782  
Provision for loan losses
    604       979  
      Net interest income after provision for loan losses
    6,359       6,803  
Noninterest income:
               
   Service charges
    1,011       936  
   Commission and fee income
    244       207  
   Change in cash surrender value of BOLI
    80       88  
   Gain on sale of loans
    141       70  
   Other-than-temporary impairment (“OTTI) credit loss on securities
    (67 )     (111 )
   Other
    437       312  
      Total noninterest income
    1,846       1,502  
Noninterest expense:
               
   Salaries and employee benefits
    3,122       3,089  
   Occupancy and equipment
    707       698  
   Advertising and marketing
    107       121  
   Telephone, delivery and postage
    182       210  
   Supplies
    48       62  
   Audit and examination
    453       169  
   FDIC premium expense
    216       360  
   Other
    1,343       1,133  
      Total noninterest expense
    6,178       5,842  
Income before income taxes
    2,027       2,463  
Income tax expense
    762       944  
      Net income
  $ 1,265     $ 1,519  
Basic earnings per share
  $ 0.21     $ 0.25  
Diluted earnings per share
  $ 0.21     $ 0.25  
                 
OTTI credit loss on securities:
               
Total OTTI loss on securities
  $ (67 )   $ (665 )
Portion of OTTI loss recognized in other comprehensive loss before income taxes
    -       554  
OTTI credit loss on securities
  $ (67 )   $ (111 )
                 
See accompanying notes to consolidated unaudited financial statements.
 
 
 
4

 
 
BEACON FEDERAL BANCORP, INC.
 
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
   
Three Months Ended
 
   
March 31,
 
   
2012
   
2011
 
   
(Unaudited)
 
             
Net income
  $ 1,265     $ 1,519  
                 
Other comprehensive income:
               
     Net change in unrealized gains on available for sale securities
    779       700  
     OTTI non-credit related loss on securities for which a portion of the OTTI
               
         has been recognized in income
    -       (554 )
    Other comprehensive income before tax
    779       146  
     Income tax
    (313 )     (58 )
Other comprehensive income, net of tax
    466       88  
Comprehensive income
  $ 1,731     $ 1,607  
                 
See accompanying notes to consolidated unaudited financial statements.
               
 
 

 
5

 

BEACON FEDERAL BANCORP, INC.
 
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)
(Dollars in thousands, except per share data)
 
                                 
Accumulated
             
   
Common Stock
   
Additional
         
Unearned
   
Other
             
   
Shares
   
Amount
   
Paid-In
   
Retained
   
ESOP
   
Comprehensive
   
Treasury
       
   
Outstanding
   
Issued
   
Capital
   
Earnings
   
Shares
   
(Loss)/Income
   
Stock
   
Total
 
Balance at January 1, 2012
    6,192,727     $ 76     $ 75,555     $ 55,616     $ (2,568 )   $ (2,490 )   $ (14,119 )   $ 112,070  
Net income
    -       -       -       1,265       -       -       -       1,265  
Other comprehensive income, net of tax
    -       -       -       -       -       466       -       466  
Earned ESOP shares
    -       -       59       -       188       -       -       247  
Stock-based compensation
    -       -       78       -       -       -       -       78  
Tax effect of stock-based compensation
    -       -       170       -       -       -       -       170  
Exercise of stock options
    8,416       -       64       -       -       -       -       64  
Cash dividends $0.07 per share
    -       -       -       (411 )     -       -       -       (411 )
Repurchase of common stock
    (2,392 )     -       (7 )     -       -       -       -       (7 )
Balance at March 31, 2012
    6,198,751     $ 76     $ 75,919     $ 56,470     $ (2,380 )   $ (2,024 )   $ (14,119 )   $ 113,942  
 
See accompanying notes to consolidated unaudited financial statements.

 
6

 
 
BEACON FEDERAL BANCORP, INC.
          
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)

   
Three Months Ended
   
March 31,
   
2012
   
2011
 
   
(Unaudited)
 
Cash flows from operating activities:
     
   Net income
  $ 1,265     $ 1,519  
   Adjustments to reconcile net income to net cash provided by operating activities:
               
         Provision for loan losses
    604       979  
         Change in fair value of servicing assets
    89       102  
         Depreciation and amortization
    370       380  
         ESOP expense
    247       227  
         Amortization of stock-based compensation expense
    78       284  
         Amortization of net deferred loan costs
    636       667  
         Net amortization of premiums and discounts on securities
    281       318  
         Gain on sale of loans
    (141 )     (70 )
         Other-than-temporary impairment credit loss on securities
    67       111  
         Originations of loans held for sale
    (12,294 )     (4,048 )
         Proceeds from loans held for sale
    9,347       6,192  
         Increase in cash surrender value of BOLI
    (80 )     (88 )
         Net change in:
               
             Accrued interest receivable
    158       55  
             Other assets
    (963 )     1,010  
             Accrued interest payable and other liabilities
    (366 )     415  
            Net cash (used for) provided by operating activities
    (702 )     8,053  
Cash flows from investing activities:
               
   Purchase of FHLB stock
    (758 )     (1,686 )
   Redemption of FHLB stock
    251       1,855  
   Securities held to maturity:
               
      Maturities, prepayments and calls
    379       1,162  
   Securities available for sale:
               
      Purchases
    (40,145 )     (15,347 )
      Proceeds from maturity or call
    13,550       12,320  
   Loan repayments (originations), net
    23,131       (9,773 )
   Purchase of premises and equipment
    (71 )     (244 )
   Proceeds from sale of foreclosed and repossessed assets
    3,980       257  
           Net cash provided by (used for) investing activities
  $ 317     $ (11,456 )
 
Continued on following page
 
 
7

 
 
BEACON FEDERAL BANCORP, INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
 
Continued
             
   
Three Months Ended
 
   
March 31,
 
   
2012
   
2011
 
   
(Unaudited)
 
Cash flows from financing activities:
     
   Net change in deposits
  $ (3,592 )   $ 3,715  
   Proceeds from FHLB advances
    -       151,600  
   Repayment of FHLB advances
    -       (156,000 )
   Exercise of stock options
    64       -  
   Cash dividends
    (411 )     (302 )
   Repurchase of common stock
    (7 )     (283 )
         Net cash used for financing activities
    (3,946 )     (1,270 )
Net change in cash and cash equivalents
    (4,331 )     (4,673 )
Cash and cash equivalents at beginning of period
    43,724       12,439  
Cash and cash equivalents at end of period
  $ 39,393     $ 7,766  
Supplemental cash flow information:
               
   Interest paid
  $ 4,359     $ 4,765  
   Income taxes paid
  $ 1,321     $ 60  
   Real estate and repossessions acquired in settlement of loans
  $ 4,861     $ 116  
                 
See accompanying notes to consolidated unaudited financial statements.
               
 
 
8

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 
Note 1 – Basis of Presentation
 
The accompanying unaudited interim consolidated financial statements include the accounts of Beacon Federal Bancorp, Inc. (the “Company”), a savings and loan holding company that owns and operates Beacon Federal (the “Bank”), and have been prepared in accordance with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X and, therefore, do not include all disclosures necessary for a complete presentation of the financial statements in conformity with U.S. generally accepted accounting principles.  In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation of the results of operations for the interim periods.  The results of operations for the three months ended March 31, 2012 are not necessarily indicative of the results that may be expected for the entire year or any other interim period.
 
Certain amounts in the prior period consolidated financial statements have been reclassified to conform with the current presentation.  The reclassifications made to the prior year have no impact on the net income or overall presentation of the consolidated financial statements.
 
Note 2 – Significant Accounting Estimates and Policies
 
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Management has identified the allowance for loan losses, the carrying value of securities and income taxes to be the accounting areas that require the most subjective and complex judgments, and as such could be the most subject to revision as new information becomes available. Actual results could differ from those estimates.
 
Securities
 
Debt securities are classified as held to maturity and carried at amortized cost when management has the positive intent and ability to hold them to maturity. Debt securities are classified as available for sale when they might be sold before maturity. Equity securities with readily determinable fair values are classified as available for sale. Securities available for sale are carried at fair value, with unrealized gains and losses reported in other comprehensive loss, net of tax. The Company does not purchase securities for trading purposes.
 
The Bank is a member of the Federal Home Loan Bank of New York. The required investment in the common stock is based upon a certain percentage of the Bank’s assets and advances. Federal Home Loan Bank stock is carried at cost, which represents redemption value, and is periodically evaluated for impairment based on ultimate recovery of par value. Dividends received on such stock are reported as income.
 
Interest income includes amortization of purchase premium or discount.  Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated.  Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
 
Declines in the fair value of securities below their cost that are other-than-temporary are reflected as realized losses. In estimating if losses are other-than-temporary, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) the Company’s intent to sell the security or whether it is more likely than not that it will be required to sell the security before the anticipated recovery of its remaining amortized cost basis and (4) evaluation of cash flows to determine if they have been adversely affected.
 
 
9

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Allowance for Loan Losses
 
The adequacy of the allowance for loan losses for all loan classes is determined by management based upon an evaluation and review of the credit quality of the loan portfolio, consideration of historical loan loss experience, relevant internal and external factors that affect the collection of a loan, and other pertinent factors. 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. The allowance for loan losses consists of two components:
 
 
(1)
allocated allowances established for any impaired loans for which the carrying value of the loan exceeds the fair value of the collateral or the present value of expected future cash flows or loans otherwise adversely classified; and
 
 
(2)
general allowances for loan losses for each loan type based on the historical loan loss experience for the last four years, including qualitative adjustments to historical loss experience, maintained to cover uncertainties that affect our estimate of probable losses for each loan type. Portions of the general allowance may be allocated for specific credits; however, the entire allowance is available for any credit that in management’s judgment should be charged-off.
 
We evaluate the allowance for loan losses for all loan classes based upon the combined total of the allocated and general components. Generally, when the loan portfolio increases, absent other factors, the allowance for loan loss methodology for the general allowance 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.
 
A general loan loss allowance is provided on all loans not specifically identified as impaired (“non-impaired loans”). The allowance is determined first based on a quantitative analysis using a loss migration methodology. The loans are stratified by type and the historical loss migration is tracked for the various stratifications. Loss experience is quantified for the most recent four years and if considered necessary by management, weighted to give more weight to the most recent losses. That loss experience is then applied to the stratified portfolio at each quarter end.
 
Additionally, in order to systematically quantify the credit risk impact of other trends and changes within the loan portfolio, the Bank utilizes qualitative adjustments to the migration analysis within parameters. The qualitative adjustments are based on the factors below. Generally, the factors are considered to have no significant impact to our historical migration ratios. However, if information exists to warrant adjustment to the migration analysis, changes are made in accordance with parameters supported by narrative and/or statistical analysis. This matrix considers the following ten factors, which are patterned after the guidelines provided under the FFIEC Interagency Policy Statement on the Allowance for Loan and Lease Losses:
 
 
changes in lending policies and procedures, including underwriting standards;
 
changes in collection, charge-off and recovery practices;
 
changes in the nature and volume of the loan portfolio;
 
changes in the experience, ability, and depth of lending management;
 
changes in the volume and severity of past due loans, non-accrual loans, troubled debt restructurings, and adversely classified loans;
 
changes in the value of underlying collateral for collateral-dependent loans;
 
the existence and effect of any concentrations of credit and changes in the level of such concentrations;
 
changes in the quality of our loan review system and the degree of oversight by the Board of Directors;
 
changes in current, national and local economic and business conditions; and
 
the effect of other external factors such as competition and legal and regulatory requirements.
 
 
10

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged-off when deemed uncollectible, with the balance remaining as an impaired loan until either the full principal is received or the loan is charged-off.  Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.
 
Allocations of the allowance may be made for individual loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off. The Bank is subject to periodic examination by regulatory agencies that may require the Bank to record increases in the allowances based on their evaluation of available information. There can be no assurance that the Bank’s regulators will not require further increases to the allowances.
 
Income Taxes
 
Provisions for income taxes are based on taxes currently payable or refundable, and deferred taxes which are based on temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements.  Deferred tax assets and liabilities are reported in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled.
 
New Accounting Pronouncements
 
In June 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220) - Presentation of Comprehensive Income.”  The ASU requires entities to present items of net income and other comprehensive income either in one continuous statement – referred to as the statement of comprehensive income – or in two separate, but consecutive, statements of net income and other comprehensive income.  The ASU was adopted for the three months ended March 31, 2012.  The adoption of this guidance did not materially impact the Company.
 
In May 2011, the FASB issued ASU No. 2011-04, “Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.”  This ASU represents the converged guidance of the FASB and the IASB (the Boards) on fair value measurement. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with U.S. GAAP and IFRSs.  Included in the ASU are requirements to disclose additional quantitative disclosures about unobservable inputs for all Level 3 fair value measurements, as well as qualitative disclosures about the sensitivity inherent in recurring Level 3 fair value measurements.  The ASU was adopted for the three months ended March 31, 2012.   The adoption of this guidance did not materially impact the Company.
 
In December 2011, the FASB issued ASU No. 2011-12, “Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05.  This update defers the requirement to present items that are reclassified from accumulated other comprehensive income to net income in both the statement of income where net income is presented and the statement where other comprehensive income is presented.  The adoption of this guidance did not materially impact the Company.
 
 
11

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 3 – Earnings Per Share
 
Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period.  ESOP shares are considered outstanding for this calculation unless unearned.  All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are considered participating securities for this calculation.  Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options.  Earnings and dividends per share are restated for all stock splits and stock dividends through the date of issuance of the financial statements. In addition, proceeds from the assumed exercise of dilutive stock options and related tax benefit are assumed to be used to repurchase common stock at the average market price during the year.
 
 
12

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The basic and diluted earnings per share are summarized as follows (amounts in thousands, except per share data):
             
   
Three Months Ended
 
   
March 31,
 
   
2012
   
2011
 
             
Basic earnings per share:
           
             
Net income
  $ 1,265     $ 1,519  
Less dividends paid:
               
  Common stock
    411       298  
  Participating securities
    -       4  
                 
Undistributed earnings
  $ 854     $ 1,217  
                 
Weighted-average basic shares outstanding
    5,950       6,038  
Add: weighted-average participating securities outstanding
    -       73  
Total weighted-average basic shares  and participating securities outstanding
    5,950       6,111  
                 
Distributed earnings per share
  $ 0.07     $ 0.05  
Undistributed earnings per share
    0.14       0.20  
Basic earnings per share
  $ 0.21     $ 0.25  
                 
Diluted earnings per share:
               
                 
Undistributed earnings
  $ 854     $ 1,217  
                 
Total weighted-average basic shares and participating securities outstanding
    5,950       6,111  
Add: Dilutive stock options
    124       108  
Total weighted-average diluted shares and participating securities outstanding
    6,074       6,219  
                 
                 
Distributed earnings per share
  $ 0.07     $ 0.05  
Undistributed earnings per share
    0.14       0.20  
Diluted earnings per share
  $ 0.21     $ 0.25  
                 
Anti-dilutive option shares
    2       154  

 
13

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 4 – Securities
 
The amortized cost, unrealized gross gains and losses and fair values of securities at March 31, 2012 were as follows (dollars in thousands):

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
March 31, 2012
 
Cost
   
Gains
   
Losses
   
Value
 
                         
     Held to maturity:
                       
     Debt securities:
                       
       Mortgage-backed securities - Residential
  $ 2,531     $ 130     $ (1 )   $ 2,660  
       Collateralized mortgage obligations - Private issuer
    2,330       40       (40 )     2,330  
       Collateralized mortgage obligations - Government agency
    1,730       155       -       1,885  
        Total
  $ 6,591     $ 325     $ (41 )   $ 6,875  
                                 
     Available for sale:
                               
     Debt securities:
                               
       Treasuries
  $ 100     $ 1     $ -     $ 101  
       Agencies
    3,000       -       (13 )     2,987  
       Pooled trust preferred securities
    10,348       -       (6,152 )     4,196  
       Mortgage-backed securities - Residential
    67,851       1,931       (135 )     69,647  
       Collateralized mortgage obligations - Private issuer
    10,896       348       (997 )     10,247  
       Collateralized mortgage obligations - Government agency
    83,002       1,777       (32 )     84,747  
        Total
  $ 175,197     $ 4,057     $ (7,329 )   $ 171,925  
 
Mortgage-backed securities and collateralized mortgage obligations consist of residential mortgage securities and are backed by single-family mortgage loans.  The Company does not have any such securities backed by commercial real estate loans.
 
 
14

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The amortized cost, unrealized gross gains and losses and fair values of securities at December 31, 2011 were as follows (dollars in thousands):

         
Gross
   
Gross
       
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
 
December 31, 2011
 
Cost
   
Gains
   
Losses
   
Value
 
                         
     Held to maturity:
                       
     Debt securities:
                       
       Mortgage-backed securities - Residential
  $ 2,682     $ 129     $ -     $ 2,811  
       Collateralized mortgage obligations - Private issuer
    2,461       40       (100 )     2,401  
       Collateralized mortgage obligations - Government agency
    1,832       163       -       1,995  
        Total
  $ 6,975     $ 332     $ (100 )   $ 7,207  
                                 
     Available for sale:
                               
     Debt securities:
                               
       Treasuries
  $ 100     $ 1     $ -     $ 101  
       Agencies
    3,000       7       -       3,007  
       Pooled trust preferred securities
    10,402       -       (6,168 )     4,234  
       Mortgage-backed securities - Residential
    47,149       1,897       (8 )     49,038  
       Collateralized mortgage obligations - Private issuer
    11,669       146       (1,674 )     10,141  
       Collateralized mortgage obligations - Government agency
    76,627       1,766       (18 )     78,375  
        Total
  $ 148,947     $ 3,817     $ (7,868 )   $ 144,896  
 
The proceeds from sales or calls of securities were $13.6 million and $12.3 million for the quarter ended March 31, 2012 and 2011, respectively.  There were no gross gains or gross losses recognized from sales and calls of securities during the quarter ended March 31, 2012 and 2011, respectively.
 
Maturities of debt securities at March 31, 2012 are summarized as follows (dollars in thousands):
                         
   
Held to Maturity
   
Available for Sale
 
   
Amortized
   
Fair
   
Amortized
   
Fair
 
March 31, 2012
 
Cost
   
Value
   
Cost
   
Value
 
                         
Due within one year
  $ -     $ -     $ -     $ -  
Due after one through five years
    -       -       100       101  
Due after five through ten years
    -       -       2,000       1,992  
Due after ten years
    -       -       11,348       5,191  
      -       -       13,448       7,284  
Mortgage-backed securities - Residential
    2,531       2,660       67,851       69,647  
Collateralized mortgage obligations - Private issuer
    2,330       2,330       10,896       10,247  
Collateralized mortgage obligations - Government agency
    1,730       1,885       83,002       84,747  
    $ 6,591     $ 6,875     $ 175,197     $ 171,925  
 
 
15

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
As of March 31, 2012 and December 31, 2011, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders equity.
 
Securities with unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows (dollars in thousands):
 
   
Less than 12 Months
   
12 Months or Longer
   
Total
       
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
March 31, 2012
 
Value
   
loss
   
Value
   
loss
   
Value
   
loss
 
                                     
Agencies
  $ 2,987     $ (13 )   $ -     $ -     $ 2,987     $ (13 )
Pooled trust preferred securities
    -       -       4,196       (6,152 )     4,196       (6,152 )
Mortgage backed securities - Residential
    22,518       (136 )     -       -       22,518       (136 )
CMOs - Private issuer
    698       (38 )     6,135       (999 )     6,833       (1,037 )
CMOs - Government Agency
    9,258       (24 )     3,204       (8 )     12,462       (32 )
    $ 35,461     $ (211 )   $ 13,535     $ (7,159 )   $ 48,996     $ (7,370 )
                                                 
   
Less than 12 Months
   
12 Months or Longer
   
Total
         
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
December 31, 2011
 
Value
   
loss
   
Value
   
loss
   
Value
   
loss
 
                                                 
Pooled trust preferred securities
  $ -     $ -     $ 4,234     $ (6,168 )   $ 4,234     $ (6,168 )
Mortgage backed  securities - Residential
    3,031       (8 )     -       -       3,031       (8 )
CMOs - Private issuer
    3,046       (367 )     6,018       (1,407 )     9,064       (1,774 )
CMOs - Government Agency
    3,609       (18 )     -       -       3,609       (18 )
    $ 9,686     $ (393 )   $ 10,252     $ (7,575 )   $ 19,938     $ (7,968 )
 
No assurance can be made that the credit quality of the securities with unrealized losses at March 31, 2012 will not deteriorate in the future which may require future reductions in income for other-than-temporary impairment (“OTTI”) credit losses.
 
Pooled Trust Preferred Securities (PTPS) (6 issues with unrealized loss at March 31, 2012). The unrealized losses on the Company’s pooled trust preferred securities, which are backed by financial institution issuers, were caused by general market conditions for financial institutions, which is an industry sector that is relatively out of favor, and the resulting lack of liquidity in the market for securities issued by or backed by financial institutions. Management of the Company does not intend to sell the securities and does not believe the Company will be required to sell the securities before recovery of their amortized cost basis, which may be upon maturity. The Company used a discounted cash flow (“DCF”) analysis to provide an estimate of the present value of expected future cash flows for all of the trust preferred securities. For three of the securities, the calculated present value of future cash flows was more than their amortized cost basis. The predominate factor in the present value of expected cash flows being greater than the carrying amount was the Company holding senior tranche positions in those securities, providing a priority in receipt of the cash flows estimated to be collected. Accordingly, the Company did not consider the unrealized losses on those three securities to be other-than-temporary credit-related losses at March 31, 2012.
 
 
16

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Our PTPS were rated “A” (upper medium grade and subject to low credit risk), or lower, and the lowest was rated “C” (lowest rated and typically in default with little prospect of recovery), as discussed below under the caption “Other-Than-Temporary Impairments.”
 
Mortgage-backed Securities (8 issues with unrealized loss at March 31, 2012) and Collateralized Mortgage Obligations (10 issues with unrealized loss at March 31, 2012). The unrealized losses on the Company’s mortgage-backed securities and collateralized mortgage obligations were caused primarily by decreased liquidity and larger non-credit risk premiums for these securities. Management of the Company does not intend to sell the securities and does not believe the Company will be required to sell the securities before recovery of their amortized cost basis, which may be upon maturity. Accordingly, the Company did not consider the unrealized losses on those securities to be other-than-temporary credit-related losses at March 31, 2012.
 
Mortgage-backed securities, and to a lesser extent, collateralized mortgage obligations (CMOs) are issued by federal agencies, primarily FNMA and FHLMC, and private issuers. Of the Company’s fifty-seven CMOs, forty-seven are government agency and ten are privately issued. Of the $1.1 million of unrealized losses on CMOs, only $32,000 of the losses is on federal agency securities. The remaining unrealized losses are on privately issued securities, which generally carry a higher yield and greater degree of credit risk and liquidity risk than agency issues. Two privately issued CMOs with unrealized losses were rated investment grade or better and six privately issued CMOs were rated less than investment grade, all of which were subprime, with the lowest rated “D.”
 
Agencies (2 issues with unrealized loss at March 31, 2012). The unrealized losses on the Company’s agency securities are related to changes in market rates and not credit quality of the issuer.
 
Individual debt securities in an unrealized loss position greater than 12 months and below investment grade with the lowest rating by security type as of March 31, 2012, are as follows (dollars in thousands):

Description
 
Class
   
Amortized Cost
   
Fair Value
   
Unrealized Loss
   
Lowest
Credit
Rating
 
CMOs - Private Issuer:
                             
CWALT 2006-19CB
    A14     $ 3,021       2,598     $ (423 )     C  
First Horizon ALT 2006
    1A1       1,585       1,366       (219 )     D  
ARMT 2005-3
    4A1       2,124       1,769       (355 )    
Caa1
 
              6,730       5,733       (997 )        
                                         
Trust Preferred Securities:
                                       
Alesco Preferred Funding IV
    B-1       455       52       (403 )     C  
US Capital Funding III 12/01/35
    A-2       2,966       1,050       (1,916 )     C  
US Capital Funding I 05/01/34
    B-2       551       200       (351 )     C  
              3,972       1,302       (2,670 )        
            $ 10,702     $ 7,035     $ (3,667 )        
 
The Company’s six investment securities that are in an unrealized loss position greater than 12 months and rated below investment grade were all originally purchased at investment grade. Beginning with the second half of 2008, factors outside the Company’s control impacted the fair value of these securities and will likely continue to do so for the foreseeable future. These factors include, but are not limited to, issuer credit deterioration, issuer deferral and default rates, potential failure or government seizure of underlying financial institutions, ratings agency actions, and regulatory actions. As a result of changes in these and various other factors during 2009 and 2010, Moody’s Investors Service and Standard & Poor’s downgraded multiple CMO and Trust Preferred Securities, including securities that are held by the Company. Of the Company’s fifty-seven CMOs, three are considered to be below investment grade and in an unrealized loss position greater than one year. Three of the Company’s six trust preferred securities are considered to be below investment grade and in an unrealized loss position greater than one year. The deteriorating economic, credit and financial conditions have resulted in illiquid and inactive financial markets and severely depressed prices for these securities.
 
 
17

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The below investment grade for those securities in the table above was only one factor evaluated in determining whether it was appropriate to recognize an other-than-temporary impairment. Since the securities were below investment grade, we performed additional cash flow analysis in determining if the unrealized losses on the below investment grade securities are considered to be other-than-temporary.
 
Of our three CMOs in unrealized loss positions greater than one year with below investment grade rating, we have determined that all but one are other-than-temporarily impaired. The ARMT 2005-3 investment is not considered other-than-temporarily impaired due to management not having an intention to sell the investment and not believing we will be required to sell the investment before recovery of its amortized cost basis and the underlying mortgages experiencing a relatively low amount of over 90 day delinquencies and foreclosures of 8.9% and an average FICO score of 741 for the underlying mortgage borrowers.
 
We have determined that all three of the PTPS securities in unrealized loss positions greater than 12 months with below investment grade ratings are other-than-temporarily impaired. Due to uncertainty in the credit markets broadly, and the lack of both trading and new issuance in pooled trust preferred securities, market price indications generally reflect the illiquidity in these markets and not the credit quality of the individual securities. Due to this illiquidity, it is unlikely that the Company would be able to recover its investment in these securities if they were sold at this time.
 
The Company has the intent not to sell or will not more likely than not be required to sell the other three PTPS until a recovery of amortized cost basis, which may be at maturity. Based on an assessment of the credit quality of the underlying issuers and the Company’s senior tranche positions, we did not consider the investment in these securities to be other-than-temporarily impaired at March 31, 2012. The Company will continue to monitor the market price of these securities and the default rates of the underlying issuers and continue to evaluate these securities for possible other-than-temporary impairment.
 
 
18

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Other-Than-Temporary Impairments. In estimating other-than-temporary impairment losses, management considers: (1) the length of time and extent that fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, (3) the Company’s intent to sell the security or whether it is more likely than not that it will be required to sell the security before the anticipated recovery of its remaining amortized cost basis and (4) evaluation of cash flows to determine if they have been adversely affected.
 
OTTI credit losses on debt securities recognized in noninterest income during the three months ended March 31, 2012 and OTTI non-credit losses recognized in accumulated other comprehensive loss (“AOCL”) at March 31, 2012 are summarized in the table below. Also included in the table is the lowest credit rating of each security and the percentage of defaults and delinquencies in the underlying banks and loans supporting each trust preferred and CMO security, respectively, as of March 31, 2012 (dollars in thousands):
 
         
OTTI Credit Loss
   
Non-Credit
   
Lowest
       
   
Fair
   
March 31, 2012
   
Loss in AOCL
   
Credit
   
Default /
 
Description
 
Value
   
QTD
   
YTD
   
March 31, 2012
   
Rating
   
Delinquency
 
Trust preferred securities:
                                   
    US Capital Funding III 12/01/35
  $ 1,050     $ -     $ -     $ 1,916       C       26.9 %
    Alesco Preferred Funding IV
    52       -       -       403       C       40.4 %
    US Capital Funding I 05/01/34
    200       -       -       351       C       19.8 %
      1,302       -       -       2,670                  
Collateralized mortgage obligations:
                                               
    CWALT 2006-19CB
    2,598       67       67       423       C       8.9 %
    First Horizon Alt 2006
    1,366       -       -       219       D       15.9 %
    JPMMT 2007-S3
    1,263       -       -       (20 )     D       13.4 %
      5,227       67       67       622                  
    $ 6,529     $ 67     $ 67     $ 3,292                  
 
For the three months ended March 31, 2011, there was OTTI credit losses of $33,000 related to three trust preferred securities.   OTTI credit losses were recognized for the three months ended March 31, 2011 of $78,000 related to three collateralized mortgage obligations.
 
The Company did not recognize an OTTI credit loss on trust preferred securities during the three months ended March 31, 2012.  The Company used a DCF analysis, in which the calculated present value of cash flows expected to be collected were more than the amortized cost basis. Inputs to the discount model included default rates, deferrals of interest, over-collateralization tests, interest coverage tests and other factors. For debt securities with credit ratings below “AA” (not high quality), the Company discounts the expected cash flows at the current yield used to accrete the beneficial interest in accordance with FASB ASC 325-40-35, “Investments-Other-Beneficial Interests in Securitized Financial Assets.” The accretable yield for the beneficial interest on the date of evaluation is the excess of estimated cash flows over the beneficial interest’s reference amount. The reference amount is equal to the initial investment minus cash received to date minus other-than-temporary impairments recognized to date plus the yield accreted to date. For those trust preferred securities that are other-than-temporarily impaired, defaults and deferrals provided by a third-party broker increased by $1.1 million for the three months ended March 31, 2012.
 
 
19

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
With regard to our PTPS valuations, unrealized losses are larger than other-than-temporarily impaired investments for two primary reasons:
 
 
1)
The discount rate used in assessing OTTI is the purchased yield of a bond, which is constant. Therefore, changes in OTTI are purely a function of changes in the amount and timing of projected future cash flows, but are not influenced by the market’s required rate of return for these cash flows (their discount rate). Fair value measures, however, incorporate the market’s perception of the risk of a bond’s future cash flows. Given that the credit quality of PTPS collateral has deteriorated significantly since the onset of the credit crisis, the riskiness of all PTPS bonds has increased, pushing the discount rates used to value them well above their coupon rates. This risk premium is the primary reason that the fair values of most PTPSs are significantly below their amortized costs.
 
 
2)
During the height of the credit bubble in late 2007 and early 2008, there was tremendous demand for PTPSs, and competition among dealers for PTPSs compressed collateral credit spreads to artificially tight levels. When the credit bubble burst, demand for PTPSs declined and PTPS credit spreads increased. This increase in credit spreads reduced the fair value of PTPS collateral, which by extension reduced the fair value of PTPSs.
 
Although the third party model we use captures the illiquidity premium embedded in the yields of benchmark, publicly traded PTPSs, we do not incorporate the illiquidity that currently exists in the PTPS market itself. The PTPS market is severely dislocated and opaque, and features a small number of sophisticated hedge funds bidding for PTPS assets held by a large number of institutions. As a result, trades have occurred over a wide range of prices that we believe contain excessive discounts for distressed sales, illiquidity and complexity, and are therefore not an accurate measure of the fair value of PTPSs.
 
The Company recognized an OTTI credit loss on collateralized mortgage obligations of $67,000 during the three months ended March 31, 2012. The Company used a DCF analysis to provide an estimate of the OTTI credit loss, which resulted from the calculated present value of cash flows expected to be collected being less than the amortized cost basis. Inputs to the DCF analysis include prepayment rate, default rate, delinquencies, loss severities and percentage of non-performing assets. For debt securities with credit ratings below “AA” (high quality), the Company discounts the expected cash flows at the current yield used to accrete the beneficial interest, which is in accordance with the subsequent measurement provisions of FASB ASC 325-40-35, “Investments-Other-Beneficial Interests in Securitized Financial Assets.” The accretable yield for the beneficial interest on the date of evaluation is the excess of estimated cash flows over the beneficial interest’s reference amount. The reference amount is equal to the initial investment minus cash received to date minus other-than-temporary impairments recognized to date plus the yield accreted to date. The increase in the percentage of delinquent loans and decrease in credit support contributed to the OTTI credit loss.
 
The following table summarizes the change in OTTI credit related losses on debt securities, exclusive of tax effects, for the three months ended March 31, 2012 and 2011 (dollars in thousands):
 
   
Three Months Ended
 
   
March 31,
 
   
2012
   
2011
 
Credit related impairments with a portion recognized in other comprehensive loss:
           
Beginning balance
  $ 4,886     $ 4,553  
Credit related impairments on portions of OTTI previously recognized in other comprehensive loss
    67       111  
Ending balance
  $ 4,953     $ 4,664  

 
20

 

BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 5 – Loans
 
Loans, net are summarized as follows (dollars in thousands):
 
   
March 31,
   
December 31,
 
   
2012
   
2011
 
             
Residential real estate:
           
    1-4 family
  $ 178,368     $ 185,509  
    Home equity
    124,640       128,370  
      Total Residential Real Estate
    303,008       313,879  
Commercial :
               
    Commercial business
    56,628       82,383  
    Commercial real estate
    172,516       167,955  
    Multi-family real estate
    35,816       35,854  
    Commercial - 1-4 family real estate
    16,635       14,979  
    Construction
    9,188       13,034  
        Total Commercial
    290,783       314,205  
Consumer:
               
    Auto - indirect
    115,954       115,712  
    Auto - direct
    18,585       18,758  
    Other consumer - secured
    19,246       18,934  
    Other consumer - unsecured
    6,341       6,765  
        Total Consumer
    160,126       160,169  
     Gross loans
    753,917       788,253  
Net deferred loan costs
    4,023       4,238  
Allowance for loan losses
    (13,831 )     (19,150 )
Loans, net of allowance for loan losses
  $ 744,109     $ 773,341  
 
 
21

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The following table details activity in the allowance for loan losses by portfolio segment for the three months ended March 31, 2012 and 2011, respectively.  Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories (dollars in thousands).
 
   
Residential
                         
   
Real Estate
   
Commercial
   
Consumer
   
Unallocated
   
Total
 
Allowance for loan losses:
                             
Balance at December 31, 2011
  $ 1,293     $ 15,855     $ 2,002     $ -     $ 19,150  
     Provision for loan losses
    146       375       83       -       604  
     Charge-offs
    (104 )     (5,941 )     (294 )     -       (6,339 )
     Recoveries
    12       268       136       -       416  
Balance at March 31, 2012
    1,347     $ 10,557     $ 1,927     $ -     $ 13,831  
                                         
Allowance for loan losses:
                                       
Balance at December 31, 2010
  $ 1,288     $ 12,070     $ 1,844     $ 38     $ 15,240  
     Provision for loan losses
    36       746       235       (38     979  
     Charge-offs
    (61     (40     (335     -       (436
     Recoveries
    1       -       112       -       113  
Balance at March 31, 2011
  $ 1,264     $ 12,776     $ 1,856     $ -     15,896  
                                         
 
The following table details the allowance for loan losses based on the impairment method for the periods ending March 31, 2012 and December 31, 2011:
 
     
Residential
                                 
     
Real Estate
     
Commercial
     
Consumer
     
Unallocated
     
Total
 
At March 31, 2012:
                                       
Period-end allowance balance attributed to loans:
                                       
     Individually evaluated for impairment
  $ 159     $ 3,285     $ -     $ -     $ 3,444  
     Collectively evaluated for impairment
    1,188       7,272       1,927       -       10,387  
                                         
Loan balance individually evaluated for impairment
  $ 3,217     $ 34,008     $ -       -     $ 37,225  
Loan balance collectively evaluated for impairment
    299,791       256,775       160,126       -       716,692  
    $ 303,008     $ 290,783     $ 160,126     -     $ 753,917  
                                         
At December 31, 2011:
                                       
Period-end allowance balance attributed to loans:
                                       
     Individually evaluated for impairment
  $ 16     $ 7,966     $ -     $ -     $ 7,982  
     Collectively evaluated for impairment
    1,277       7,889       2,002       -       11,168  
                                         
Loan balance individually evaluated for impairment
  $ 3,232     $ 39,524     $ -       -     $ 42,756  
Loan balance collectively evaluated for impairment
    310,647       274,681       160,169       -       745,497  
    $ 313,879     $ 314,205     $ 160,169     $ -     $ 788,253  
 
The stratification of the non-impaired loan portfolio resulted in a quantitative general loan loss allowance of $4.9 million at March 31, 2012 and $3.5 million at December 31, 2011.  The qualitative adjustments made to the general loan loss provision resulted in $5.5 million at March 31, 2012 compared to $7.7 million at December 31, 2011.
 
For homogeneous loan pools, such as 1-4 family residential mortgages, home equity lines of credit and consumer loans, the Company uses payment status to identify the credit risk in these loan portfolios. Payment status is reviewed on a monthly basis by the Bank’s collection area and on a quarterly basis with respect to determining the adequacy of the allowance for loan losses.
 
 
22

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Commercial real estate loans 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 and 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' 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 expose the Company to the risk that improvements will not be completed on time in accordance with specifications and projected costs. 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.  In addition, the ultimate sale or rental of the property may not occur as anticipated.
 
Nonaccrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are automatically placed on nonaccrual status when payment of principal or interest is more than 90 days delinquent. Restructured loans are placed on nonaccrual status if collection of principal or interest in full is in doubt. Collateral-dependent loans may 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 interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. At any time a loan is less than 90 days delinquent, and we expect to collect principal and interest in full, the loan will return to accrual status.
 
 
23

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The recorded investment in nonaccrual loans, segregated by class of loans, was as follows (dollars in thousands):
 
   
March 31,
   
December 31,
 
   
2012
   
2011
 
Residential real estate:
           
1-4 family
  $ 583     $ 250  
Home equity
    430       632  
Commercial:
               
Commercial business
    14,196       18,128  
Commercial real estate
    9,411       9,764  
Multi-family real estate
    452       755  
Commercial - 1-4 family real estate
    454       1,648  
Construction
    485       267  
    $ 26,011     $ 31,444  

 
24

 

BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

An aging analysis of past due loans, segregated by class of loans, as of March 31, 2012 was as follows (dollars in thousands):
 
   
30-59 Days
   
60-89 Days
   
90-119 Days
   
120 Days
   
Current
   
Total
   
Accruing Loans
90 or More
 
   
Past Due
   
Past Due
   
Past Due
   
and Greater
   
Loans
   
Loans
   
Days Past Due
 
Residential real estate:
                                         
    1-4 family
  $ 677     $ -     $ 165     $ 419     $ 177,107     $ 178,368     $ -  
    Home equity
    424       30       -       430       123,756       124,640       -  
Commercial:
                                                       
    Commercial business
    1,299       -       -       323       55,006       56,628       -  
    Commercial real estate
    842       3,166       -       3,083       165,425       172,516       -  
    Multi-family real estate
    -       -       -       453       35,363       35,816       -  
    Commercial - 1-4 family real estate
    82       1,200       -       115       15,238       16,635       -  
    Construction
    750       -       -       51       8,387       9,188       -  
Consumer:
                                                       
    Auto - indirect
    1,069       100       -       -       114,785       115,954       -  
    Auto - direct
    67       -       -       -       18,518       18,585       -  
    Other consumer - secured
    47       -       -       -       19,199       19,246       -  
    Other consumer - unsecured
    5       10       -       -       6,326       6,341       -  
        Total
  $ 5,262     $ 4,506     $ 165     $ 4,874     $ 739,110     $ 753,917     $ -  
 
An aging analysis of past due loans, segregated by class of loans, as of December 31, 2011 was as follows (dollars in thousands):
 
                                       
Accruing Loans
 
   
30-59 Days
   
60-89 Days
   
90-119 Days
   
120 Days
   
Current
   
Total
   
90 or More
 
   
Past Due
   
Past Due
   
Past Due
   
and Greater
   
Loans
   
Loans
   
Days Past Due
 
Residential real estate:
                                         
    1-4 family
  $ 60     $ 199     $ 250     $ -     $ 185,000     $ 185,509     $ -  
    Home equity
    672       232       84       548       126,834       128,370       -  
Commercial:
                                                       
    Commercial business
    4,042       717       401       91       77,132       82,383       -  
    Commercial real estate
    1,834       -       400       1,738       163,983       167,955       -  
    Multi-family real estate
    -       -       -       755       35,099       35,854       -  
    Commercial - 1-4 family real estate
    15       50       -       1,648       13,266       14,979       -  
    Construction
    -       1,126       -       208       11,700       13,034       -  
Consumer:
                                                       
    Auto - indirect
    2,306       104       -       -       113,302       115,712       -  
    Auto - direct
    109       4       -       -       18,645       18,758       -  
    Other consumer - secured
    92       -       -       -       18,842       18,934       -  
    Other consumer - unsecured
    37       1       -       -       6,727       6,765       -  
        Total
  $ 9,167     $ 2,433     $ 1,135     $ 4,988     $ 770,530     $ 788,253     $ -  
 
Nonperforming loans totaled $38.2 million at March 31, 2012.  Of the $38.2 million of nonperforming loans, $26.0 million were on nonaccrual status and $12.2 million were on accrual status.  Of the $26.0 million loans on nonaccrual status $15.7 million were current and $10.3 million were past due.  Large groups of smaller balance homogenous loans consisted of consumer and residential real estate loans that totaled $1.0 million at March 31, 2012 and these loans were collectively evaluated for impairment. The $12.2 million of nonperforming loans on accrual status were troubled debt restructurings that were performing in accordance with restructured terms.
 
 
25

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Impaired loans. Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature, such as consumer and residential real estate loans, and on an individual loan basis for other loans, such as multi-family, commercial business and commercial real estate loans. If a loan is impaired, a valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged-off when deemed uncollectible, with the balance remaining as an impaired loan until either the full principal is received or the loan is charged-off.
 
 
26

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Impaired loans are set forth in the following tables (dollars in thousands).
 
                                 
Three Months Ended
 
   
March 31, 2012
   
March 31, 2012
 
   
Unpaid
   
Recorded
   
Recorded
                         
   
Contractual
   
Investment
   
Investment
   
Total
         
Average
   
Interest
 
   
Principal
   
With No
   
With
   
Recorded
   
Related
   
Recorded
   
Income
 
   
Balance
   
Allowance
   
Allowance
   
Investment
   
Allowance
   
Investment
   
Recognized
 
                                           
Residential real estate:
                                         
    1-4 family
  $ 3,217     $ -     $ 3,217     $ 3,217     $ 159     $ 3,222     $ 40  
Commercial :
                                                       
    Commercial business
    23,027       10,426       7,719       18,145       2,469       19,155       272  
    Commercial real estate
    13,894       10,438       2,834       13,272       798       13,706       99  
    Multi-family real estate
    593       452       -       452               648       -  
    Construction
    659       485       -       485               254       10  
    Commercial 1-4 family real estate
    1,776       1,594       60       1,654       18       1,682       5  
        Total
  $ 43,166     $ 23,395     $ 13,830     $ 37,225     $ 3,444     $ 38,667     $ 426  
 
               December 31, 2011            
Year Ended
December 31, 2011
 
   
Unpaid
   
Recorded
   
Recorded
                         
   
Contractual
   
Investment
   
Investment
   
Total
         
Average
   
Interest
 
   
Principal
   
With No
   
With
   
Recorded
   
Related
   
Recorded
   
Income
 
   
Balance
   
Allowance
   
Allowance
   
Investment
   
Allowance
   
Investment
   
Recognized
 
Residential real estate:
                                         
    1-4 family
  $ 3,232     $ -     $ 3,232     $ 3,232     $ 16     $ 877     $ 31  
Commercial :
                                                       
    Commercial business
    23,361       5,493       17,705       23,198       6,878       2,076       96  
    Commercial real estate
    14,889       7,050       6,607       13,657       734       2,852       63  
    Multi-family real estate
    1,772       452       303       755       91       755       -  
    Construction
    267       -       267       267       175       15       -  
    Commercial 1-4 family real estate
    1,647       1,500       147       1,647       88       1,537       -  
        Total
  $ 45,168     $ 14,495     $ 28,261     $ 42,756     $ 7,982     $ 8,112     $ 190  
 
The average recorded investment in impaired loans and interest income recognized for the three months ended March 31, 2011 were $11.0 million and $37,000, respectively.
 
Credit quality indicators. As part of the on-going monitoring of the credit quality of the Company’s loan portfolio, management tracks certain credit quality indicators. For non-commercial loans, management analyzes primarily historical payment experience, credit documentation and current economic trends. Additionally, for commercial loans, management tracks loans based on risk ratings.  We use the following definitions for risk ratings:
 
Special mention – Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or the institution’s credit position at some future date.
 
Substandard – Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the repayment of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
 
Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or repayment in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
 
 
27

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The following table presents risk rated classified loans by class of commercial loan (dollars in thousands).
 
   
March 31, 2012
 
   
Pass
   
Special
Mention
 
Substandard
   
Doubtful
   
Total
 
    Commercial business
  $ 24,549     $ 7,632     $ 21,050     $ 3,397     $ 56,628  
    Commercial real estate
    134,203       14,708       23,375       230       172,516  
    Multi-family real estate
    33,779       1,529       56       452       35,816  
    Commercial- 1-4 family real estate
    13,862       643       2,014       116       16,635  
    Construction
    3,263       5,407       467       51       9,188  
    $ 209,656     $ 29,919     $ 46,962     $ 4,246     $ 290,783  
                                         
   
December 31, 2011
 
   
Pass
   
Special
Mention
 
Substandard
   
Doubtful
   
Total
 
    Commercial business
  $ 29,086     $ 19,993     $ 25,602     $ 7,702     $ 82,383  
    Commercial real estate
    135,280       9,663       22,507       505       167,955  
    Multi-family real estate
    33,045       2,054       -       755       35,854  
    Commercial - 1-4 family real estate
    12,361       489       1,981       148       14,979  
    Construction
  $ 11,898       415       513       208       13,034  
      221,670     $ 32,614     $ 50,603     $ 9,318     $ 314,205  
 
Loan modifications.  The Company had the following restructured loans, including troubled debt restructurings, classified by type of concession made at March 31, 2012 and December 31, 2011, respectively:
 
   
March 31, 2012
Type of concession
 
# of Loans
   
Unpaid Principal Balance
 
Allocated Allowance
 
         
(Dollars in thousands)
 
Commercial loans - non collateral-dependent
                 
Term extended and interest rate reduced (reduced to market rate)
    8     $ 2,585     $ 423  
Total
    8     $ 2,585     $ 423  
                         
Commercial loans - collateral-dependent
                       
Interest-only for 6 to 12 months
    10     $ 3,320     $ -  
Term extended and interest rate reduced (reduced to market rate)
    7       7,555       218  
Total
    17     $ 10,875     $ 218  
                         
Residential 1-4 family loan - collateral-dependent
                       
Term extended and interest rate reduced to below-market rate
    2     $ 3,217     $ 155  
Total
    2     $ 3,217     $ 155  
 
 
28

 

BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
 
 
                         
   
December 31, 2011
 
                         
Type of concession
 
# of Loans
   
Unpaid Principal Balance
 
Allocated Allowance
 
           
(Dollars in thousands)
 
Commercial loans - non collateral-dependent
                       
Term extended and interest rate reduced (reduced to market rate)
    6     $ 2,876     $ 407  
Total
    6     $ 2,876     $ 407  
                         
Commercial loans - collateral-dependent
                       
Interest-only for 6 to 12 months
    10     $ 4,095     $ 826  
Term extended and interest rate reduced (reduced to market rate)
    7       7,577       1,430  
Total
    17     $ 11,672     $ 2,256  
                         
Residential 1-4 family loan - collateral-dependent
                       
Term extended and interest rate reduced to below-market rate
    2     $ 3,232     $ 95  
Total
    2     $ 3,232     $ 95  

 
At March 31, 2012, there were $3.3 million of restructured loans classified as nonaccrual loans and nonperforming loans. At December 31, 2011, there were $4.4 million of restructured loans classified as nonaccrual loans and nonperforming loans.
 
Based on the underwriting at the time of the restructuring, the Company makes a determination whether or not the loan is a troubled debt restructuring (“TDR”). Restructured loans are not considered TDRs when the loan terms are consistent with the Company’s current product offerings and the borrowers meet the Company’s current underwriting standards with regard to financial condition, payment history and collateral.
 
The Company considers a TDR to be any restructured 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 restructured 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.
 
During the three month periods ended March 31, 2012 and 2011, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan.
 
We establish an allowance when loans are determined to be impaired, including troubled debt restructurings. Loss is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses.  The Company has allocated an allowance for loan losses of $530,000 and $2.0 million to customers whose loan terms have been modified in troubled debt restructurings as of March 31, 2012 and December 31, 2011.  The Company has not committed to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructurings as of March 31, 2012 and December 31, 2011.
 
 
29

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Following is a summary of troubled debt restructurings during the three months ended March 31, 2012:
 
         
Pre-modification
   
Post-modification
 
         
Outstanding
   
Outstanding
 
   
Number of
   
Recorded
   
Recorded
 
   
Contracts
   
Investment
   
Investment
 
    Commercial business
    2     $ 166     $ 166  
        Total
    2     $ 166     $ 166  
 
The troubled debt restructurings described above increased the allowance for loan losses by $40,000 and resulted in no charge-offs during the three months ended March 31, 2012.
 
Following is a summary of troubled debt restructurings at March 31, 2012:
 
   
Number of
   
Recorded
 
   
Contracts
   
Investment
 
Residential real estate:
           
    1-4 family
    2     $ 3,217  
Commercial:
               
    Commercial business
    10       5,401  
    Commercial real estate
    5       5,461  
    Commercial - 1-4 family real estate
    1       1,200  
        Total
    18     $ 15,279  
 
The Company had twelve TDRs totaling $12.2 million as of March 31, 2012, which were included in impaired loans on accrual status since these loans were performing in accordance with the restructured terms.
 
At December 31, 2011, there were sixteen TDRs totaling $15.9 million.  There were six TDRs totaling $3.7 million that were included in impaired loans and on nonaccrual status, while the remaining ten TDRs totaling $12.2 million were included in impaired loans on accrual status.
 
No troubled debt restructurings have occurred during the previous 12 months, which subsequently defaulted during the three months ended March 31, 2012.
 
The terms of certain other loans were modified during the three months ended March 31, 2012 that did not meet the definition of a troubled debt restructuring. These loans have a total recorded investment as of March 31, 2012 of $1.4 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.
 
 
30

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default or any of its debt in the foreseeable future without the modification. This evaluation is performed under the Company’s internal underwriting policy.
 
In general, a delay in payment is considered to be insignificant if it is less than three months.
 
Note 6 – Deposits
 
Deposits are summarized as follows (dollars in thousands):
 
   
March 31,
   
December 31,
 
   
2012
   
2011
 
             
Noninterest-bearing checking
  $ 49,619     $ 47,152  
Interest-bearing checking accounts
    69,289       62,453  
Savings accounts
    105,952       101,897  
Money market accounts
    214,846       205,565  
Time accounts
    237,558       263,789  
    $ 677,264     $ 680,856  
 
Note 7 – Equity Incentive Plan
 
As authorized by the Beacon Federal Bancorp, Inc. 2008 Equity Incentive Plan (the “2008 Plan”), the Board of Directors granted 153,735 shares of non-incentive stock options to directors, officers and employees on January 27, 2011.  The options have an exercise price of $12.60 per share, vest over a three-year period and expire ten years from the date of the grant.  The Company has estimated the fair value of awards under this option issuance to be $3.72 per award using the Black-Scholes pricing model.  The Company has recorded $45,000 of expense related to this option issuance for the three months ended March 31, 2012.  Total option expense for the three months ended March 31, 2012 and 2011 was $78,000 and $131,000 respectively.
 
Restricted stock award expense for the three months ended March 31, 2012 and 2011 was $0 and $153,000, respectively.
 
Note 8 – Income Taxes
 
Under FASB ASC 740-10-25, “Income Taxes,” a tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur.  The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination.  For tax positions not meeting the “more likely than not” test, no tax benefit is recorded.
 
At March 31, 2012, the Company had no unrecognized tax benefits.  We are subject to U.S. Federal income taxes, as well as State of New York, Massachusetts and Tennessee income taxes.  State income tax returns filed for the years ended December 31, 2008 through December 31, 2011 and the U.S. Federal income tax returns for the years ended December 31, 2011 and 2010 remain open to examination by these jurisdictions.
 
 
31

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 9 – Commitments and Financial Guarantees
 
As a financial services provider, we routinely are a party to various financial instruments with off-balance sheet risks, such as commitments to extend credit and unused lines of credit.  While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may, and are likely to, expire without being drawn upon.  Such commitments are subject to the same credit policies and approval process accorded to loans we make.
 
The contractual amount of financial instruments with off-balance sheet risk was as follows (dollars in thousands):
 
   
March 31, 2012
   
December 31, 2011
 
   
Fixed
   
Variable
   
Fixed
   
Variable
 
   
Rate
   
Rate
   
Rate
   
Rate
 
Commitments to make loans
  $ 32,913     $ 17,766     $ 25,616     $ 22,318  
Unused lines of credit
  $ 2,362     $ 55,273     $ 2,279     $ 51,060  
Range of fixed-rate commitments
    3.25%-15.00 %             3.375%-15.00 %        
 
The following instruments are considered financial guarantees and are carried at fair value.  The contract amount and fair value of these instruments was as follows (dollars in thousands):
 
   
March 31, 2012
   
December 31, 2011
 
   
Contract
   
Fair
   
Contract
   
Fair
 
   
Amount
   
Value
   
Amount
   
Value
 
Standby letters of credit
  $ 1,109     $ -     $ 1,621     $ -  
Limited recourse obligations related to loans sold
  $ 2,260     $ -     $ 2,036     $ -  
 
Loans sold to the Federal Home Loan Bank (FHLB) of New York under the Mortgage Partnership Finance program are sold with recourse.  The Bank has an annual agreement that allows selling up to $50 million of residential loans to the FHLB of New York.  Approximately $62.6 million has been sold through March 31, 2012 under the current and previous agreements.  Under the agreements, the Bank has a maximum credit enhancement of $2.3 million at March 31, 2012.  Based upon a favorable payment history, the Bank does not anticipate recognizing any losses on these residential loans, and accordingly, has not recorded a liability for the credit enhancement.
 
Note 10 – Fair Value Measurements and Financial Instruments
 
Fair Value Measurements
 
General. The Company follows the provisions of FASB ASC 820-10, “Fair Value Measurements,” for financial assets and liabilities. FASB ASC 820-10 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy prioritizes the assumptions that market participants would use in pricing the assets or liabilities (the “inputs”) into three broad levels.
 
 
32

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The fair value hierarchy gives the highest priority (Level 1) to quoted prices in active markets for identical assets and liabilities and the lowest priority (Level 3) to unobservable inputs in which little, if any, market activity exists, requiring entities to develop their own assumptions and data.
 
Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. These inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in market areas that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks and default rates) or inputs that are derived principally from or corroborated by observable market data by correlation or other means.
 
Valuation Techniques. Securities available for sale are carried at fair value on a recurring basis utilizing Level 1, Level 2 and Level 3 inputs. For U.S. Treasuries, the Company obtains fair values using quoted prices in the U.S. Treasury market. For agencies, mortgage-backed securities, and collateralized mortgage obligations, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, live trading levels, trade execution data, cash flows, market consensus prepayment speeds, market spreads, credit information and the U.S. Treasury yield curve.
 
For trust preferred securities, the Company obtains fair values using a discounted cash flow analysis. The analysis considers the structure and term of the trust preferred securities and the financial condition of the underlying financial institution issuers. Specifically, the analysis details interest rates, principal balances of note classes and underlying issuers, the timing and amount of interest and principal payments of the underlying issuers, and the allocation of the payments to the note classes. The current estimate of expected cash flows is based on the most recent trustee reports and any other relevant market information including announcements of interest payment deferrals or defaults. Assumptions used in the analysis include default rate, deferral of interest, over-collateralization test, interest coverage test and other factors. For debt securities with credit ratings below “AA” (not high quality), the Company discounts the expected cash flows at the current yield used to accrete the beneficial interest. The accretable yield for the beneficial interest on the date of evaluation is the excess of estimated cash flows over the beneficial interest’s reference amount. The reference amount is equal to the initial investment minus cash received to date minus other-than-temporary impairments recognized to date plus the yield accreted to date.
 
In determining the amount of currently performing collateral for purposes of modeling the expected future cash flows, management analyzed the default and deferral history. This review indicated significant amounts of defaults and deferrals by the financial institution issuers. We assume that all deferrals will default, and 10% recoveries for deferrals and no recoveries for the failed banks. Additionally, management has noted the correlation between the rising levels of nonperforming loans as a percent of tangible equity plus loan loss reserves, by those issuers that have defaulted and/or, deferred interest payments. Therefore management has used this ratio as a primary indicator to project the levels of future defaults for fair value analysis purposes.
 
Given that the Federal Reserve Board approved PTPS as a source of Tier 1 capital in 1996, the short history of PTPSs and the scarcity of bank defaults prior to the credit crisis has left us with limited data with which to estimate recoveries. A 10% recovery was obtained for Silver State Bancorp’s PTPS, and developments in the bankruptcy proceedings for Corus Bank and Washington Mutual provide some support for an assumption of positive recoveries. However, until further recovery data emerges from the bankruptcy proceedings of numerous PTPS issuers, we believe it is prudent to assume zero recoveries for all failed banks.
 
With regard to currently deferring issuers, we assume that banks that have either raised significant amounts of new capital, or that have been acquired by stronger institutions, will cure within six months.  For the remaining deferrals, we refer to Moody’s preferred stock research which reveals that, historically, 71% of issuers that suspended dividends eventually defaulted. Given the historically high default risk of deferring issuers, and the current stress on the banking system, we apply a conservative assumption that deferring issuers will default immediately. As it is likely that some deferring issuers will eventually cure, a development that is already underway with the acquisition of deferring banks by stronger banks, we assume a 10% recovery on projected defaults.
 
 
33

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Subsequent to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) we expect that banks with total assets greater than $15 billion will call their PTPS within the first six months of 2013. To account for future growth and consolidation expected in the industry, we assume banks that currently have $13 billion in total assets will reach the $15 billion threshold by early 2013. We believe that profitable, well capitalized banks will begin to call PTPS with fixed rate coupons above 9%, or floating rate coupons with spreads above 325 basis points. We are assuming that these prepayments will occur sometime during 2012. In addition, we are assuming prepayments of 5% every five years to account for further industry growth and isolated prepayments unrelated to the Dodd-Frank Act.
 
We assume that all auction calls will fail due to the dramatic decline in value of PTPS pools below the par value of PTPS liabilities.
 
Under the ASC 825-10-25 election, all mortgage loans originated and intended for sale in the secondary market are carried at fair value, utilizing Level 2 inputs as determined based on quotes in the secondary market of outstanding commitments to sell our loans from investors. The fair value election was made to match changes in the value of these loans with the value of the loan commitment derivatives. None of the loans held for sale are in a delinquent status. Fair value gains or losses on loans held for sale are reported on the statement of income in the line “Gain on sale of loans.”
 
The Company estimates fair values on mortgage servicing rights using Level 2 inputs, which include discounted cash flows based on current market pricing. The Company measures servicing rights at fair value at each reporting date and reports changes in fair value of servicing assets in earnings in the period in which the changes occur, and are included with other noninterest expense on the income statement.  The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses. 
 
Derivative instruments used in the ordinary course of business consist of mandatory forward sales contracts and interest rate lock commitments. The Company manages interest rate risk and hedges the interest rate lock commitments through mandatory forward sales contracts, which have fair value changes opposite to market movements. Generally, in an interest rate lock commitment, the borrower locks-in the current market rate for a fixed-rate loan. The mandatory forward sales contract is a loans sales agreement in which the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specific price on or before a specific date.
 
The Company had outstanding forward sales contracts of $13.0 million in notional value, matched against $13.9 million of interest rate lock commitments at March 31, 2012. The interest rate lock commitments included in other assets and forward sales contracts recognized in other liabilities amounted to $227,000 and $0, respectively, at March 31, 2012 and were accounted for at fair value as an undesignated derivative with a $141,000 fair value gain on the interest rate lock commitments and a $17,000 loss on the mandatory forward sales contracts recognized in noninterest income for the three months ended March 31, 2012. The fair value of the Company’s derivative financial instruments is primarily measured by obtaining pricing from broker-dealers recognized to be market participants. The pricing is derived from market observable inputs that can generally be verified and do not typically involve significant judgment by the Company. Forward contracts and loan commitments are recorded at fair value utilizing Level 2 inputs. The Company believes that it has enough sources of liquidity to satisfy future cash requirements as they related to these derivative instruments.
 
 
34

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Loans are generally not recorded at fair value on a recurring basis.  Periodically, the Company records nonrecurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans.  Multi-family, commercial business and commercial real estate loans are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Real estate collateral is typically valued using independent appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace, adjusted based on non-observable inputs and the related nonrecurring fair value measurement adjustments and have generally been classified as Level 3. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.
 
Nonfinancial assets measured at fair value on a non-recurring basis include foreclosed and repossessed assets. Assets acquired through, or instead of, loan foreclosure and by repossession are initially recorded at fair value utilizing level 3 inputs based on recent appraisals less costs to sell when acquired, establishing a new cost basis. The fair value under such appraisals is determined by using one of the following valuation techniques: income, cost or comparable sales.
 
Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis. The following table summarizes financial assets and liabilities measured at fair value on a recurring basis at March 31, 2012, segregated by the level of the inputs within the hierarchy used to measure fair value (dollars in thousands):
 
   
Quoted Prices in
   
Significant
             
   
Active Markets
   
Other
   
Significant
       
   
for Identical
   
Observable
   
Unobservable
   
Total
 
   
Assets
   
Inputs
   
Inputs
   
Fair
 
 Assets
 
(Level 1)
   
(Level 2)
   
(Level 3)
   
Value
 
                         
Available for sale securities:
                       
Debt securities:
                       
  U.S. Treasury and agencies
  $ 101     $ 2,987     $ -     $ 3,088  
  Pooled trust preferred securities
    -       -       4,196       4,196  
  Mortgage-backed securities - Residential
    -       69,647       -       69,647  
  Collateralized mortgage obligations - Private issuer
    -       10,247       -       10,247  
  Collateralized mortgage obligations - Government agency
    -       84,747       -       84,747  
    $ 101     $ 167,628     $ 4,196     $ 171,925  
                                 
Loans held for sale in the secondary market
  $ -     $ 4,438     $ -     $ 4,438  
                                 
Mortgage servicing rights
  $ -     $ 938     $ -     $ 938  
                                 
Loan commitment derivatives
  $ -     $ 227     $ -     $ 227  
 
The aggregate fair value exceeded the aggregate unpaid principal balance of loans held for sale that are carried at fair value under ASC 825-10-25 by $76 as of March 31, 2012.
 
 
35

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The following table summarizes financial assets and liabilities measured at fair value on a recurring basis at December 31, 2011, segregated by the level of the inputs within the hierarchy used to measure fair value (dollars in thousands):
 
   
Quoted Prices in
   
Significant
             
   
Active Markets
   
Other
   
Significant
       
   
for Identical
   
Observable
   
Unobservable
   
Total
 
   
Assets
   
Inputs
   
Inputs
   
Fair
 
 Assets
 
(Level 1)
   
(Level 2)
   
(Level 3)
   
Value
 
                         
Securities available for sale:
                       
Debt securities:
                       
  U.S. Treasury and agencies
  $ 101     $ 3,007     $ -     $ 3,108  
  Pooled trust preferred securities
    -       -       4,234       4,234  
  Mortgage-backed securities - Residential
    -       49,038       -       49,038  
  Collateralized mortgage obligations - Private issuer
    -       10,141       -       10,141  
  Collateralized mortgage obligations - Government agency
    -       78,375       -       78,375  
    $ 101     $ 140,561     $ 4,234     $ 144,896  
                                 
Loans held for sale
  $ -     $ 1,350     $ -     $ 1,350  
                                 
Mortgage servicing rights
  $ -     $ 790     $ -     $ 790  
                                 
Loan commitment derivatives
  $ -     $ 145     $ -     $ 145  
                                 
Liabilities
                               
                                 
Sales contract derivatives
  $ -     $ 41     $ -     $ 41  
 
The aggregate fair value exceeded the aggregate unpaid principal balance of loans held for sale that are carried at fair value under ASC 825-10-25 by $5 as of December 31, 2011.
 
There were no transfers between Level 1 and Level 2 categorizations for the periods presented.
 
 
36

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Financial Assets Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs (Level 3). The changes in fair value of assets measured using Level 3 inputs were as follows (dollars in thousands):
 
   
Three Months Ended March 31,
 
   
2012
   
2011
 
             
Beginning balance
  $ 4,234     $ 5,446  
Capitalized interest
    -       -  
Principal paydowns
    (54 )     (32 )
Total gains or losses (realized/unrealized)
               
     Included in earnings
    -       (34 )
     Included in other comprehensive income
    16       593  
Ending balance
  $ 4,196     $ 5,973  
 
There were no transfers into or out of Level 3 categorization for the periods presented.
 
For Level 3 financial assets measured at fair value on a recurring basis at March 31, 2012, the significant unobservable inputs used in the fair value measurements were as follows (dollars in thousands):
 
       
Valuation
 
Unobservable
 
Range (Weighted
Assets
 
Fair Value
 
Technique
 
Input(s)
 
Average)
                 
Pooled trust preferred securities
  $ 4,196  
Discounted
 
Collateral default rate
  0.45%-0.6%
         
cash flow
 
Recoveries
  2.5%-7.5%
 
Financial Assets Measured at Fair Value on a Non-Recurring Basis. Financial assets measured at fair value on a non-recurring basis, utilizing level 3 inputs at March 31, 2012, include impaired loans that had a principal balance of $31.3 million, with a valuation allowance of $2.1 million at March 31, 2012, resulting in an additional provision for loan losses of $927,000 for the three months ended March 31, 2012.  At December 31, 2011, impaired loans had a principal balance of $35.6 million, with a valuation allowance of $4.5 million, resulting in an additional provision for loan losses of $1.1 milion for the year ended December 31, 2011. The impaired loans are collateral dependent and are measured for impairment using the fair value of collateral.
 
Assets measured at fair value on a non-recurring basis utilizing Level 3 inputs are summarized below (dollars in thousands):
 
   
March 31,
   
December 31,
 
   
2012
   
2011
 
             
Impaired loans:
           
  Residential real estate
  $ 3,058     $ 3,215  
  Commercial business
    11,694       12,652  
  Commercial real estate
    12,311       12,922  
  Multi-family real estate
    452       664  
  Commercial 1-4 family real estate
    1,636       1,560  
  Construction
    75       93  
     Total
  $ 29,226     $ 31,106  
 
 
37

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
There were no transfers into or out of level 3 categorization for the three months ended March 31, 2012.
 
Nonfinancial Assets Measured at Fair Value on a Non-Recurring Basis.  Nonfinancial assets measured at fair value on a non-recurring basis at March 31, 2012 and December 31, 2011 consisted of foreclosed and repossessed assets of $2.8 million and $1.9 million, respectively, utilizing level 3 inputs.  There were no losses on foreclosed and repossessed assets during the three months ended March 31, 2012 and 2011.
 
For Level 3 financial and nonfinancial assets measured at fair value on a non-recurring basis at March 31, 2012, the significant unobservable inputs used in the fair value measurements were as follows (dollars in thousands):
 
       
Valuation
 
Unobservable
 
Range (Weighted
Assets
 
Fair Value
 
Technique
 
Input(s)
 
Average)
                 
Impaired loans
  29,226  
Sales comparison and income
approaches
 
Adjustments for differences
between comparable sales and net operating income
expectations
 
  8.00%-15.00%
Foreclosed and repossessed assets
  2,827  
Sales comparison and income
approaches
 
Adjustments for differences between comparable sales and net operating income expectations
  8.00%-15.00%
           
Capitalization rate
  8.00%-9.00%
 
 
38

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Financial Instruments. Carrying amount, estimated fair value and the financial hierarchy of the Company’s financial instruments were as follows (dollars in thousands):
 
               
Quoted Prices in
   
Significant
       
   
March 31,
   
Active Markets
   
Other
   
Significant
 
   
2012
   
for Identical
   
Observable
   
Unobservable
 
   
Carrying
   
Fair
   
Assets
   
Inputs
   
Inputs
 
   
Amount
   
Value
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Financial assets:
                             
   Cash and cash equivalents
  $ 39,393     $ 39,393     $ 39,393     $ -     $ -  
   Securities available for sale
    171,925       171,925       101       167,628       4,196  
   Securities held to maturity
    6,591       6,875       -       6,875       -  
   Loans held for sale in the secondary market
    4,438       4,438       -       4,438       -  
   Loans, net
    744,109       756,785       -       -       756,785  
   Mortgage servicing rights
    938       938               938       -  
   FHLB stock and other restricted stock
    13,112       N/A       -       -       -  
   Accrued interest receivable
    3,016       3,016       -       3,016       -  
                                         
Financial liabilities:
                                       
    Deposits
    677,264       679,826       438,949       240,877       -  
    Federal Home Loan Bank advances
    148,427       151,030       -       151,030       -  
Securities sold under agreement to repurchase and other short-term borrowings
    73,000       79,318       -       79,318       -  
    Accrued interest payable
    1,423       1,423       -       1,423       -  
 
               
Quoted Prices in
   
Significant
       
   
December 31,
   
Active Markets
   
Other
   
Significant
 
   
2011
   
for Identical
   
Observable
   
Unobservable
 
   
Carrying
   
Fair
   
Assets
   
Inputs
   
Inputs
 
   
Amount
   
Value
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Financial assets:
                             
   Cash and cash equivalents
  $ 43,724     $ 43,724     $ 43,724     $ -     $ -  
   Securities available for sale
    144,896       144,896       101       140,561       4,234  
   Securities held to maturity
    6,975       7,207       -       7,207       -  
   Loans held for sale in the secondary market
    1,350       1,350       -       1,350       -  
   Loans, net
    773,341       786,152       -       -       786,152  
   Mortgage servicing rights
    790       790       -       790       -  
   FHLB stock and other restricted stock
    12,605       N/A       -       -       -  
   Accrued interest receivable
    3,174       3,174       -       3,174       -  
                                         
Financial liabilities:
                                       
    Deposits
    680,856       678,108       410,463       267,645       -  
    Federal Home Loan Bank advances
    148,427       152,433       -       152,433       -  
    Securities sold under agreement to repurchase and other short-term borrowings
    73,000       79,158       -       79,158       -  
    Accrued interest payable
    1,454       1,454       -       1,454       -  
 
 
39

 
 
BEACON FEDERAL BANCORP, INC.
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The methods and assumptions used to estimate fair value are described as follows:
 
(a) Cash and Cash Equivalents
 
The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.
 
(b) FHLB Stock
 
It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.
 
(c) Loans

Fair values of loans, excluding loans held for sale, are estimated as follows:  For fixed rate loans or variable rate loans that reprice with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk, resulting in a Level 3 classification.  If a loan is impaired, a portion of the allowance is allocated so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Real estate collateral is typically valued using independent appraisals or other indications of value based on recent comparable sales of similar properties or assumptions generally observable in the marketplace, adjusted based on non-observable inputs and the related nonrecurring fair value measurement adjustments and have generally been classified as Level 3.

The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

(e) Deposits

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. The carrying amounts of variable rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date resulting in a Level 2 classification.


(f) Short-term Borrowings

The carrying amounts of federal funds purchased, borrowings under repurchase agreements, and other short-term borrowings, generally maturing within ninety days, approximate their fair values resulting in a Level 2 classification.

(g) Other Borrowings

The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.
 
(h) Accrued Interest Receivable/Payable
 
The carrying amounts of accrued interest approximate fair value resulting in a Level 2 classification.

 (i) Off-balance Sheet Instruments
 
Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.
 
The discounted cash flow models used to determine fair value are significantly affected by the assumptions used, including, but not limited to, the discount rate and estimates of future cash flows.
 
 
40

 
 
BEACON FEDERAL BANCORP, INC.

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Management’s discussion and analysis of financial condition and results of operations at March 31, 2012 and for the three months ended March 31, 2012 and 2011 is intended to assist in understanding the financial condition and results of operations of the Company.  The information contained in this section should be read in conjunction with the unaudited Consolidated Financial Statements and the notes thereto, appearing in Part 1, Item 1 of this report.
 
Forward-Looking Statements
 
When used in this Form 10-Q, the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.  Such statements are subject to certain risks and uncertainties including changes in economic conditions in our market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in our market area, and competition that could cause actual results to differ materially from historical earnings and those presently anticipated or projected.  Additionally, other risks and uncertainties are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the Securities and Exchange Commission (the “SEC”), which is available through the SEC’s website at www.sec.gov.  The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which only speak as of the date made.  The Company wishes to advise readers that the factors listed above could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.
 
The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
 
Critical Accounting Policies
 
Preparation of our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. We believe the most complex and sensitive judgments, because of their significance to the Consolidated Financial Statements, result primarily from the need to make estimates about the effects of matters that are inherently uncertain.  Management’s Discussion and Analysis of Financial Condition and Results of Operations, Note 1 to the Consolidated Financial Statements in our 2011 Form 10-K and Note 2 to the Consolidated Financial Statements in this Form 10-Q, describe the significant accounting estimates and policies used in preparation of the Consolidated Financial Statements in this Form 10-Q.  The critical accounting policies are the accounting for credit losses, the valuation of securities and the accounting for income taxes.  Actual results in these areas could differ from management’s estimates. There have been no significant changes in our critical accounting policies during the first three months of 2012.
 
Overview
 
General.  Our results of operations depend mainly on our net interest income, which is the difference between the interest income earned on our loan and investment portfolios and interest expense we pay on our deposits and borrowings. Results of operations are also affected by the fee income from banking operations, the provision for loan losses, gains on sales of loans and other miscellaneous income.  Our noninterest expense consists primarily of salaries and employee benefits, occupancy and equipment, marketing, general administrative expenses, FDIC premium expense and income tax expense.
 
Our results of operations are also significantly affected by general economic and competitive conditions, particularly with respect to changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable law, regulations or government policies may materially affect our financial condition and results of operations.
 
 
41

 
 
BEACON FEDERAL BANCORP, INC.
 
Economic Conditions.  The national economy, as well as the local economies within our market areas, continues to be weak.  The economy has been marked by high unemployment rates, rising numbers of foreclosures, declining home prices and contractions in business and consumer credit.  The national unemployment rate ended the first quarter at 8.2%.  The unemployment rate in the Company’s primary market area in New York State is slightly above the national average at 8.5% in March 2012 compared to 8.0% in March 2011.  The Federal Open Market Committee has announced that it will keep the federal funds rate between 0.00% and 0.25% through at least the middle of 2013.
 
Operating Results.  Net income decreased to $1.3 million for the quarter ended March 31, 2012 from $1.5 million for the quarter ended March 31, 2011.  The decrease in net income resulted primarily from a decline in net interest income, partially offset by a lower provision for loan losses.
 
Financial Condition.  Total assets decreased by $2.1 million at March 31, 2012 to $1.02 billion from December 31, 2011, as a result of a $29.2 million decrease in net loans and a $4.3 million decrease in cash and cash equivalents, partially offset by a $27.0 million increase in securities. Deposits decreased by $3.6 million to $677.3 million at March 31, 2012.  Stockholders’ equity increased by $1.9 million, or 1.7%, to $113.9 million at March 31, 2012 from $112.1 million at December 31, 2011.
 
At March 31, 2012, Beacon Federal was categorized as “well capitalized” under regulatory capital requirements.
 
Comparison of Financial Condition at March 31, 2012 and December 31, 2011
 
Cash and Cash Equivalents. Cash and cash equivalents decreased by $4.3 million to $39.4 million at March 31, 2012 from $43.7 million at December 31, 2011 due to the purchase of securities.
 
Securities.  Securities available for sale increased to $171.9 million at March 31, 2012 from $144.9 million at December 31, 2011.  The increase in securities available for sale reflected the reinvestment of loan repayments from borrowers.
 
Loans.  Net loans decreased by $29.2 million to $744.1 million at March 31, 2012 due to a combination of weak loan demand primarily in our commercial loan portfolio, an exceptionally competitive lending environment and a higher than normal level of prepayments in our commercial loan portfolio and an increased amount of loan charge-offs taken in the first quarter of 2012.
 
During the three months ended March 31, 2012 commercial loans and residential loans decreased by $23.4 million and $10.9 million, respectively.  Consumer loans remained virtually unchanged.
 
The decrease of $23.4 million in commercial loans was due to a higher than normal level of prepayments in our commercial loan portfolio and an increased amount of loan charge-offs taken in the first quarter of 2012. The Company took $5.9 million of commercial loan charge-offs, related to impaired loans, during the first quarter of 2012. Of the $5.9 million commercial loan charge-offs, $5.4 million were specifically reserved for at December 31, 2011.  Commercial loan originations were $5.3 million in the first quarter of 2012, compared to $26.9 million for the first three months of 2011.  The decrease in the first quarter’s originations was primarily due to a higher than expected number of loans closing in the fourth quarter of 2011 coupled with the deferment of several loan closings from the first quarter of 2012 to the second quarter of 2012.
 
The $10.9 million decrease in residential loans was due to normal loan amortizations and a decrease in mortgage refinances.  Originations of residential loans amounted to $19.8 million in the first quarter of 2012, compared to $17.4 million for the first three months of 2011.
 
Deposits.  Deposits decreased by $3.6 million to $677.3 million at March 31, 2012. Time deposits decreased by $26.2 million when compared to December 31, 2011 due to the Companys strategy to pursue lower cost non-maturity deposits.  Non-maturity deposits increased by $22.6 million during the first three months of 2012. This increase reflects the Company’s efforts to continue to decrease the cost of funds by targeting our marketing efforts on attracting new core accounts.
 
Borrowings.  FHLB advances and securities sold under agreement to repurchase and other short-term borrowings remained unchanged at $221.4 million at March 31, 2012.  The Company has access when necessary to alternative sources of financing, including brokered deposits, CDARS and the Borrower-in-Custody (“BIC”) program with the Federal Reserve Bank of New York.
 
 
42

 
 
BEACON FEDERAL BANCORP, INC.
 
Stockholders’ Equity. Stockholders’ equity increased by $1.9 million, or 1.7%, to $113.9 million at March 31, 2012 from $112.1 million at December 31, 2011.  The increase primarily reflected $1.3 million of net income for the three months ended March 31, 2012, $466,000 of other comprehensive income, $78,000 of amortization of stock related compensation and $247,000 of allocated ESOP shares, partially offset by cash dividends of $411,000.
 
Comparison of Operating Results for the Three Months Ended March 31, 2012 and 2011
 
Interest Income.  Interest income was $11.3 million in the first quarter of 2012, decreasing by $1.2 million, or 9.8%, compared with the same quarter of 2011.  The decrease resulted primarily from lower yields on loans and securities.
 
Interest income on loans of $9.9 million for the first quarter of 2012 decreased $986,000, or 9.1%, from the same period in the prior year.  The average yield on loans declined 34 basis points to 5.08% for the first quarter of 2012 from 5.42% for the same period in the prior year, which reflected a decline in the yield on loans indexed to prime, partially offset by the greater proportion of higher-yielding commercial real estate, commercial business and secured consumer loans in our loan portfolio and a higher level of nonaccrual loans during the 2012 period compared to the 2011 period.  In addition, the average balance on loans decreased to $784.1 million for the quarter ended March 31, 2012 from $814.6 million for the quarter ended March 31, 2011.
 
Interest income on securities for the first quarter of 2012 was $1.3 million and decreased by $220,000 from the first quarter of 2011, reflecting lower average yields on such securities which decreased to 3.15% for the first quarter of 2012 from 3.47% for the first quarter of 2011.  The yield on securities decreased due to new purchases of securities at lower interest rates.  The average balance of securities decreased $12.3 million, or 7.1%, to $160.4 million for the three months ended March 31, 2012 from $172.7 million for the three months ended March 31, 2011.
 
Interest Expense.  Interest expense decreased 8.6% to $4.3 million for the first quarter of 2012, from $4.7 million for the same quarter in 2011.  The decrease in interest expense resulted primarily from lower average rates and average balances on deposits in addition to a decline in the average balance of FHLB advances.
 
Interest expense on deposits decreased by $316,000, or 14.6%, to $1.8 million for the quarter ended March 31, 2012 from $2.2 million for the quarter ended March 31, 2011.  The average rate paid on deposits decreased 20 basis points to 1.18% for the first quarter of 2012 from 1.38% for the comparable quarter in 2011 due to low market interest rates. The average balance of interest-bearing deposits decreased to $629.1 million for the quarter ended March 31, 2012 from $634.2 million for the quarter ended March 31, 2011.
 
Interest expense on time accounts (certificates of deposit, brokered deposits and CDARS) decreased by $535,000, or 32.8%, to $1.1 million for the quarter ended March 31, 2012 from $1.6 million for the quarter ended March 31, 2011, due primarily to a decrease of 30 basis points in average time account rates to 1.76% for the quarter ended March 31, 2012 from 2.06% for the prior year quarter and a $70.0 million lower average balance of time accounts.
 
Interest expense on borrowings decreased to $2.5 million for the quarter ended March 31, 2012 from $2.6 million for the quarter ended March 31, 2011, due primarily to a lower average balance as certain FHLB advances matured.  The average balance on borrowings decreased to $227.2 million for the quarter ended March 31, 2012 from $241.6 million for the quarter ended March 31, 2011.
 
Net Interest Income.  Net interest income decreased by $819,000, to $7.0 million for the first quarter of 2012.  The decrease in net interest income was due primarily to a lower net interest rate spread and an increase in nonaccrual loans between the comparative periods.  Our net interest rate spread decreased to 2.55% for the first quarter of 2012 from 2.90% for the first quarter of 2011 and the net interest margin decreased to 2.82% from 3.16% for the same comparative periods.  The lower net interest rate spread was attributable to a lower yield earned on our loans and securities.  As high-yielding assets mature, they are being replaced with current market rate assets which are at consistently lower yields leading to pressure on the Company’s net interest margin, which is expected to continue in the near term.  Our nonaccrual loans were $26.0 million at March 31, 2012, compared to $31.4 million at December 31, 2011 and $11.4 million at March 31, 2011.
 
 
43

 
 
BEACON FEDERAL BANCORP, INC.
 
Provision for Loan Losses.  We recorded a provision for loan losses of $604,000 for the quarter ended March 31, 2012 compared to a provision for loan losses of $979,000 for the quarter ended March 31, 2011.  Nonperforming loans increased to $38.2 million as of March 31, 2012, compared to $16.6 million as of March 31, 2011.  The allowance for loan losses was $13.8 million, or 1.83% of total loans, exclusive of loans held for sale, at March 31, 2012 compared to $19.2 million, or 2.43% of total loans, exclusive of loans held for sale, at December 31, 2011.  The ratio of the allowance for loan losses to gross loans decreased as a result of an increase in net charge-offs.  The ratio of the allowance for loan losses to nonperforming loans was 36.17% at March 31, 2012, compared with 43.88% at December 31, 2011.
 
Net loan charge-offs were $5.9 million for the quarter ended March 31, 2012, compared to net charge-offs of $323,000 for the quarter ended March 31, 2011.  In the Company’s on-going efforts to implement credit enhancements, an expanded internal loan review and an assessment of overall credit risk in the loan portfolio was conducted by our new Chief Credit Officer, leading to the increase in net loan charge-offs.  The allowance for loan losses were adequate to cover all amounts charged off.
 
To the best of our knowledge, we have recorded all losses that are both probable and reasonable to estimate as of March 31, 2012.
 
Noninterest Income.  Noninterest income increased $344,000, or 22.9%, to $1.8 million for the quarter ended March 31, 2012 from $1.5 million for the quarter ended March 31, 2011. Noninterest income increased primarily due to a $125,000 increase in other noninterest income, a $75,000 increase in service charges, a $71,000 increase in gain on sale of loans and a $44,000 decrease in the other-than-temporary credit impairment charges for the quarter.
 
Other-than-temporary credit impairment charges for the quarter resulted from one collateralized mortgage obligation (“CMO”).  The extent of impairment recognized was based on the current and projected delinquencies along with reduced credit support in the underlying mortgages for the CMO.  The other-than-temporary credit impairment for the quarter of $67,000 was less than 1% of the fair value of our securities portfolio at March 31, 2012.
 
The 8.0% increase in service charge income related primarily to an increase in debit card fees.  The Bank is actively promoting debit card usage and core deposits that require debit card transactions in order to obtain an attractive rate of interest for depositors. The resulting increased debit card usage is leading to the increase in the debit card fee income.
 
Other noninterest income increased primarily from an increase in income related to carrying loans held for sale at fair value, partially offset by a decrease in prepayment fee and other loan related income.
 
Noninterest Expense.  Noninterest expense increased by $336,000, or 5.8%, to $6.2 million for the quarter ended March 31, 2012 from $5.8 million for the quarter ended March 31, 2011.  The increase in noninterest expense was due primarily to increases in audit and examination and other noninterest expense, partially offset by lower FDIC premium expense.
 
Audit and examination expense increased by $284,000, or 168.0%, to $453,000 for the quarter ended March 31, 2012 due primarily to additional work performed by the Company’s independent registered public accounting firm, including a review of the effectiveness of internal controls over financial reporting.
 
FDIC premium expense decreased by $144,000, or 40.0%, to $216,000 for the quarter ended March 31, 2012 as a result of a decrease in the deposit insurance assessment rate.
 
 
44

 
 
BEACON FEDERAL BANCORP, INC.
 
Other noninterest expense increased by $210,000, or 18.5%, to $1.3 million for the quarter ended March 31, 2012 due to higher loan collection costs.
 
Income Tax Expense.  The provision for income taxes was $762,000 for the quarter ended March 31, 2012, compared to $944,000 for the quarter ended March 31, 2011.  The decrease was due primarily to a $436,000 decrease in pre-tax income.  The effective tax rate for the three months ended March 31, 2012 and 2011 was 37.6% and 38.3%, respectively.
 
 
45

 
 
BEACON FEDERAL BANCORP, INC.
 
Average Balances and Yields.  The following table sets forth average balance sheets, average yields and rates, and certain other information for the periods indicated.  No tax-equivalent yield adjustments were made, as the effect thereof was not material.  All average balances are daily average balances.  Nonaccrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield.  The yields set forth below include the effect of net deferred costs, discounts and premiums that are amortized or accreted to interest income.
 
 
46

 
 
BEACON FEDERAL BANCORP, INC.
 
    For the Three Months Ended March 31,  
    2012     2011  
   
Average
               
Average
             
   
Outstanding
   
Interest
   
Yield /
   
Outstanding
   
Interest
   
Yield /
 
   
Balance
   
Earned/Paid
   
Rate (1)
   
Balance
   
Earned/Paid
   
Rate (1)
 
      (Dollars in thousands)  
Interest-earning assets:
                                   
Loans (2)
  $ 784,135     $ 9,901       5.08 %   $ 814,641     $ 10,887       5.42 %
Securities
    160,448       1,258       3.15       172,732       1,478       3.47  
FHLB stock
    10,762       120       4.48       10,253       150       5.93  
Interest-earning deposits
    37,089       12       0.13       221       3       5.51  
Total interest-earning assets
    992,434       11,291       4.58       997,847       12,518       5.09  
Noninterest-earning assets
    28,054                       34,044                  
Total assets
  $ 1,020,488                     $ 1,031,891                  
                                                 
                                                 
Interest-bearing liabilities:
                                               
Savings
  $ 102,579     $ 105       0.41     $ 110,012     $ 135       0.50  
Money market accounts
    211,929       471       0.89       142,050       262       0.75  
Checking accounts
    63,281       172       1.09       60,928       132       0.88  
Time accounts
    251,277       1,098       1.76       321,242       1,633       2.06  
Total deposits
    629,066       1,846       1.18       634,232       2,162       1.38  
FHLB advances
    148,427       1,611       4.37       163,841       1,710       4.23  
Reverse repurchase agreements
    71,055       675       3.82       70,000       668       3.87  
Lease obligation
    7,743       196       10.18       7,740       196       10.27  
Total interest-bearing liabilities
    856,291       4,328       2.03       875,813       4,736       2.19  
                                                 
Noninterest-bearing deposits
    46,192                       41,330                  
Other noninterest-bearing liabilities
    6,223                       5,370                  
Total liabilities
    908,706                       922,513                  
Stockholders equity
    111,782                       109,378                  
Total liabilities and equity
  $ 1,020,488                     $ 1,031,891                  
                                                 
                                                 
Net interest income
          $ 6,963                     $ 7,782          
                                                 
                                                 
Net interest rate spread (3)
                    2.55 %                     2.90 %
                                                 
Net interest-earning assets (4)
  $ 136,143                     $ 122,034                  
                                                 
Net interest margin (5)
                    2.82 %                     3.16 %
                                                 
Average of interest-earning assets to interest-bearing liabilities
                    115.90 %                     113.93 %
 

(1)  Yields and rates for the three months ended March 31, 2012 and 2011 are annualized. 
(2)  Includes loans held for sale and nonaccrual loans. 
(3)  Net interest rate spread represents the difference between the yield on total average interest-earning assets and the cost of total average interest-bearing liabilities for the three months ended March 31, 2012 and 2011. 
(4)  Net interest-earning assets represents total interest-earning assets less interest-bearing liabilities. 
(5)  Net interest margin represents annualized net interest income divided by average total interest-earning assets. 
 
 
47

 
 
BEACON FEDERAL BANCORP, INC.
 
Liquidity and Capital Resources
 
Our primary sources of funds consist of deposit inflows, loan repayments, advances from the Federal Home Loan Bank of New York, and maturities and sales of securities.  In addition, we have the ability to collateralize borrowings in the wholesale markets.  While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.  We seek to maintain a liquidity ratio of 8.0% or greater.  For the quarter ended March 31, 2012, our liquidity ratio averaged 12.3%.  We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of March 31, 2012.  Excess liquid assets have been invested generally in interest-earning deposits and short- and intermediate-term securities.
 
Our most liquid assets are cash and cash equivalents.  The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period.  At March 31, 2012, cash and cash equivalents totaled $39.4 million.
 
Securities classified as available for sale, which provide additional sources of liquidity, totaled $171.9 million at March 31, 2012.  On that date, we had $148.4 million of Federal Home Loan Bank advances outstanding and $2.3 million in limited recourse obligations related to loans sold, with the ability to borrow an additional $69.2 million.
 
At March 31, 2012, we had $50.7 million in loan commitments outstanding.  In addition to commitments to originate loans, we had $57.6 million in unused lines of credit to borrowers. Certificates of deposit due within one year of March 31, 2012 totaled $120.2 million, or 17.7% of total deposits.  If these deposits do not remain with us, we will be required to seek other sources of funds, including loan and security sales, brokered deposits, CDARS, BIC and Federal Home Loan Bank advances. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before March 31, 2013.  We believe, however, based on past experience that a significant portion of such deposits will remain with us.  We have the ability to attract and retain deposits by adjusting the interest rates offered.
 
Our primary investing activity is originating loans.  During the three months ended March 31, 2012, we originated $44.1 million of loans, and during the three months ended March 31, 2011, we originated $64.6 million of loans.
 
We purchased $40.1 million of securities during the three months ended March 31, 2012, compared to $15.3 million during the three months ended March 31, 2011.
 
Financing activities consist primarily of activity in deposit accounts and Federal Home Loan Bank advances.  We experienced a net decrease in total deposits of $3.6 million for the three months ended March 31, 2012, compared to a net increase of $3.7 million for the three months ended March 31, 2011.  Deposit flows are affected by the interest rates and products offered by us and our local competitors, and by other factors.
 
Federal Home Loan Bank advances remained unchanged for the three months ended March 31, 2012, compared to a decrease of $4.4 million for the three months ended March 31, 2011.  Historically, Federal Home Loan Bank advances have primarily been used to fund loan demand. At March 31, 2012, we had the ability to borrow up to $217.6 million ($69.2 million available) from the Federal Home Loan Bank of New York.
 
Banks are subject to regulatory capital requirements administered by federal banking agencies.  Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance sheet items calculated under regulatory accounting practices.  Capital amounts and classifications are also subject to qualitative judgments by regulators.  Failure to meet capital requirements can initiate regulatory action.  At March 31, 2012 the Bank met all capital adequacy requirements.
 
 
48

 
 
BEACON FEDERAL BANCORP, INC.
 
Prompt corrective action regulations provide five classifications:  well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition.  If an institution is only adequately capitalized, regulatory approval is required to accept brokered deposits.  If an institution is undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required.  At March 31, 2012 and December 31, 2011, the most recent regulatory notification categorized the Bank as well capitalized under the regulatory framework for prompt corrective action.  There are no conditions or events since that notification that management believes have changed the institutions category.
 
Actual and required capital amounts and ratios for the Bank are presented below (dollars in thousands):
 
                           
To Be Well
 
                           
Capitalized Under
 
               
For Capital
   
Prompt Corrective
 
   
Actual
   
Adequacy Purposes
   
Action Provisions
 
March 31, 2012
 
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
Equity
  $ 106,882                                
Disallowed deferred tax assets
    (673 )                              
Unrealized loss on AFS securities
    2,024                                
Tier 1 (Core) Capital
    108,233                                      
General valuation allowance (1)     9,473                                      
Deduction for low-level recourse
    (2,260 )                                    
Total Capital to risk-weighted assets
  $ 115,446       15.29 %   $ 61,346       8.00 %   $ 76,683       10.00 %
Tier 1 (Core) Capital to risk-weighted assets
  $ 105,973       14.11 %   $ 30,673       4.00 %   $ 46,010       6.00 %
Tier 1 (Core) Capital to adjusted total assets
  $ 108,233       10.57 %   $ 40,968       4.00 %   $ 51,210       5.00 %
                                                 
(1)       Limited to 1.25% of risk-weighted assets.
                                               
                                   
To Be Well
 
                                   
Capitalized Under
 
                   
For Capital
   
Prompt Corrective
 
   
Actual
   
Adequacy Purposes
   
Action Provisions
 
December 31, 2011
 
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
Equity
  $ 104,512                                          
Disallowed deferred tax assets
    (673 )                                        
Unrealized loss on AFS securities
    2,490                                          
Tier 1 (Core) Capital and Tangible Capital
    106,329       10.32 %   $ 15,453       1.50 %                
General valuation allowance (1)     9,815                                          
Deduction for low-level recourse
    (2,036 )                                        
Total Capital to risk-weighted assets
  $ 114,108       14.53 %   $ 62,818       8.00 %   $ 78,522       10.00 %
Tier 1 (Core) Capital to risk-weighted assets
  $ 104,293       13.28 %   $ 31,409       4.00 %   $ 47,113       6.00 %
Tier 1 (Core) Capital to adjusted total assets
  $ 106,329       10.32 %   $ 41,208       4.00 %   $ 51,510       5.00 %
                                                 
(1)       Limited to 1.25% of risk-weighted assets.
                                               
 
 
49

 
 
BEACON FEDERAL BANCORP, INC.
 
Asset Quality
 
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 March 31, 2012, classified assets included substandard loans of $50.2 million, which included certain residential real estate loans, and doubtful loans of $4.2 million.   Substandard loans and doubtful loans were $53.8 million, which included certain residential real estate loans, and $9.3 million, respectively, at December 31, 2011.  The Company allocated $6.3 million and $12.0 million of loan loss allowances to these classified assets at March 31, 2012 and December 31, 2011, respectively.
 
As of March 31, 2012, we had $29.9 million of loans designated as special mention, compared to $32.6 million at December 31, 2011.  All of the loans classified as special mention are performing in accordance with their terms.  The Company allocated $690,000 and $624,000 of the general loan loss allowance to these special mention assets at March 31, 2012 and December 31, 2011, respectively.

As of March 31, 2012, our largest borrower under the substandard asset category had loans secured by commercial and residential real estate in Massachusetts and New Hampshire, with a principal balance of $6.4 million.  As of March 31, 2012, our largest doubtful loan was secured by numerous properties and equipment located in Central New York, with a principal balance of $1.8 million.  As of March 31, 2012, our largest loan designated as special mention was secured by a commercial real estate complex located in Tennessee, with a principal balance of $9.7 million.
 
Total nonperforming assets were $41.1 million or 4.01% of total assets at March 31, 2012 compared to $45.6 million or 4.44% of total assets at December 31, 2011.  Included in nonperforming assets at March 31, 2012 were nonperforming loans of $38.2 million, of which $12.2 million were on accrual status, compared to nonperforming loans of $43.6 million, of which $12.2 million were on accrual status, at December 31, 2011.  The $12.2 million of nonperforming loans on accrual status at March 31, 2012 and December 31, 2011 were troubled debt restructurings that were performing in accordance with restructured terms.  Nonperforming assets decreased by $4.5 million from December 31, 2011 primarily due to the repayment of one classified commercial business loan totaling $2.0 million and an increased amount of loan charge-offs taken in the first quarter of 2012, partially offset by additions to nonperforming assets.

Net charge-offs for the first quarter of 2012 were $5.9 million, or an annualized 3.03% of average loans, compared to $323,000 or an annualized 0.16% of average loans, for the first quarter of 2011.  The Company took $5.9 million of commercial loan charge-offs, related to impaired loans, during the first quarter of 2012.  Of the $5.9 million commercial loan charge-offs, $5.4 million were specifically reserved for at December 31, 2011.

The current quarter’s provision for loan losses was $604,000, a decrease of $375,000 when compared to the first quarter of 2011.

The allowance for loan losses was $13.8 million at March 31, 2012, compared to $19.2 million at December 31, 2011.  The ratio of the allowance for loan losses to total loans was 1.83% at March 31, 2012, compared with 2.43% at December 31, 2011.  The ratio of the allowance for loan losses to nonperforming loans was 36.17% at March 31, 2012, compared with 43.88% at December 31, 2011.  Of the $38.2 million of nonperforming loans at March 31, 2012, $37.2 million were impaired and $1.0 million consisted of large groups of smaller balance consumer and residential homogenous loans, which were collectively evaluated for impairment.  The amount of impaired loans decreased $5.5 million when compared to December 31, 2011 primarily due to the repayment of one classified commercial business loan totaling $2.0 million and an increased amount of loan charge-offs taken in the first quarter of 2012.
 
The following table presents certain asset quality ratios for the periods indicated:
 
   
Three months ended
 
   
March 31,
 
   
2012
   
2011
 
Nonperforming loans to total loans
    5.07 %     2.04 %
Nonperforming assets to total assets
    4.01 %     1.61 %
Annualized net charge-offs to average loans outstanding
    3.03 %     0.16 %
Allowance for loan losses to non-performing loans at end of period
    36.17 %     96.07 %
Allowance for loan losses to total loans at end of period
    1.83 %     1.96 %
 
 
50

 
 
Off-Balance Sheet Arrangements and Contractual Obligations
 
The Company has various financial obligations, including contractual obligations and commitments that may require future cash payments.  The following table presents, as of March 31, 2012, significant contractual obligations to third parties by payment date (dollars in thousands):  
 
      Payments Due by Period  
   
Less than
   
One to
   
Three to
   
More Than
       
Contractual Obligations
 
One Year
   
Three Years
   
Five Years
   
Five Years
   
Total
 
                               
Federal Home Loan Bank advances
  $ 121,427     $ 22,000     $       $ 5,000     $ 148,427  
Securities sold under agreement to repurchase and other short-term borrowings
            30,000               43,000       73,000  
Capital lease obligation
    3       135       307       7,298       7,743  
Operating leases
    72       220       82       295       669  
Certificates of deposit
    165,696       69,075       2,787       -       237,558  
    $ 287,198     $ 121,430     $ 3,176     $ 55,593     $ 467,397  
 
The Company has a capital lease for the corporate headquarters and branch located on Manlius Center Road, East Syracuse, New York.  The lease term is for 25 years with two, five-year lease renewal options.  The Company has an operating lease for its Chelmsford, MA branch premises, with a non-cancelable 10-year term ending in 2020.  The Company has the option to extend the lease for an additional two five-year terms upon completion of the initial term.
 
Item 3.  Quantitative and Qualitative Disclosures About Market Risk.
 
General. Because the majority of our assets and liabilities are sensitive to changes in interest rates, our most significant form of market risk is interest rate risk. We are vulnerable to an increase in interest rates to the extent that our interest-bearing liabilities mature or reprice more quickly than our interest-earning assets. As a result, a principal part of our business strategy is to manage interest rate risk and limit the exposure of our net interest income to changes in market interest rates. Accordingly, our Board of Directors has established an Asset/Liability Management Committee, that is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors.
 
51

 
 
BEACON FEDERAL BANCORP, INC.
 
Our interest rate sensitivity is monitored primarily through financial modeling of economic value of equity estimation (market value of assets less market value of liabilities) and net interest income.  Both measures are highly assumption dependent and change on a regular basis as the balance sheet and interest rates change, however, taken together they represent in management’s opinion a reasonable view of the Company’s interest rate risk position.
 
We have sought to manage our interest rate risk in order to control the exposure of our earnings and capital to changes in interest rates. As part of our ongoing asset-liability management, we currently use the following strategies to manage our interest rate risk:
 
 
(i)
actively market adjustable-rate commercial loans;
     
 
(ii)
actively market commercial business loans, which tend to have shorter terms and higher interest rates than residential mortgage loans, and which generate customer relationships that can result in higher non-interest-bearing demand deposit accounts;
     
 
(iii)
lengthen the weighted average maturity of our liabilities through retail deposit pricing strategies and through longer-term wholesale funding sources such as fixed-rate advances from the Federal Home Loan Bank of New York and brokered deposits;
     
 
(iv)
invest in shorter- to medium-term securities;
     
 
(v)
sell all conforming one- to four-family mortgage loans with maturities of 20 years or more;
     
 
(vi)
originate high volumes of consumer loans, which have shorter terms, including direct and indirect automobile loans; and
     
 
(vii)
maintain high levels of capital.

Economic Value of Equity of Beacon Federal. The Company currently utilizes an outside vendor model to analyze interest rate sensitivity. The current model evaluates interest rate sensitivity by estimating the change in the Company’s economic value of equity (“EVE”) over a range of interest rate scenarios.  The EVE analysis estimates the economic value of each type of asset, liability and off-balance sheet contract under the assumption that the United States Treasury yield curve increases or decreases instantaneously by 100 to 300 basis points in 100 basis point increments. However, given the current relatively low level of market interest rates, an EVE calculation for an interest rate decrease of greater than 100 basis points has not been prepared. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 2% to 3% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below. The Company’s outside vendor provides us the results of the interest rate sensitivity model on a quarterly basis, which is based on information we provide to them to estimate the sensitivity of our economic value of equity.
 
The information provided below sets forth, as of March 31, 2012, the calculation of the estimated changes in the Bank’s economic value of equity that would result from the designated instantaneous changes in the United States Treasury yield curve. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.
 
 
52

 
 
BEACON FEDERAL BANCORP, INC.
 
                     
EVE as a Percentage of
Assets(3)
 
                               
Change in
                             
Interest
 
EVE (2),
   
Estimated Increase
         
Increase
 
Rates
 
Gross of
    (Decrease) in    
EVE
   
(Decrease)
 
(basis
 
Reserves
    EVE    
Ratio (4)
   
(basis
 
points) (1)
     
Amount
   
Percent
         
points)
 
(Dollars in thousands)          
+300
  $ 75,678     $ (49,284 )     (39.4 )%     7.74 %     (418 )
+200
    101,660       (23,302 )     (18.7 )%     10.08 %     (184 )
+100
    115,759       (9,203 )     (7.4 )%     11.24 %     (68 )
    124,962                   11.92 %      
-100
    131,957       6,995       5.6 %     12.42 %     50  
 

  (1)  Assumes an instantaneous uniform change in interest rates at all maturities. 
  (2)  EVE is the market value of assets less the market value of liabilities at each specific rate shock environment.
  (3)  EVE as a percentage of assets is the calculated EVE in each rate scenario divided by the value of assets in that scenario 
  (4)  EVE Ratio represents EVE divided by assets.
 
The table above indicates that at March 31, 2012, in the event of a 200 basis point increase in interest rates, we would experience a 19% decrease in economic value of equity. In the event of a 100 basis point decrease in interest rates, we would experience a 6% increase in economic value of equity.
 
Certain shortcomings are inherent in the methodologies used in determining interest rate risk through changes in economic value of equity. Modeling changes in economic value of equity require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the economic value tables presented assume that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assume that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the economic value of equity tables provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.
 
Net Interest Income. In addition to EVE calculations, we analyze our sensitivity to changes in interest rates through our internal net interest income model. Net interest income is the difference between the interest income we earn on our interest-earning assets, such as loans and securities, and the interest we pay on our interest-bearing liabilities, such as deposits and borrowings. In our model, we estimate what our net interest income would be for a twelve-month period using historical data for assumptions such as loan prepayment rates and deposit decay rates, the current term structure for interest rates, and current deposit and loan offering rates. We then calculate what the net interest income would be for the same period in the event of an instantaneous 200 basis point increase or 100 basis point decrease in market interest rates. As of March 31, 2012, using our internal interest rate risk model, we estimated that our net interest income for the three months ended March 31, 2012 would decrease by 9% in the event of an instantaneous 200 basis point increase in market interest rates, and would decrease by 3% in the event of an instantaneous 100 basis point decrease in market interest rates.
 
 
53

 
 
BEACON FEDERAL BANCORP, INC.
 
Item 4.  Controls and Procedures.
 
Under the supervision and with the participation of our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the fiscal quarter.
 
As part of the evaluation as of and for the quarter ended March 31, 2012, the CEO and CFO concluded that certain deficiencies in Beacon Federal Bancorp, Inc.’s credit risk and loan administration functions aggregated to a material weakness in internal controls over financial reporting at March 31, 2012.  A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis.  As a result of Beacon Federal Bancorp, Inc.’s credit administration process, the following deficiencies existed:
 
 
Loan risk ratings and classification changes used to determine the allowance for loan losses and related provision as of and during the quarter ended March 31, 2012 were not consistently identified and evaluated in a timely manner.  Impaired loans, including troubled debt restructurings, were also not consistently identified and evaluated in a timely manner.
 
 
For certain loans, documentation of loan approval during the quarter ended March 31, 2012 occurred after loan disbursement or renewal.
 
 
Due to limitations of Beacon Federal Bancorp, Inc.’s information systems, it was difficult to generate reports to identify and aggregate related loans as part of managing credit risk.
 
Because of the above material weakness, the CEO and CFO during their quarterly evaluation of disclosure controls have concluded that Beacon Federal Bancorp, Inc’s disclosure controls and procedures were not effective at March 31, 2012.
 
Changes in internal control.
 
During the quarter ended March 31, 2012, the Bank hired a former OCC examiner with many years’ experience as its new Chief Credit Officer.  Moreover, the Bank engaged an independent loan review firm to complete a full scope review of the loan portfolio for loans in excess of $75,000 in 2012 and to assess overall credit risk management.  The Bank remains dedicated to safe and sound loan practices and will continue to implement credit enhancements throughout 2012 to improve processes to properly assess loan risk ratings, identify trouble debt restructurings, expand loan documentation and develop information systems going forward.
 
PART II – OTHER INFORMATION
 
Item 1 - Legal Proceedings.
 
There are no material legal proceedings to which the Company is a party or of which any of its property is subject.  From time to time, the Company is a party to various legal proceedings incident to its business.

 
54

 
 
BEACON FEDERAL BANCORP, INC.
 
Item 1A – Risk Factors.
 
For a summary of risk factors relevant to our operations, see Part I, Item 1A, “Risk Factors” in our 2011 Annual Report on Form 10-K. There are no material changes in the risk factors relevant to our operations.
 
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds.
 
There were no shares purchased in the first quarter of 2012 as part of the Company’s fourth stock repurchase program of 326,669 shares, which was approved by the Board of Directors on April 29, 2010.
 
Item 3 - Defaults Upon Senior Securities.
 
Not applicable.
 
Item 4 – Mine Safety Disclosures.
 
Not applicable.
 
Item 5 - Other Information.
 
None.
 
Item 6 – Exhibits.
 
(a)  Exhibits. 
   
3.1
Articles of Incorporation of Beacon Federal Bancorp, Inc. (1)
3.2
Bylaws of Beacon Federal Bancorp, Inc. (1)
4
Form of Common Stock Certificate of Beacon Federal Bancorp, Inc. (1)
10.1
Employee Stock Ownership Plan (1)
10.2
Employment Agreement with Ross J. Prossner (2)
10.3
Employment Agreement with J. David Hammond (2)
10.4
Employment Agreement with Darren T. Crossett (2)
10.5
Employment Agreement with Lisa M. Jones (3)
10.6
Form of Change in Control Agreement (2)
10.7
Beacon Federal Excess Benefit Plan (4)
10.8
Beacon Federal Annual Cash Incentive Plan (1)
10.9
Beacon Federal Supplemental Executive Retirement Plan (5)
10.10
Beacon Federal 2008 Equity Incentive Plan (6)
23
Consent of Independent Registered Public Accounting Firm.
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32
Statement of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS
XBRL Instance Document
101.SCH
XBRL Taxonomy Extension Schema Document
101.CAL
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
XBRL Extension Label Linkbase Document
101.PRE
XBRL Taxonomy Extension Presentation Linkbase Document
 
 
55

 
 
BEACON FEDERAL BANCORP, INC.
 

Attached as Exhibit 101 to this report are the following formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Balance Sheets at March 31, 2012 and December 31, 2011, (ii) Consolidated Statements of Income for the three months ended March 31, 2012 and 2011, (iii) Consolidated Statements of Comprehensive Income for the three months ended March 31, 2012 and 2011, (iv) Consolidated Statement of Changes in Stockholders’ Equity for the three months ended March 31, 2012 (v) Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011, and (vi) Notes to Consolidated Financial Statements.  In accordance with Rule 406T of Regulation S-T, the XBRL related information in Exhibit 101 to this Quarterly Report on Form 10-Q shall not be deemed “filed” for purposes of Section 19 of the Exchange Act, or otherwise subject to the liability of that section, and shall not be part of any registration statement or other document filed under the Securities Act or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.
 
(1)
Incorporated by reference to the Registration Statement on Form S-1 of Beacon Federal Bancorp, Inc. (File No. 333-143522), originally filed with the Securities and Exchange Commission on June 5, 2007.
(2)
Filed with the Securities and Exchange Commission on October 4, 2007 on Form 8K.
(3)
Filed with the Securities and Exchange Commission on December 23, 2010 on Form 8K.
(4)
Filed with the Securities and Exchange Commission on October 31, 2008 on Form 8K.
(5)
Filed with the Securities and Exchange Commission on December 28, 2007 on Form 8K.
(6)
Incorporated by reference to Appendix A of the Company’s Definitive Proxy Statement for the Special Meeting of Stockholders (File No. 001-33713), as filed with the Securities and Exchange Commission on October 9, 2008.
 
 
56

 
 
BEACON FEDERAL BANCORP, INC.
 
SIGNATURES
 
Pursuant to the requirements 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.
 
 
BEACON FEDERAL BANCORP, INC.
 
(Registrant)
 
       
DATE: May 10, 2012
BY: 
Ross J. Prossner  
  Ross J. Prossner, President and Chief Executive Officer
       
  BY: Lisa M. Jones  
  Lisa M. Jones, Senior Vice President and Chief Financial Officer
 
57