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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
x | QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2005
OR
¨ | 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 0-15137
MASSBANK Corp.
(Exact name of registrant as specified in its charter)
Delaware | 04-2930382 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
123 HAVEN STREET
Reading, Massachusetts 01867
(Address of principal executive offices, including Zip Code)
Registrant’s telephone number, including area code: (781) 662-0100
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx No¨
Indicate by check mark whether the registrant is an accelerated filer (as Defined in Rule 12(b)-2 of the Exchange Act). Yes x No ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes¨ Nox
The number of shares outstanding of the issuer’s classes of common stock, as of the latest practicable date is:
Class: Common stock $1.00 per share.
Outstanding at October 31, 2005: 4,332,367 shares.
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MASSBANK CORP. AND SUBSIDIARIES
INDEX
Page | ||||
PART I – FINANCIAL INFORMATION | ||||
ITEM 1. | Financial Statements | |||
Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004 (unaudited) | 3 | |||
4 – 5 | ||||
6 – 7 | ||||
8 – 9 | ||||
10 – 15 | ||||
ITEM 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 16 – 43 | ||
ITEM 3. | 44 – 45 | |||
ITEM 4. | 45 | |||
PART II – OTHER INFORMATION | ||||
ITEM 1. | 46 | |||
ITEM 2. | 46 | |||
ITEM 3. | 47 | |||
ITEM 4. | 47 | |||
ITEM 5. | 47 | |||
ITEM 6. | 47 | |||
48 |
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PART 1. ITEM 1
MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(In thousands except share data)
(Unaudited)
September 30, 2005 | December 31, 2004 | |||||||
Assets: | ||||||||
Cash and due from banks | $ | 10,441 | $ | 9,829 | ||||
Short-term investments (Note 5) | 181,740 | 194,250 | ||||||
Total cash and cash equivalents | 192,181 | 204,079 | ||||||
Term federal funds sold | 15,000 | — | ||||||
Interest-bearing deposits in banks | 1,112 | 2,718 | ||||||
Securities available for sale, at market value (amortized cost of $433,468 in 2005 and $440,835 in 2004) | 430,027 | 443,753 | ||||||
Securities held-to-maturity, at amortized cost (market value of $4,525 in 2005 and $4,883 in 2004) | 4,577 | 4,877 | ||||||
Trading securities, at market value | 22,803 | 59,013 | ||||||
Loans: (Note 6) | ||||||||
Mortgage loans | 220,722 | 226,197 | ||||||
Other loans | 10,351 | 10,001 | ||||||
Allowance for loan losses | (1,253 | ) | (1,307 | ) | ||||
Net loans | 229,820 | 234,891 | ||||||
Premises and equipment | 6,182 | 6,464 | ||||||
Accrued interest receivable | 4,268 | 3,416 | ||||||
Goodwill | 1,090 | 1,090 | ||||||
Income tax receivable, net | 45 | 164 | ||||||
Deferred income tax asset, net | 2,762 | 588 | ||||||
Other assets | 10,562 | 15,115 | ||||||
Total assets | $ | 920,429 | $ | 976,168 | ||||
Liabilities and Stockholders’ Equity: | ||||||||
Deposits | $ | 802,597 | $ | 849,465 | ||||
Escrow deposits of borrowers | 1,009 | 1,074 | ||||||
Allowance for loan losses on off-balance sheet credit exposures | 588 | 588 | ||||||
Other liabilities | 10,895 | 15,026 | ||||||
Total liabilities | 815,089 | 866,153 | ||||||
Stockholders’ Equity: | ||||||||
Preferred stock, par value $1.00 per share; 2,000,000 shares authorized, none issued | — | — | ||||||
Common stock, par value $1.00 per share; 10,000,000 shares authorized, 7,793,930 and 7,736,430 shares issued, respectively | 7,794 | 7,736 | ||||||
Additional paid-in capital | 56,670 | 55,313 | ||||||
Retained earnings | 104,025 | 102,003 | ||||||
168,489 | 165,052 | |||||||
Treasury stock at cost, 3,472,563 and 3,354,703 shares, respectively | (60,932 | ) | (56,794 | ) | ||||
Accumulated other comprehensive income (loss) | (2,217 | ) | 1,757 | |||||
Shares held in rabbi trust at cost, 15,144 and 25,804 shares, respectively (Note 8) | (335 | ) | (553 | ) | ||||
Deferred compensation obligation (Note 8) | 335 | 553 | ||||||
Total stockholders’ equity | 105,340 | 110,015 | ||||||
Total liabilities and stockholders’ equity | $ | 920,429 | $ | 976,168 |
See accompanying condensed notes to consolidated financial statements.
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MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Three months ended September 30, | |||||||
(In thousands except share data) | 2005 | 2004 | |||||
Interest and dividend income: | |||||||
Mortgage loans | $ | 2,998 | $ | 3,342 | |||
Other loans | 181 | 167 | |||||
Securities available for sale: | �� | ||||||
Mortgage-backed securities | 1,737 | 1,712 | |||||
Other securities | 2,450 | 2,199 | |||||
Mortgage-backed securities held-to-maturity | 59 | 63 | |||||
Trading securities | 187 | 301 | |||||
Federal funds sold | 1,722 | 615 | |||||
Other investments | 12 | 37 | |||||
Total interest and dividend income | 9,346 | 8,436 | |||||
Interest expense: | |||||||
Deposits | 3,878 | 3,225 | |||||
Total interest expense | 3,878 | 3,225 | |||||
Net interest income | 5,468 | 5,211 | |||||
Provision (credit) for loan losses | — | (74 | ) | ||||
Net interest income after provision (credit) for loan losses | 5,468 | 5,285 | |||||
Non-interest income: | |||||||
Deposit account service fees | 100 | 109 | |||||
Gains on securities available for sale, net | 177 | 113 | |||||
Gains on trading securities, net | 61 | 69 | |||||
Deferred compensation plan income (loss) | 49 | (10 | ) | ||||
Other | 167 | 168 | |||||
Total non-interest income | 554 | 449 | |||||
Non-interest expense: | |||||||
Salaries and employee benefits | 1,877 | 1,778 | |||||
Deferred compensation plan expense | 71 | 5 | |||||
Occupancy and equipment | 521 | 524 | |||||
Data processing | 137 | 131 | |||||
Professional services | 115 | 143 | |||||
Advertising and marketing | 44 | 31 | |||||
Deposit insurance | 35 | 39 | |||||
Other | 376 | 327 | |||||
Total non-interest expense | 3,176 | 2,978 | |||||
Income before income taxes | 2,846 | 2,756 | |||||
Income tax expense | 962 | 945 | |||||
Net income | $ | 1,884 | $ | 1,811 | |||
Weighted average common shares outstanding: | |||||||
Basic | 4,342,872 | 4,398,346 | |||||
Diluted | 4,397,998 | 4,482,585 | |||||
Earnings per share (in dollars): | |||||||
Basic | $ | 0.43 | $ | 0.41 | |||
Diluted | 0.43 | 0.40 |
See accompanying condensed notes to consolidated financial statements.
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MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Nine months ended September 30, | ||||||||
(In thousands except share data) | 2005 | 2004 | ||||||
Interest and dividend income: | ||||||||
Mortgage loans | $ | 9,148 | $ | 10,369 | ||||
Other loans | 507 | 502 | ||||||
Securities available for sale: | ||||||||
Mortgage-backed securities | 5,211 | 4,689 | ||||||
Other securities | 7,158 | 6,587 | ||||||
Mortgage-backed securities held-to-maturity | 181 | 111 | ||||||
Trading securities | 620 | 895 | ||||||
Federal funds sold | 4,310 | 1,540 | ||||||
Other investments | 45 | 209 | ||||||
Total interest and dividend income | 27,180 | 24,902 | ||||||
Interest expense: | ||||||||
Deposits | 11,013 | 9,425 | ||||||
Total interest expense | 11,013 | 9,425 | ||||||
Net interest income | 16,167 | 15,477 | ||||||
Provision (credit) for loan losses | (53 | ) | (187 | ) | ||||
Net interest income after provision (credit) for loan losses | 16,220 | 15,664 | ||||||
Non-interest income: | ||||||||
Deposit account service fees | 301 | 342 | ||||||
Gains on securities available for sale, net | 307 | 1,156 | ||||||
Gains (losses) on trading securities, net | 119 | (214 | ) | |||||
Deferred compensation plan income | 59 | 24 | ||||||
Other | 550 | 530 | ||||||
Total non-interest income | 1,336 | 1,838 | ||||||
Non-interest expense: | ||||||||
Salaries and employee benefits | 5,572 | 5,443 | ||||||
Deferred compensation plan expense | 125 | 68 | ||||||
Occupancy and equipment | 1,649 | 1,644 | ||||||
Data processing | 404 | 391 | ||||||
Professional services | 380 | 383 | ||||||
Advertising and marketing | 104 | 79 | ||||||
Deposit insurance | 110 | 122 | ||||||
Other | 1,035 | 972 | ||||||
Total non-interest expense | 9,379 | 9,102 | ||||||
Income before income taxes | 8,177 | 8,400 | ||||||
Income tax expense | 2,742 | 2,906 | ||||||
Net income | $ | 5,435 | $ | 5,494 | ||||
Weighted average common shares outstanding: | ||||||||
Basic | 4,377,372 | 4,413,910 | ||||||
Diluted | 4,440,659 | 4,509,796 | ||||||
Earnings per share (in dollars): | ||||||||
Basic | $ | 1.24 | $ | 1.24 | ||||
Diluted | 1.22 | 1.22 |
See accompanying condensed notes to consolidated financial statements.
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MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
For The Nine Months Ended September 30, 2005 (Unaudited)
(In thousands except share data)
COMMON STOCK | ADDITIONAL PAID-IN CAPITAL | RETAINED EARNINGS | TREASURY STOCK | ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) | SHARES HELD IN RABBI TRUST | DEFERRED COMPENSATION OBLIGATION | TOTAL | |||||||||||||||||||||||
Balance at December 31, 2004 | $ | 7,736 | $ | 55,313 | $ | 102,003 | $ | (56,794 | ) | $ | 1,757 | $ | (553 | ) | $ | 553 | $ | 110,015 | ||||||||||||
Net Income | — | — | 5,435 | — | — | — | — | 5,435 | ||||||||||||||||||||||
Other comprehensive loss, net of tax: | ||||||||||||||||||||||||||||||
Unrealized losses on securities, net of reclassification adjustment (Note 9) | — | — | — | — | (3,974 | ) | — | — | (3,974 | ) | ||||||||||||||||||||
Comprehensive income | 1,461 | |||||||||||||||||||||||||||||
Cash dividends paid ($0.78 per share) | — | — | (3,413 | ) | — | — | — | — | (3,413 | ) | ||||||||||||||||||||
Purchase of treasury stock | — | — | — | (4,138 | ) | — | — | — | (4,138 | ) | ||||||||||||||||||||
Purchase of company stock for deferred compensation plan | — | — | — | — | — | (14 | ) | 14 | — | |||||||||||||||||||||
Distribution of company stock from deferred compensation plan | — | — | — | — | — | 232 | (232 | ) | — | |||||||||||||||||||||
Exercise of stock options | 58 | 1,094 | — | — | — | — | — | 1,152 | ||||||||||||||||||||||
Tax benefit on stock options exercised | — | 263 | — | — | — | — | — | 263 | ||||||||||||||||||||||
Balance at September 30, 2005 | $ | 7,794 | $ | 56,670 | $ | 104,025 | $ | (60,932 | ) | $ | (2,217 | ) | $ | (335 | ) | $ | 335 | $ | 105,340 |
See accompanying condensed notes to consolidated financial statements.
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MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
For The Nine Months Ended September 30, 2004 (Unaudited)
(In thousands except share data)
COMMON STOCK | ADDITIONAL PAID-IN CAPITAL | RETAINED EARNINGS | TREASURY STOCK | ACCUMULATED OTHER COMPREHENSIVE INCOME | SHARES HELD IN RABBI TRUST | DEFERRED COMPENSATION OBLIGATION | TOTAL | |||||||||||||||||||||||
Balance at December 31, 2003 | $ | 7,688 | $ | 54,417 | $ | 99,038 | $ | (54,177 | ) | $ | 3,961 | $ | (515 | ) | $ | 515 | $ | 110,927 | ||||||||||||
Net Income | — | — | 5,494 | — | — | — | — | 5,494 | ||||||||||||||||||||||
Other comprehensive loss, net of tax: | ||||||||||||||||||||||||||||||
Unrealized losses on securities, net of reclassification adjustment (Note 9) | — | — | — | — | (1,702 | ) | — | — | (1,702 | ) | ||||||||||||||||||||
Comprehensive income | 3,792 | |||||||||||||||||||||||||||||
Cash dividends paid ($0.75 per share) | — | — | (3,315 | ) | — | — | — | — | (3,315 | ) | ||||||||||||||||||||
Purchase of treasury stock | — | — | — | (1,473 | ) | — | — | — | (1,473 | ) | ||||||||||||||||||||
Purchase of company stock for deferred compensation plan (Note 8) | — | — | — | — | — | (52 | ) | 52 | — | |||||||||||||||||||||
Distribution of company stock from deferred compensation plan | — | — | — | — | — | 33 | (33 | ) | — | |||||||||||||||||||||
Exercise of stock options | 37 | 441 | — | — | — | — | — | 478 | ||||||||||||||||||||||
Tax benefit on stock options exercised | — | 195 | — | — | — | — | — | 195 | ||||||||||||||||||||||
Balance at September 30, 2004 | $ | 7,725 | $ | 55,053 | $ | 101,217 | $ | (55,650 | ) | $ | 2,259 | $ | (534 | ) | $ | 534 | $ | 110,604 |
See accompanying condensed notes to consolidated financial statements.
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MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
Nine Months Ended September 30, | ||||||||
2005 | 2004 | |||||||
(In thousands) | ||||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 5,435 | $ | 5,494 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 445 | 514 | ||||||
Amortization of loan valuation premium | 2 | 4 | ||||||
Loan interest capitalized | (7 | ) | (4 | ) | ||||
Increase in accrued interest receivable | (852 | ) | (524 | ) | ||||
(Decrease) increase in other liabilities | (179 | ) | 47 | |||||
Decrease in income tax receivable, net | 119 | 283 | ||||||
Amortization of premiums (accretion of discounts) on securities, net | (33 | ) | 515 | |||||
Net trading securities activity | 36,329 | 16,637 | ||||||
Gains on securities available for sale, net | (307 | ) | (1,156 | ) | ||||
(Gains) losses on trading securities, net | (119 | ) | 214 | |||||
Decrease in deferred mortgage loan origination fees, net of amortization | (86 | ) | (186 | ) | ||||
Deferred income tax expense (benefit) | 229 | (42 | ) | |||||
Decrease (increase) in other assets | 584 | (81 | ) | |||||
Provision (credit) for loan losses | (53 | ) | (187 | ) | ||||
Provision (credit) for off-balance sheet credit exposures | — | (10 | ) | |||||
Gain on sale of equipment | — | (4 | ) | |||||
Net cash provided by operating activities | 41,507 | 21,514 | ||||||
Cash flows from investing activities: | ||||||||
Purchases of term federal funds | (15,000 | ) | — | |||||
Net decrease in interest-bearing bank deposits | 1,606 | 1,478 | ||||||
Proceeds from sales of investment securities available-for-sale | 24,732 | 22,154 | ||||||
Proceeds from maturities and redemption of investment securities available-for-sale | 86,959 | 128,499 | ||||||
Purchases of investment securities available-for-sale | (95,468 | ) | (150,269 | ) | ||||
Purchases of mortgage-backed securities available-for-sale | (32,662 | ) | (58,884 | ) | ||||
Principal repayments of mortgage-backed securities | 24,445 | 28,408 | ||||||
Principal repayments of securities available-for-sale | — | 1 | ||||||
Loans originated | (40,009 | ) | (44,325 | ) | ||||
Loan principal payments received | 45,224 | 59,892 | ||||||
Proceeds from sales of equipment | — | 4 | ||||||
Purchases of premises & equipment | (163 | ) | (167 | ) | ||||
Net cash used in investing activities | (336 | ) | (13,209 | ) | ||||
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MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(unaudited)
Nine Months Ended September 30, | ||||||||
2005 | 2004 | |||||||
(In thousands) | ||||||||
Cash flows from financing activities: | ||||||||
Net decrease in deposits | (46,868 | ) | (28,975 | ) | ||||
Decrease in escrow deposits of borrowers | (65 | ) | (102 | ) | ||||
Payments to acquire treasury stock | (4,138 | ) | (1,473 | ) | ||||
Purchase of Company stock for deferred compensation plan | (14 | ) | (52 | ) | ||||
Increase in deferred compensation obligation | 14 | 52 | ||||||
Proceeds from exercise of stock options, including tax benefit | 1,415 | 673 | ||||||
Cash dividends paid on common stock | (3,413 | ) | (3,315 | ) | ||||
Net cash used in financing activities | (53,069 | ) | (33,192 | ) | ||||
Net decrease in cash and cash equivalents | (11,898 | ) | (24,887 | ) | ||||
Cash and cash equivalents at beginning of period | 204,079 | 222,910 | ||||||
Cash and cash equivalents at end of period | $ | 192,181 | $ | 198,023 | ||||
Supplemental cash flow disclosures: | ||||||||
Cash transactions: | ||||||||
Cash paid during the period for interest | $ | 11,059 | $ | 9,460 | ||||
Cash paid during the period for taxes, net of refunds | 2,132 | 2,471 |
See accompanying condensed notes to consolidated financial statements.
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CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(1) | Basis of Presentation |
The financial condition and results of operations of MASSBANK Corp. (the “Company”) essentially reflect the operations of its subsidiary, MASSBANK (the “Bank”). All significant intercompany balances and transactions have been eliminated in consolidation.
The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and in the opinion of management, include all adjustments of a normal recurring nature necessary for the fair presentation of the financial condition of the Company as of September 30, 2005 and December 31, 2004, and its operating results for the three months and nine months ended September 30, 2005 and 2004, respectively. The results of operations for any interim period are not necessarily indicative of the results to be expected for the entire year.
Certain amounts in the prior years’ consolidated financial statements were reclassified to facilitate comparison with the current fiscal year.
The information in this report should be read in conjunction with the financial statements and related notes included in the Annual Report on Form 10-K for the year ended December 31, 2004.
(2) | Stock-Based Employee Compensation |
MASSBANK Corp. utilizes stock options to compensate its officers and non-employee directors. Options are issued pursuant to plans approved by the Company’s shareholders. Under the Company’s Stock Incentive Plan (“the Plan”), options to purchase MASSBANK Corp. common stock have been granted to bank officers and non-employee directors of the Company at prices equal to the fair market value of the underlying stock on the dates the options were granted. The options have all been 100% vested at date of grant, and expire in 10 years.
The Company applies the intrinsic-value-based method to account for its fixed-plan stock options. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS No. 123, as amended, to require prominent disclosures in both annual and interim financial statements about the methods of accounting for stock-based employee compensation and the effect of the method used on reported results.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123-Revised 2004 (“SFAS 123(R)”), “Share-Based Payment”. This is a revision of SFAS No. 123, Accounting for Stock-Based Compensation, and supersedes APB No. 25, Accounting for Stock issued to Employees. Under SFAS No. 123(R), the Company will be required to measure the cost of employee services received in exchange for stock based on the grant-date fair value (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award (usually the vesting period). The fair value will be estimated using an option-pricing model. Excess tax benefits, as defined in SFAS 123(R), will be recognized as an addition to paid-in capital. This was scheduled to become effective as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. However, the Securities and Exchange Commission (SEC), in April 2005, announced the adoption of a new rule that delays the compliance dates for the adoption of FASB statement No. 123 (revised 2004) Share-Based Payment (“FAS 123(R)”).
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CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)
The SEC’s new rule allows companies to implement FAS 123(R) at the beginning of their next fiscal year, instead of the next reporting period, that begins after June 15, 2005. The Company is currently in the process of evaluating the impact of SFAS 123(R) on the consolidated financial statements, including different option-pricing models.
The following pro forma table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS 123. The fair value of stock options was determined using the Black Scholes option-pricing model.
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
(In thousands, except per share data) | 2005 | 2004 | 2005 | 2004 | |||||||||||
Net income, as reported | $ | 1,884 | $ | 1,811 | $ | 5,435 | $ | 5,494 | |||||||
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects | — | (2 | ) | (161 | ) | (170 | ) | ||||||||
Pro forma net income | $ | 1,884 | $ | 1,809 | $ | 5,274 | $ | 5,324 | |||||||
EARNINGS PER SHARE: | |||||||||||||||
Basic – as reported | $ | 0.43 | $ | 0.41 | $ | 1.24 | $ | 1.24 | |||||||
Basic – pro forma | $ | 0.43 | $ | 0.41 | $ | 1.20 | $ | 1.21 | |||||||
Diluted – as reported | $ | 0.43 | $ | 0.40 | $ | 1.22 | $ | 1.22 | |||||||
Diluted – pro forma | $ | 0.43 | $ | 0.40 | $ | 1.19 | $ | 1.18 | |||||||
Weighed average fair value | $ | 8.11 | $ | 9.55 | |||||||||||
Expected life | 7.3 yrs | 7.3 yrs | |||||||||||||
Risk-free interest rate | 3.97 | % | 3.49 | % | |||||||||||
Expected volatility | 21.2 | % | 21.9 | % | |||||||||||
Expected dividend yield | 2.80 | % | 2.34 | % |
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CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)
(3) | Recent Accounting Pronouncements: |
(a) In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 123R, Share-Based Payment which revised SFAS No. 123, Accounting for Stock-Based Compensation. This Statement supercedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and related implementation guidance and amends SFAS No. 95, Statement of Cash Flows. It requires that all stock-based compensation now be measured at fair value and recognized as expense in the income statement. This Statement also clarifies and expands guidance on measuring fair value of stock compensation, requires estimation of forfeitures when determining expense, and requires that excess tax benefits be shown as financing cash inflows versus a reduction of taxes paid in the statement of cashflows. Various other changes are also required. This Statement is effective beginning January 1, 2006 for public companies as a result of recent SEC actions. Management expects no significant effect on the Company’s financial statements as a result of the adoption of this Statement.
(4) | Cash and Cash Equivalents: |
For purposes of reporting cash flows, cash and cash equivalents consist of cash and due from banks, and short-term investments with original maturities of less than 90 days.
(5) | Short-Term Investments |
Short-term investments consist of the following:
(In thousands) | At September 30, 2005 | At December 31, 2004 | ||||
Federal funds sold (overnight) | $ | 181,737 | $ | 193,728 | ||
Money market investment funds | — | 302 | ||||
Interest-bearing bank money market accounts | 3 | 220 | ||||
Total short-term investments | $ | 181,740 | $ | 194,250 | ||
The investments above are stated at cost, which approximates market value, and have original maturities of less than 90 days.
(6) | Commitments |
At September 30, 2005, the Company had outstanding commitments to originate mortgage loans and to advance funds for construction loans amounting to $1,676,000 and commitments under existing home equity lines of credit and other loans of approximately $36,253,000 which are not reflected on the consolidated balance sheet. The Bank maintains an allowance for loan losses on off-balance sheet credit exposures. At September 30, 2005 this allowance, which is shown separately on the balance sheet, totaled $588,000.
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CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)
(7) | Earnings Per Common Share |
Basic EPS is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period.
Diluted EPS reflects the effect on the weighted average shares outstanding of the number of additional shares outstanding if dilutive stock options were converted into common stock using the treasury stock method.
The shares acquired in connection with the Company’s directors’ deferred compensation plan are considered outstanding in the computation of earnings per share and book value per share.
Earnings per share was calculated as follows:
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||
(In thousands, except per share data) | 2005 | 2004 | 2005 | 2004 | ||||||||
Denominator for basic earnings per share: | ||||||||||||
Average common shares outstanding | 4,343 | 4,398 | 4,377 | 4,414 | ||||||||
Dilutive common stock options | 55 | 85 | 64 | 96 | ||||||||
Denominator for diluted earnings per share | 4,398 | 4,483 | 4,441 | 4,510 | ||||||||
Numerator: Net income attributable to common shares | $ | 1,884 | $ | 1,811 | $ | 5,435 | $ | 5,494 | ||||
Earnings per share: | ||||||||||||
Basic | $ | 0.43 | $ | 0.41 | $ | 1.24 | $ | 1.24 | ||||
Diluted | 0.43 | 0.40 | 1.22 | 1.22 |
(8) | Directors’ Deferred Compensation Plan |
In 1988, the Company established a deferred compensation plan for its directors. The Plan allows the Company’s directors to defer receipt of all or a portion of their compensation until (1) their attaining the age of 72, or (2) their termination as a director of the Company. The Plan was later amended to allow the directors’ compensation to be invested in Company stock held in a rabbi trust. At September 30, 2005 the trust held 15,144 shares of MASSBANK Corp. common stock which were purchased in the open market or in private transactions over a period of time. The deferred compensation obligation of the Plan may be settled only by delivery of the shares of MASSBANK Corp. stock to the directors participating in the Plan. These shares are considered outstanding in the computation of earnings per share and book value per share.
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CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)
(9) | Comprehensive Income (Loss) |
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income (loss).
The components of other comprehensive income (loss) and related tax effect for the nine months ended September 30, 2005 and 2004 are as follows:
For the Nine Months Ended September 30, | ||||||||
(In thousands) | 2005 | 2004 | ||||||
Unrealized holding losses arising during period | $ | (6,070 | ) | $ | (1,662 | ) | ||
Less: reclassification adjustment for gains realized in income | 307 | 1,156 | ||||||
Net unrealized losses | (6,377 | ) | (2,818 | ) | ||||
Tax (expense) or benefit | 2,403 | 1,116 | ||||||
Other comprehensive loss | $ | (3,974 | ) | $ | (1,702 | ) | ||
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CONDENSED NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (continued)
(10) | Pension Plan |
The Bank sponsors a noncontributory defined benefit pension plan that covers all employees who meet specified age and length of service requirements, which is administered by the Savings Banks Employees Retirement Association (“SBERA”). The plan provides for benefits to be paid to eligible employees at retirement based primarily upon their years of service with the Bank and compensation levels near retirement. Contributions to the plan reflect benefits attributed to employees’ service to date, as well as service expected to be earned in the future.
The following table sets forth the amount of net periodic pension expense recognized for the three months and nine months ended September 30, 2005 and 2004:
Pension Benefits
Three months ended September 30, | Nine months ended September 30, | |||||||||||||||
(In thousands) | 2005 | 2004 | 2005 | 2004 | ||||||||||||
Service cost | $ | 114 | $ | 107 | $ | 344 | $ | 322 | ||||||||
Interest cost | 136 | 131 | 409 | 393 | ||||||||||||
Expected return on plan assets | (151 | ) | (136 | ) | (455 | ) | (409 | ) | ||||||||
Amortization of prior service cost | (3 | ) | (3 | ) | (10 | ) | (10 | ) | ||||||||
Amortization of net (gains) losses | 12 | 2 | 36 | 6 | ||||||||||||
Net periodic pension expense | $ | 108 | $ | 101 | $ | 324 | $ | 302 | ||||||||
The Bank made its annual contribution to its defined benefit pension plan in the amount of $364 thousand in the first quarter of 2005.
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MASSBANK CORP. AND SUBSIDIARIES
MANAGEMENT’S DISCUSSION & ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
September 30, 2005
Forward-Looking Statement Disclosure.
This Form 10-Q may contain forward-looking information, including information concerning the Company’s expectations of future business prospects. These forward-looking statements are made pursuant to the safe harbor provision of the Private Securities Litigation Reform Act of 1995. The Company may also make forward-looking statements in other documents filed with the Securities and Exchange Commission (“SEC”), in its annual and quarterly reports to stock-holders, in press releases and other written materials, and in oral statements made by the Company’s officers, directors or employees. You can identify forward-looking statements by the use of the words “may”, “could”, “should”, “believe,” “expect,” “anticipate,” “intend,” “estimate,” “assume,” “will,” “would,” and other expressions which predict or indicate future events and trends and which do not relate to historical matters. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the Company’s actual results or performance to be materially different from the results and performance expressed or implied by the forward-looking statements. Forward-looking statements include, but are not limited to, statements concerning the Company’s belief, expectations, or intentions concerning the Company’s future performance, the financial outlook of the markets it serves and the performance and activities of its competitors. These statements reflect the Company’s current views, are based on numerous assumptions and are subject to numerous risks and uncertainties, and other factors including but not limited to the following:
• | The strength of the local economy and the U.S. economy in general; |
• | Unexpected fluctuations in market interest rates; |
• | Unexpected fluctuations in the markets for equities, bonds, federal funds and other financial instruments; |
• | An increase in the level of the Company’s non-performing assets; |
• | An increase in competitive pricing pressures within the Company’s market which may result in the following: |
• | An increase in the Company’s cost of funds; |
• | A decrease in its loan originations; |
• | A decrease in its deposits; and |
• | A limit on the ability of the Company to attract and retain banking customers; |
• | Adverse legislative or regulatory developments; |
• | A significant decline in residential real estate values in the Company’s market area; |
• | Adverse impacts resulting from the continuing war on terrorism; |
• | An increase in employee-related costs, including healthcare expenses; and |
• | The impact of deflation or inflation, and other factors described in the Company’s annual report on Form 10-K. |
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Critical Accounting Policies
The Company’s consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles. As such, the Company is required to make estimates and assumptions that affect the reported amounts of assets and liabilities at the balance sheet dates and the reported amounts of income and expense during the reporting periods. Actual amounts could differ from such estimates.
The Company believes that the following accounting policies are among the most critical because they involve significant judgments and uncertainties and could potentially result in materially different results under different assumptions and conditions.
Provisions (Credit) for Loan Losses
The provision (credit) for loan losses represents a charge or credit against current earnings and an addition to or deduction from the allowance for loan losses. In determining the amount to provide for loan losses, the key factor is the adequacy of the allowance for loan losses (“loan allowance”). Management uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the portfolio for purposes of establishing a sufficient loan allowance. The methodology includes three elements: an analysis of individual loans deemed to be impaired, general loss allocations for various types of loans based on loss experience factors, and an unallocated allowance. The unallocated allowance is maintained based on management’s assessment of many factors including the risk characteristics of the portfolio, concentrations of credit, current and anticipated economic conditions that may affect borrowers’ ability to pay, and trends in loan delinquencies and charge-offs.
The provision (credit) for loan losses on off-balance sheet credit exposures represents a charge or credit against current earnings (reported in other non-interest expense) and an addition to or deduction from the allowance for loan losses on off-balance sheet credit exposures (“off-balance sheet exposures”). In determining the amount to provide for off-balance sheet exposures, the key factor is the adequacy of the balance. The balance of the off-balance sheet exposures is maintained based on expected drawdowns of committed loans, their loss experience factors, management’s assessment of various other factors including current and anticipated economic conditions that may affect the borrowers’ ability to pay, and trends in loan delinquencies and charge-offs.
Any significant changes in these assumptions and/or conditions could result in higher than estimated losses that could adversely affect the Company’s earnings results. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowances. Such agencies may require the Bank to recognize additional allowances based on judgements different from those of management, which could also adversely affect the Company’s earnings results.
Investment Securities Other Than Temporarily Impaired
Management judgment is involved in the evaluation of declines in value (“impairment”) of individual investment securities held by the Company. Declines in value that are deemed other than temporary are recognized in the income statement through write-downs in the recorded value of the affected securities. Management considers many factors in their analysis of other than temporarily impaired securities, including industry analyst reports, sector credit ratings, volatility in market price and other relevant information, such as the financial condition, earnings capacity and near term prospects of the company and the length of time and extent to which the market value has been less than cost.
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Investment Securities Other Than Temporarily Impaired (continued)
Whenever a debt or equity security is deemed to be “other than temporarily impaired” due to a fundamental deterioration in its financial condition as determined by management’s analysis, it is written down to its current fair market value. U.S. Treasury Securities and other securities backed by the U.S. Government are never considered impaired due to a fundamental deterioration in financial condition.
If “due to general market conditions” an investment security declines in price from its cost basis by 25% or more for more than a year, between 30% and 40% for more than nine months, between 40% and 50% for more than six months or over 50% for more than ninety days, and in each case the value of the investment security has been below its cost basis for the entire period in question, then the security is considered “other than temporarily impaired” and it is written down to its current fair market value and the loss is recognized in earnings. U.S. Treasury and Government Agency securities fluctuate in value based on changes in market interest rates and other factors; however, they can be redeemed at par value if held to maturity and therefore, if their maturity date is less than one year into the future regardless of their market value they are considered only temporarily impaired. Any unfavorable change in general market conditions could cause an increase in the Company’s impairment write downs of investment securities. This would have an adverse effect on the Company’s earnings results. There were no other than temporary impairment write downs of investment securities in the first nine months of 2005 or 2004.
Securities available-for-sale deemed temporarily impaired are carried at market value in the asset section of the Company’s balance sheet. Any change in value is reflected in accumulated other comprehensive income (loss) in the stockholders’ equity section of the Company’s balance sheet.
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FINANCIAL OVERVIEW
MASSBANK Corp. provides a broad range of banking services through its subsidiary, MASSBANK (“the Bank”). The Bank offers a full range of retail and commercial deposit products through its fifteen banking offices located in Eastern Massachusetts. The Bank’s lending business includes residential and commercial real estate mortgages, construction loans, commercial loans and a variety of consumer loans. The Bank’s loan portfolio is concentrated among borrowers from the municipalities in which it operates banking offices and all of the contiguous cities and towns. The Bank also invests a significant portion of its funds in U.S. Treasury and Government agency securities, mortgage-backed securities, federal funds sold and other authorized investments. The Bank’s earnings depend largely upon net interest income. Securities gains are also an important source of revenue for the Bank.
The Bank faces strong competition from banks and other financial services providers in our market area. The principal methods of competition are through interest rates, financing terms and other customer conveniences. Among the external factors affecting MASSBANK’s operating results are market interest rates, the shape of the U.S. Treasury securities yield curve, the condition of the financial markets and both regional and national economic conditions.
For the quarter ended September 30, 2005, MASSBANK Corp. reported net income of $1,884,000 or $0.43 in diluted earnings per share compared to net income of $1,811,000 or $0.40 in diluted earnings per share in the third quarter of 2004. This represents an increase of 7.5% over the earnings per share results of the prior year. This is also the Company’s second consecutive quarter of year-over-year earnings per share increases.
The improvement in the third quarter 2005 earnings and operating ratios was mainly due to an increase in net interest income. Net interest income, the Company’s core earnings, totaled $5,468,000 for the third quarter of 2005, up $257,000 or 4.9% from the same quarter in 2004. This is the fourth consecutive quarter that the Company has reported a year-over-year improvement in net interest income. The net interest margin in the recent quarter improved 24 basis points to 2.44% from 2.20% in the third quarter of 2004. This is an increase of 10.9% over the same quarter last year. The Company continues to benefit from rising short-term interest rates. The Federal Reserve Bank Board’s Federal Open Market Committee (FOMC) has raised the target rate for Federal Funds by 25 basis points eight times since the end of September 2004, increasing the rate from 1.75% to 3.75%.
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FINANCIAL OVERVIEW (continued)
Earnings results for the third quarter of 2005 included the following that are more fully disclosed below:
• | An improvement in net interest income of $257,000 due primarily to a rise in short-term interest rates. |
• | No credit for loan losses as in the third quarter of 2004. |
• | Securities gains of $238,000 versus gains of $182,000 in the third quarter of 2004. |
• | An increase in non-interest expense of $198,000, attributable primarily to an increase in salaries and employee benefits, and deferred compensation plan expense. |
(In thousands) Quarters Ended September 30, | 2005 | 2004 | Variance | ||||||||
Income Statement Data | |||||||||||
Interest and dividend income: | |||||||||||
Mortgage and other loans | $ | 3,179 | $ | 3,509 | $ | (330 | ) | ||||
Mortgage-backed securities | 1,796 | 1,775 | 21 | ||||||||
Federal funds sold | 1,722 | 615 | 1,107 | ||||||||
Other | 2,649 | 2,537 | 112 | ||||||||
Total interest and dividend income | 9,346 | 8,436 | 910 | ||||||||
Total interest expense | 3,878 | 3,225 | (653 | ) | |||||||
Net interest income | 5,468 | 5,211 | 257 | ||||||||
Provision (credit) for loan losses | — | (74 | ) | (74 | ) | ||||||
Gains on securities, net | 238 | 182 | 56 | ||||||||
Deferred compensation plan income (loss) | 49 | (10 | ) | 59 | |||||||
Other non-interest income | 267 | 277 | (10 | ) | |||||||
Non-interest expense: | |||||||||||
Salaries and employee benefits | 1,877 | 1,778 | (99 | ) | |||||||
Deferred compensation plan expense | 71 | 5 | (66 | ) | |||||||
Other | 1,228 | 1,195 | (33 | ) | |||||||
Income tax expense | 962 | 945 | (17 | ) | |||||||
Net income | $ | 1,884 | $ | 1,811 | $ | 73 | |||||
Diluted earnings per share | $ | 0.43 | $ | 0.40 | $ | 0.03 | |||||
(In thousands) Quarters Ended September 30, | 2005 | 2004 | Variance | ||||||||
Average Balance Sheet Data | |||||||||||
Earning assets: | |||||||||||
Mortgage and other loans | $ | 228,626 | $ | 241,394 | $ | (12,768 | ) | ||||
Mortgage-backed securities | 135,396 | 127,435 | 7,961 | ||||||||
Federal funds sold | 199,336 | 174,191 | 25,145 | ||||||||
Short-term investments | 1,345 | 6,359 | (5,014 | ) | |||||||
Other securities available for sale and trading | 332,889 | 400,772 | (67,883 | ) | |||||||
Total earning assets | $ | 897,592 | $ | 950,151 | $ | (52,559 | ) | ||||
Total deposits | $ | 809,607 | $ | 859,135 | $ | (49,528 | ) | ||||
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FINANCIAL OVERVIEW (Continued)
Condensed Consolidated Balance Sheets
(In Thousands) | September 30, 2005 | December 31, 2004 | Variance | |||||||||
Assets: | ||||||||||||
Short-term investments | $ | 181,740 | $ | 194,250 | $ | (12,510 | ) | |||||
Term federal funds sold | 15,000 | — | 15,000 | |||||||||
Interest-bearing deposits in banks | 1,112 | 2,718 | (1,606 | ) | ||||||||
Securities available-for-sale, at market value | 430,027 | 443,753 | (13,726 | ) | ||||||||
Securities held-to-maturity, at amortized cost | 4,577 | 4,877 | (300 | ) | ||||||||
Trading securities, at market value | 22,803 | 59,013 | (36,210 | ) | ||||||||
Total investments | 655,259 | 704,611 | (49,352 | ) | ||||||||
Total loans | 231,073 | 236,198 | (5,125 | ) | ||||||||
Allowance for loan losses | (1,253 | ) | (1,307 | ) | 54 | |||||||
Net loans | 229,820 | 234,891 | (5,071 | ) | ||||||||
Other assets | 35,350 | 36,666 | (1,316 | ) | ||||||||
Total assets | $ | 920,429 | $ | 976,168 | $ | (55,739 | ) | |||||
Liabilities: | ||||||||||||
Total deposits | $ | 802,597 | $ | 849,465 | $ | (46,868 | ) | |||||
Escrow deposits of borrowers | 1,009 | 1,074 | (65 | ) | ||||||||
Other liabilities | 11,483 | 15,614 | (4,131 | ) | ||||||||
Total liabilities | 815,089 | 866,153 | (51,064 | ) | ||||||||
Total stockholders’ equity | 105,340 | 110,015 | (4,675 | ) | ||||||||
Total liabilities and stockholders’ equity | $ | 920,429 | $ | 976,168 | $ | (55,739 | ) |
Financial Condition
The Company’s total assets were $920.4 million at September 30, 2005, compared to $976.2 million at December 31, 2004 reflecting a decrease of $55.7 million. This includes a decrease of $49.4 million in total investments and a decrease of $5.1 million in total loans. Deposits, the primary funding source for the Company’s assets, decreased $46.9 million during the first nine months of 2005.
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Investments
At September 30, 2005 the Company’s total investments were $655.3 million representing 71.2% of total assets compared to $704.6 million representing 72.2% of total assets at December 31, 2004. Total investments have decreased $49.4 million from year-end 2004 due primarily to a decrease in trading and available-for-sale securities. The securities portfolios were reduced primarily to fund the outflow of Bank deposits.
The Bank continues to maintain approximately 20% of its assets in short-term investments, primarily federal funds sold, during this period of rising short-term interest rates. Further increases in the target rate for federal funds will likely have a positive affect on the Bank’s future net interest income and net interest margin.
Loans
The loan portfolio, net of allowance for loan losses, decreased $5.1 million or 2.2% in the first nine months of 2005. At September 30, 2005 the loan portfolio, net of allowance for loan losses, totaled $229.8 million representing 25.0% of total assets compared to $234.9 million representing 24.1% of total assets at December 31, 2004. The decrease in loans is due to regular principal payments and prepayments exceeding the volume of new loan originations. New loan originations increased $6.6 million or over 60% to $17.5 million in the third quarter of 2005 compared to $10.9 million in the same quarter of 2004. For the first nine months of 2005, new loan originations totaled $40.0 million compared to $44.3 million in the first nine months of last year.
The Bank’s loan portfolio consists predominately of residential mortgages. Residential mortgage loans amounted to $220.7 million at September 30, 2005, representing 95.5% of the total loan portfolio. See page 40 of this Form 10-Q for a table setting forth the composition of the loan portfolio at September 30, 2005 and December 31, 2004.
Non-Performing Assets
Non-accrual loans, generally those loans that are 90 days or more delinquent, were $267,000 at September 30, 2005 as compared to $74,000 at December 31, 2004 and $182,000 as of September 30, 2004. This represents 0.12% of total loans at September 30, 2005. The Bank had no impaired loans or real estate acquired through foreclosure at September 30, 2005.
Deposits
Deposits have traditionally been the Bank’s primary source of funds for lending and investment activities. MASSBANK attracts deposits within its primary market area by offering a variety of deposit instruments including demand and NOW accounts, money market accounts, different types of savings accounts, certificates of deposit and retirement savings plans. Deposit flows vary significantly and are influenced by prevailing interest rates, market conditions, economic conditions and competition. The Bank’s management attempts to manage its deposits through selective pricing and marketing.
Deposits at September 30, 2005 totaled $802.6 million, reflecting a decrease of $46.9 million or 5.5% from $849.5 million at December 31, 2004. In the first nine months of 2005 we saw an outflow of deposits due to increased competition for deposits and some deposits being reinvested in the stock market and other types of investments.
For information concerning deposit balances at September 30, 2005 and December 31, 2004, see page 43 of this Form 10-Q.
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Stockholders’ Equity
Total stockholders’ equity decreased $4.7 million to $105.3 million at September 30, 2005 representing a book value of $24.38 per share. This compares to $110.0 million representing a book value of $25.11 per share at December 31, 2004.
The decrease in stockholders’ equity was essentially the result of the following: a decrease in accumulated other comprehensive income of $4.0 million due primarily to the decline in market value of the Company’s debt securities portfolio as a result of rising interest rates; the payment of dividends to stockholders of $3.4 million; and the Company’s repurchase of treasury stock in the amount of $4.1 million during the first nine months of 2005. This was partially offset by the Company’s net income for the first nine months of 2005 of $5.4 million and the payments and related tax benefits received from the exercise of stock options by the Company’s officers and directors of $1.4 million.
Comparison of Operating Results for the Three Months ended September 30, 2005 and 2004.
Net interest income
Net interest income totaled $5,468,000 in the third quarter of 2005, up $257,000 or 4.9% from the same quarter in 2004. This is the fourth consecutive quarter that the Company has reported a year-over-year improvement in net interest income. The improvement is primarily attributable to an increase in interest income on federal funds sold due to a rise in short-term interest rates.
The increase in net interest income reflects an increase in net interest margin and a decrease in average earning assets. Net interest margin represents the relationship between net interest income and average earning assets. Net interest margin is affected by several factors, including fluctuations in the overall interest rate environment, funding strategies, and the mix of interest earning assets and interest bearing liabilities. The Company’s net interest margin for the three months ended September 30, 2005 improved 24 basis points to 2.44% from 2.20% reported in the third quarter of last year. Average earning assets for the quarter ended September 30, 2005 decreased $52.6 million to $897.6 million, from $950.2 million in the same quarter of 2004.
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Interest and Dividend Income
Interest and dividend income on a fully taxable equivalent basis for the three months ended September 30, 2005 increased $909,000 or 10.8% to $9,362,000 from $8,453,000 for the three months ended September 30, 2004. The increase in interest and dividend income resulted from an increase in yield on the Company’s average earning assets, partially offset by a decrease in interest income resulting from a decrease of $52.6 million in average earning assets. As reflected in the table on page 25 of this report, the yield on the Company’s average earning assets in the third quarter of 2005 was 4.17%, as compared to 3.55% in the same quarter of 2004. The improvement in yield on the Company’s average earning assets is primarily attributable to an increase in interest income on federal funds sold due to higher short-term interest rates.
Interest Expense
Total interest expense for the three months ended September 30, 2005 increased $653,000, or 20.2% to $3,878,000 from $3,225,000 for the three months ended September 30, 2004. The increase in interest expense is due primarily to the higher interest rate environment in 2005 and the continued shift in the Bank’s deposit mix from savings accounts to certificates of deposit accounts. This has resulted in an increase in the Company’s average cost of funds, from 1.49% in the third quarter of 2004 to 1.90% in the third quarter of 2005. The increase in interest expense resulting from the higher average cost of funds was partially offset by a decrease in interest expense resulting from a decrease in the Company’s average deposits. The Company’s average deposits in the recent quarter, as shown in the table on page 26, decreased approximately $49.5 million or 5.8% to $809.6 million, from $859.1 million in the same quarter of the prior year.
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AVERAGE BALANCE SHEETS
Three Months Ended September 30, | ||||||||||||||||||||
2005 | 2004 | |||||||||||||||||||
(In thousands) | Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate | Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate | ||||||||||||||
Assets: | ||||||||||||||||||||
Earning assets: | ||||||||||||||||||||
Federal funds sold | $ | 199,336 | $ | 1,722 | 3.43 | % | $ | 174,191 | $ | 615 | 1.40 | % | ||||||||
Short-term investments (4) | 1,345 | 12 | 3.51 | 6,359 | 37 | 2.33 | ||||||||||||||
Securities available-for-sale: | ||||||||||||||||||||
Other securities (2) | 304,074 | 2,466 | 3.24 | 327,505 | 2,216 | 2.70 | ||||||||||||||
Mortgage-backed securities (2) | 130,809 | 1,737 | 5.31 | 122,531 | 1,712 | 5.59 | ||||||||||||||
Mortgage-backed securities held-to-maturity | 4,587 | 59 | 5.08 | 4,904 | 63 | 5.12 | ||||||||||||||
Trading securities | 28,815 | 187 | 2.57 | 73,267 | 301 | 1.63 | ||||||||||||||
Mortgage loans (3) | 218,316 | 2,998 | 5.49 | 230,932 | 3,342 | 5.79 | ||||||||||||||
Other loans (3) | 10,310 | 181 | 6.96 | 10,462 | 167 | 6.35 | ||||||||||||||
Total earning assets | 897,592 | $ | 9,362 | 4.17 | % | 950,151 | $ | 8,453 | 3.55 | % | ||||||||||
Allowance for loan losses | (1,253 | ) | (1,437 | ) | ||||||||||||||||
Total earning assets less allowance for loan losses | 896,339 | 948,714 | ||||||||||||||||||
Other assets | 23,946 | 24,911 | ||||||||||||||||||
Total assets | $ | 920,285 | $ | 973,625 | ||||||||||||||||
(1) | Dividend income on equity securities is included on a tax equivalent basis. |
(2) | Average balances include net unrealized gains (losses) on securities available-for-sale. |
(3) | Loans on non-accrual status are included in the average balance. |
(4) | Short-term investments consist of interest-bearing deposits in banks and investments in money market funds. |
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AVERAGE BALANCE SHEETS – (continued)
Three Months Ended September 30, | ||||||||||||||||||
2005 | 2004 | |||||||||||||||||
(In thousands) | Average Balance | Interest Income/ Expense | Average Yield/ Rate | Average Balance | Interest Income/ Expense | Average Yield/ Rate | ||||||||||||
Liabilities: | ||||||||||||||||||
Deposits: | ||||||||||||||||||
Demand and NOW | $ | 86,239 | $ | 45 | 0.21 | % | $ | 84,996 | $ | 40 | 0.19 | % | ||||||
Savings | 484,754 | 1,967 | 1.61 | 579,831 | 2,127 | 1.46 | ||||||||||||
Time certificates of deposit | 238,614 | 1,866 | 3.10 | 194,308 | 1,058 | 2.17 | ||||||||||||
Total deposits | 809,607 | 3,878 | 1.90 | 859,135 | 3,225 | 1.49 | ||||||||||||
Other liabilities | 4,003 | 5,842 | ||||||||||||||||
Total liabilities | 813,610 | 864,977 | ||||||||||||||||
Stockholders’ equity | 106,675 | 108,648 | ||||||||||||||||
Total liabilities and stockholders’ equity | $ | 920,285 | $ | 973,625 | ||||||||||||||
Net interest income (tax-equivalent basis) | 5,484 | 5,228 | ||||||||||||||||
Less adjustment for tax-exempt interest income | 16 | 17 | ||||||||||||||||
Net interest income | $ | 5,468 | $ | 5,211 | ||||||||||||||
Interest rate spread (5) | 2.27 | % | 2.06 | % | ||||||||||||||
Net interest margin (6) | 2.44 | % | 2.20 | % | ||||||||||||||
(5) | Interest rate spread represents the difference between the yield on earning assets and the cost of the company’s deposits. |
(6) | Net interest margin represents net interest income (tax equivalent basis) divided by average interest-earning assets. |
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Provision (Credit) for Loan Losses
The Bank, in the third quarter of 2005, recorded a zero provision for loan losses as compared to a negative provision for loan losses of $74,000 in the same quarter of last year. The Bank’s loan portfolio in the recent quarter increased by $1.1 million to $231.1 million. In the first nine months of 2005 the loan portfolio decreased $5.1 million or 2.2% from $236.2 million at December 31, 2004 to $231.1 million at September 30, 2005.
In determining the amount to provide for loan losses, the key factor is the adequacy of the allowance for loan losses. Management uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the portfolio for the purposes of establishing a sufficient allowance for loan losses. The methodology includes three elements: an analysis of individual loans deemed to be impaired, general loss allocations for various loan types based on loss experience factors, and an unallocated allowance which is maintained based on management’s assessment of many factors including the risk characteristics of the portfolio, concentrations of credit, current and anticipated economic conditions that may affect the borrowers’ ability to pay, and trends in loan delinquencies and charge-offs.
At September 30, 2005, the allowance for loan losses was $1.3 million representing 0.54% of total loans and 469% of non-accrual loans. This compares to $1.3 million representing 0.55% of total loans and 1,766% of non-accrual loans at December 31, 2004. Non-accrual loans totaled $267,000 at September 30, 2005. This compares to $74,000 at December 31, 2004 and $182,000 a year earlier. Management believes that the allowance for loan losses as of September 30, 2005 is adequate to cover the risks inherent in the loan portfolio under current conditions.
The Bank also maintains an allowance for loan losses on off-balance sheet credit exposures (shown separately on the balance sheet) that totaled $588,000 at September 30, 2005 and December 31, 2004. This is intended to protect the Bank against losses on loan commitments made to customers that have not yet been drawn down.
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Non-Interest Income
Non-interest income consists of deposit account service fees, net gains on securities and other non-interest income.
Non-interest income increased $105,000 to $554,000 in the recent quarter, from $449,000 in the comparable quarter of the prior year.
In the third quarter 2005, the Company recorded net gains on securities of $238,000 compared to net securities gains of $182,000 in the same quarter last year. Net securities gains in the recent quarter consisted of net gains on securities available for sale of $177,000 and net gains on trading securities of $61,000. This compares to net gains on securities available for sale of $113,000 and net gains on trading securities of $69,000 in the third quarter of 2004. The Company’s equity securities portfolio had net unrealized gains of $508,000 as of September 30, 2005; and the Company’s debt securities portfolio had net unrealized losses of $3,949,000 as of the end of the recent quarter. See page 36 of this report for more detail concerning the Company’s investment securities.
The Bank has a supplemental retirement plan for certain executive officers. In the recent quarter, the Bank recorded $49,000 in income and market value appreciation on plan assets, compared to a net loss of $10,000 in the third quarter of 2004. This improvement is offset by a corresponding increase in deferred compensation plan expense reported in non-interest expense.
The Bank’s deposit account service fees and other non-interest income totaled $100,000 and $167,000, respectively, for the third quarter of 2005. This compares to $109,000 and $168,000, respectively, in the third quarter of 2004. The combined total of these two items decreased $10,000 from the same quarter of the prior year.
Non-Interest Expense
Non-interest expense increased $198,000 or 6.6% to $3,176,000 for the three months ended September 30, 2005 compared to the same period in 2004.
Salaries and employee benefits, the largest component of non-interest expense increased $99,000 or 5.6% to $1,877,000 in the recent quarter, from $1,778,000 in the comparable quarter of 2004. The increase is primarily attributable to an increase in employee salary expense of $69,000 and a net increase in the cost of various employee benefits of $30,000.
Deferred compensation plan expense related to the Bank’s supplemental retirement plan for certain executive officers increased $66,000 to $71,000 in the recent quarter compared to the same quarter last year. This increase is essentially offset by a corresponding increase in deferred compensation plan income reported in non-interest income.
Professional services expenses decreased $28,000 compared to the same quarter of the prior year due mainly to a decrease in the amount of audit fees accrued for the Company’s independent registered public accountants.
All other non-interest expenses combined increased $61,000 or 5.8% to $1,113,000 for the three months ended September 30, 2005 from $1,052,000 for the three months ended September 30, 2004.
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Income Tax Expense
The Company, the Bank and its subsidiaries file a consolidated federal income tax return. The Parent Company, the Bank and its subsidiaries are subject to a Massachusetts Corporate Excise Tax as calculated in separately filed Massachusetts tax returns.
The Company recorded income tax expense of $962,000 in the third quarter of 2005, an increase of $17,000 when compared to the same quarter last year. The increase in income tax expense is due primarily to an increase in income before income taxes partially offset by a decrease in effective income tax rate. The Company’s income before income taxes was $2,846,000 in the recent quarter compared to $2,756,000 for the same quarter a year ago. The effective income tax rate for the three months ended September 30, 2005 and 2004 was 33.8% and 34.3%, respectively.
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Comparison of Operating Results for the Nine Months ended September 30, 2005 and 2004
FINANCIAL OVERVIEW
For the nine months ended September 30, 2005, the Company reported net income of $5,435,000, or $1.22 in diluted earnings per share ($1.24 in basic earnings per share) compared to net income of $5,494,000 or $1.22 in diluted earnings per share ($1.24 in basic earnings per share) for the first nine months of 2004. Return on average assets and return on average equity were 0.77% and 6.72%, respectively, in the first nine months of 2005 compared to 0.75% and 6.66%, respectively, in the same period of 2004.
Earnings results for the first nine months of 2005 included the following that are more fully disclosed below:
• | An improvement in net interest income of $690,000 due primarily to a rise in short-term interest rates. |
• | Negative provision for loan losses in the amount of $53,000, which was $134,000 less than the credit of $187,000 recorded in the first nine months of last year. |
• | Net securities gains of $426,000 versus gains of $942,000 in the first nine months of 2004. |
• | An increase in non-interest expense of $277,000 or 3.0% over the same period of the prior year |
(In thousands) Nine Months Ended September 30, | 2005 | 2004 | Variance | |||||||||
Income Statement Data | ||||||||||||
Interest and dividend income: | ||||||||||||
Mortgage and other loans | $ | 9,655 | $ | 10,871 | $ | (1,216 | ) | |||||
Mortgage-backed securities | 5,392 | 4,800 | 592 | |||||||||
Federal funds sold | 4,310 | 1,540 | 2,770 | |||||||||
Other | 7,823 | 7,691 | 132 | |||||||||
Total interest and dividend income | 27,180 | 24,902 | 2,278 | |||||||||
Total interest expense | 11,013 | 9,425 | (1,588 | ) | ||||||||
Net interest income | 16,167 | 15,477 | 690 | |||||||||
Provision (credit) for loan losses | (53 | ) | (187 | ) | (134 | ) | ||||||
Gains on securities, net | 426 | 942 | (516 | ) | ||||||||
Deferred compensation plan income | 59 | 24 | 35 | |||||||||
Other non-interest income | 851 | 872 | (21 | ) | ||||||||
Non-interest expense: | ||||||||||||
Salaries and employee benefits | 5,572 | 5,443 | (129 | ) | ||||||||
Deferred compensation plan expense | 125 | 68 | (57 | ) | ||||||||
Other | 3,682 | 3,591 | (91 | ) | ||||||||
Income tax expense | 2,742 | 2,906 | 164 | |||||||||
Net income | $ | 5,435 | $ | 5,494 | $ | (59 | ) | |||||
Diluted earnings per share | $ | 1.22 | $ | 1.22 | — | |||||||
(In thousands) Nine Months Ended September 30, | 2005 | 2004 | Variance | |||||||||
Average Balance Sheet Data | ||||||||||||
Earning assets: | ||||||||||||
Mortgage and other loans | $ | 230,774 | $ | 245,614 | $ | (14,840 | ) | |||||
Mortgage-backed securities | 134,255 | 111,276 | 22,979 | |||||||||
Federal funds sold | 196,101 | 186,859 | 9,242 | |||||||||
Short-term investments | 1,897 | 19,780 | (17,883 | ) | ||||||||
Other securities available for sale and trading | 352,142 | 396,171 | (44,029 | ) | ||||||||
Total earning assets | $ | 915,169 | $ | 959,700 | $ | (44,531 | ) | |||||
Total deposits | $ | 825,946 | $ | 866,418 | $ | (40,472 | ) | |||||
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AVERAGE BALANCE SHEETS
Nine Months Ended September 30, | ||||||||||||||||||||
2005 | 2004 | |||||||||||||||||||
(In thousands) | Average Balance | Interest Income/ Expense(1) | Average Yield/ Rate | Average Balance | Interest Income/ Expense (1) | Average Yield/ Rate | ||||||||||||||
Assets: | ||||||||||||||||||||
Earning assets: | ||||||||||||||||||||
Federal funds sold | $ | 196,101 | $ | 4,310 | 2.94 | % | $ | 186,859 | $ | 1,540 | 1.10 | % | ||||||||
Short-term investments (4) | 1,897 | 45 | 3.19 | 19,780 | 209 | 1.41 | ||||||||||||||
Securities available-for-sale: | ||||||||||||||||||||
Other securities (2) | 314,980 | 7,201 | 3.05 | 322,397 | 6,634 | 2.74 | ||||||||||||||
Mortgage-backed securities (2) | 129,547 | 5,211 | 5.36 | 108,372 | 4,689 | 5.77 | ||||||||||||||
Mortgage-backed securities held-to-maturity | 4,708 | 181 | 5.12 | 2,904 | 111 | 5.09 | ||||||||||||||
Trading securities | 37,162 | 620 | 2.22 | 73,774 | 895 | 1.62 | ||||||||||||||
Mortgage loans (3) | 220,690 | 9,148 | 5.53 | 234,854 | 10,369 | 5.89 | ||||||||||||||
Other loans (3) | 10,084 | 507 | 6.72 | 10,760 | 502 | 6.22 | ||||||||||||||
Total earning assets | 915,169 | $ | 27,223 | 3.97 | % | 959,700 | $ | 24,949 | 3.47 | % | ||||||||||
Allowance for loan losses | (1,271 | ) | (1,493 | ) | ||||||||||||||||
Total earning assets less allowance for loan losses | 913,898 | 958,207 | ||||||||||||||||||
Other assets | 25,145 | 25,031 | ||||||||||||||||||
Total assets | $ | 939,043 | $ | 983,238 | ||||||||||||||||
(1) | Dividend income on equity securities is included on a tax equivalent basis. |
(2) | Average balances include net unrealized gains (losses) on securities available-for-sale. |
(3) | Loans on non-accrual status are included in the average balance. |
(4) | Short-term investments consist of interest-bearing deposits in banks and investments in money market funds. |
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AVERAGE BALANCE SHEETS – (continued)
Nine Months Ended September 30, | ||||||||||||||||||
2005 | 2004 | |||||||||||||||||
(In thousands) | Average Balance | Interest Income/ Expense | Average Yield/ Rate | Average Balance | Interest Income/ Expense | Average Yield/ Rate | ||||||||||||
Liabilities: | ||||||||||||||||||
Deposits: | ||||||||||||||||||
Demand and NOW | $ | 85,808 | $ | 137 | 0.21 | % | $ | 84,353 | $ | 128 | 0.20 | % | ||||||
Savings | 515,216 | 6,022 | 1.56 | 591,534 | 6,472 | 1.46 | ||||||||||||
Time certificates of deposit | 224,922 | 4,854 | 2.89 | 190,531 | 2,825 | 1.98 | ||||||||||||
Total deposits | 825,946 | 11,013 | 1.78 | 866,418 | 9,425 | 1.45 | ||||||||||||
Other liabilities | 5,240 | 6,816 | ||||||||||||||||
Total liabilities | 831,186 | 873,234 | ||||||||||||||||
Stockholders’ equity | 107,857 | 110,004 | ||||||||||||||||
Total liabilities and stockholders’ equity | $ | 939,043 | $ | 983,238 | ||||||||||||||
Net interest income (tax-equivalent basis) | 16,210 | 15,524 | ||||||||||||||||
Less adjustment for tax-exempt interest income | 43 | 47 | ||||||||||||||||
Net interest income | $ | 16,167 | $ | 15,477 | ||||||||||||||
Interest rate spread (5) | 2.19 | % | 2.02 | % | ||||||||||||||
Net interest margin (6) | 2.36 | % | 2.16 | % | ||||||||||||||
(5) | Interest rate spread represents the difference between the yield on earning assets and the cost of the company’s deposits. |
(6) | Net interest margin represents net interest income (tax equivalent basis) divided by average interest-earning assets. |
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Net Interest Income
Net interest income totaled $16,167,000 for the nine months ended September 30, 2005, up $690,000 from the same period in 2004. The improvement in net interest income is primarily attributable to an increase in interest income on federal funds sold due to a rise in short-term interest rates.
The increase in net interest income reflects an increase in net interest margin and a decrease in average earning assets. Net interest margin represents the relationship between net interest income and average earning assets. Net interest margin is affected by several factors, including fluctuations in the overall interest rate environment, funding strategies, and the mix of interest earning assets and interest bearing liabilities. The Company’s net interest margin for the nine months ended September 30, 2005 improved 20 basis points to 2.36% from 2.16% reported in the first nine months of last year. Average earning assets for the nine months ended September 30, 2005 decreased $44.5 million to $915.2 million, from $959.7 million in the same period of 2004.
Interest and Dividend Income
Interest and dividend income on a fully taxable equivalent basis for the nine months ended September 30, 2005 increased $2,274,000 or 9.1% to $27,223,000 from $24,949,000 for the nine months ended September 30, 2004. The increase in interest and dividend income resulted from an increase in yield on the Company’s average earning assets, partially offset by a decrease in interest income resulting from a decrease of $44.5 million in average earning assets. As reflected in the table on page 31 of this report, the yield on the Company’s average earning assets in the first nine months of 2005 was 3.97%, as compared to 3.47% in the same period of 2004. The improvement in yield on the Company’s average earning assets is primarily attributable to an increase in interest income on federal funds sold due to higher short-term interest rates.
Interest Expense
Total interest expense for the nine months ended September 30, 2005 increased $1,588,000, or 16.8% to $11,013,000 from $9,425,000 for the nine months ended September 30, 2004. The increase in interest expense is due primarily to the higher interest rate environment in 2005 and the continued shift in the Bank’s deposit mix from savings accounts to certificates of deposit accounts. This has resulted in an increase in the Company’s average cost of funds, from 1.45% in the first nine months of 2004 to 1.78% in the first nine months of 2005. The increase in interest expense resulting from the higher average cost of funds was partially offset by a decrease in interest expense resulting from a decrease in the Company’s average deposits. The Company’s average deposits in the first nine months of 2005, as shown in the table on page 32, decreased $40.5 million or 4.7% to $825.9 million, from $866.4 million in the same period of the prior year.
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Provision (Credit) for Loan Losses
In the first nine months of 2005, the Bank recorded a negative provision for loan losses of $53,000, which was $134,000 less than the negative provision of $187,000 recorded in the first nine months of 2004. The negative provisions are due to reductions in the size of the Bank’s loan portfolio and a low level of problem loans.
In determining the amount to provide for loan losses, the key factor is the adequacy of the allowance for loan losses (“loan allowance”). Management uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the portfolio for the purposes of establishing a sufficient loan allowance. The methodology includes three elements: an analysis of individual loans deemed to be impaired, general loss allocations for various loan types based on loss experience factors and an unallocated allowance. The unallocated allowance is maintained based on management’s assessment of many factors including the risk characteristics of the portfolio, concentrations of credit, current and anticipated economic conditions that may affect the borrowers’ ability to pay, and trends in loan delinquencies and charge-offs.
At September 30, 2005, the allowance for loan losses was $1.3 million representing 0.54% of total loans and 469% of non-accrual loans. This compares to $1.3 million representing 0.55% of total loans and 1,766% of non-accrual loans at December 31, 2004. Non-accrual loans totaled $267,000 at September 30, 2005. This compares to $74,000 at December 31, 2004 and $182,000 a year earlier. Management believes that the allowance for loan losses as of September 30, 2005 is adequate to cover the risks inherent in the loan portfolio under current conditions.
The Bank also maintains an allowance for loan losses on off-balance sheet credit exposures (shown separately on the balance sheet) that totaled $588,000 at September 30, 2005 and December 31, 2004. This is intended to protect the Bank against losses on loan commitments made to customers that have not yet been drawn down.
Non-Interest Income
Non-interest income consists of deposit account service fees, net gains on securities and other non-interest income.
Non-interest income decreased $502,000 to $1,336,000 in the nine months ended September 30, 2005, from $1,838,000 in the comparable period of the prior year.
In the first nine months of 2005, the Company recorded net gains on securities of $426,000 compared to net securities gains of $942,000 in the same period last year. Net securities gains in the first nine months of 2005 consisted of net gains on securities available for sale of $307,000 and net gains on trading securities of $119,000. This compares to net gains on securities available for sale of $1,156,000 and net losses on trading securities of $214,000 in the first nine months of 2004.
The Bank has a supplemental retirement plan for certain executive officers. The Bank recorded $59,000 in income and market value appreciation on plan assets for the first nine months of 2005 compared to $24,000 in the same period last year. This improvement is offset by an increase in deferred compensation plan expense reported in non-interest expense.
The Bank’s deposit account service fees and other non-interest income totaled $301,000 and $550,000, respectively, for the nine months ended September 30, 2005. This compares to $342,000 and $530,000, respectively, in the nine months ended September 30, 2004. Deposit account service fees have continued to decline due to a decrease in the number of deposit accounts subject to these types of charges.
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Non-Interest Expense
Non-interest expense increased $277,000 or 3.0% to $9,379,000 for the nine months ended September 30, 2005 compared to the same period in 2004.
Salaries and employee benefits, the largest component of non-interest expense increased $129,000 or 2.4% to $5,572,000 for the first nine months of 2005 from $5,443,000 for the first nine months of 2004. The increase in salaries and employee benefits is primarily the result of broad based salary increases of $104,000 and an increase in health and other benefit costs for employees of $25,000.
Deferred compensation plan expense related to the Bank’s supplemental retirement plan for certain executive officers increased $57,000 to $125,000 for the first nine months of 2005 from $68,000 for the same period in 2004. This increase is partially offset by the increase in deferred compensation plan income reported in non-interest income.
All other non-interest expenses combined increased $91,000 or 2.5% to $3,682,000 for the nine months ended September 30, 2005 from $3,591,000 for the nine months ended September 30, 2004.
Income Tax Expense
The Company, the Bank and its subsidiaries file a consolidated federal income tax return. The Parent Company, the Bank and its subsidiaries are subject to a Massachusetts Corporate Excise Tax as calculated in separately filed Massachusetts tax returns.
The Company recorded income tax expense of $2,742,000 in the first nine months of 2005, a decrease of $164,000 when compared to the same period last year. The decrease in income tax expense is due primarily to a decrease in income before income taxes and a decrease in effective income tax rate. The Company’s income before income taxes was $8,177,000 in the first nine months of 2005 compared to $8,400,000 for the same period a year ago. The effective income tax rate for the nine months ended September 30, 2005 and 2004 was 33.5% and 34.6%, respectively.
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FINANCIAL CONDITION
INVESTMENT SECURITIES
The amortized cost and market value of investment securities at September 30, 2005 with gross unrealized gains and losses follows:
(In thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Market Value | ||||||||||
Securities held-to-maturity: | ||||||||||||||
Mortgage-backed securities: | ||||||||||||||
Federal National Mortgage Association | $ | 4,577 | $ | — | $ | (52 | ) | $ | 4,525 | |||||
Total securities held-to-maturity | 4,577 | — | $ | (52 | ) | $ | 4,525 | |||||||
Securities available-for-sale: | ||||||||||||||
Debt securities: | ||||||||||||||
U.S. Treasury obligations | 83,104 | 5 | (930 | ) | 82,179 | |||||||||
U.S. Government agency obligations | 216,023 | 8 | (3,926 | ) | 212,105 | |||||||||
Total | 299,127 | 13 | (4,856 | ) | 294,284 | |||||||||
Mortgage-backed securities: | ||||||||||||||
Government National Mortgage Association | 3,762 | 123 | — | 3,885 | ||||||||||
Federal Home Loan Mortgage Corporation | 120,171 | 1,354 | (563 | ) | 120,962 | |||||||||
Federal National Mortgage Association | 3,328 | 2 | (22 | ) | 3,308 | |||||||||
Collateralized mortgage obligations | 107 | — | — | 107 | ||||||||||
Total mortgage-backed securities | 127,368 | 1,479 | (585 | ) | 128,262 | |||||||||
Total debt securities available for sale | 426,495 | 1,492 | (5,441 | ) | 422,546 | |||||||||
Equity securities | 6,973 | 694 | (186 | ) | 7,481 | |||||||||
Total securities available-for-sale | 433,468 | $ | 2,186 | $ | (5,627 | ) | $ | 430,027 | ||||||
Net unrealized losses on securities available-for-sale | (3,441 | ) | ||||||||||||
Total securities available for sale, net | 430,027 | |||||||||||||
Total investment securities, net | $ | 434,604 | ||||||||||||
TRADING SECURITIES
The market value of trading securities is as follows:
(In Thousands) At September 30, 2005 | Market Value | ||
U.S. Treasury obligations | $ | 20,803 | |
Marketable equity securities | 1,996 | ||
Investments in mutual funds | 4 | ||
Total trading securities | $ | 22,803 | |
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FINANCIAL CONDITION
INVESTMENT SECURITIES (continued)
The amortized cost and market value of investment securities at December 31, 2004 with gross unrealized gains and losses follows:
(In thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Market Value | |||||||||
Securities held to maturity: | |||||||||||||
Mortgage-backed securities: | |||||||||||||
Federal National Mortgage Association | $ | 4,877 | $ | 6 | $ | — | $ | 4,883 | |||||
Total | 4,877 | 6 | — | 4,883 | |||||||||
Securities available-for-sale: | |||||||||||||
Debt securities: | |||||||||||||
U.S. Treasury obligations | 125,491 | 126 | (520 | ) | 125,097 | ||||||||
U.S. Government agency obligations | 190,032 | 81 | (1,594 | ) | 188,519 | ||||||||
Total | 315,523 | 207 | (2,114 | ) | 313,616 | ||||||||
Mortgage-backed securities: | |||||||||||||
Government National Mortgage Association | 5,622 | 297 | — | 5,919 | |||||||||
Federal Home Loan Mortgage Corporation | 112,929 | 3,694 | (66 | ) | 116,557 | ||||||||
Federal National Mortgage Association | 94 | 4 | — | 98 | |||||||||
Collateralized mortgage obligations | 133 | 2 | — | 135 | |||||||||
Total mortgage-backed securities | 118,778 | 3,997 | (66 | ) | 122,709 | ||||||||
Total debt securities available for sale | 434,301 | 4,204 | (2,180 | ) | 436,325 | ||||||||
Equity securities | 6,534 | 933 | (39 | ) | 7,428 | ||||||||
Total securities available-for-sale | 440,835 | $ | 5,137 | $ | (2,219 | ) | $ | 443,753 | |||||
Net unrealized gains on securities available-for-sale | 2,918 | ||||||||||||
Total securities available for sale, net | 443,753 | ||||||||||||
Total investment securities, net | $ | 448,630 | |||||||||||
TRADING SECURITIES
The market value of trading securities is as follows:
(In Thousands) | Market Value | ||
U.S. Treasury obligations | $ | 57,878 | |
Marketable equity securities | 1,131 | ||
Investments in mutual funds | 4 | ||
Total trading securities | $ | 59,013 |
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Investments (continued)
The amortized cost and market value of debt securities available-for-sale by contractual maturity at September 30, 2005 and December 31, 2004 are shown in the following tables. Actual maturities will differ from contractual maturities because of callable government agency securities in the Company’s portfolio that may be called prior to maturity.
September 30, 2005 | ||||||
Available-for-Sale | ||||||
Amortized Cost | Market Value | |||||
(In thousands) | ||||||
Maturing: | ||||||
Within 1 year | $ | 88,803 | $ | 88,220 | ||
After 1 year but within 5 years | 191,310 | 187,257 | ||||
After 5 years but within 10 years | 17,976 | 17,781 | ||||
After 10 years but within 15 years | 1,038 | 1,026 | ||||
U.S. Treasury and Government agency obligations (a) | 299,127 | 294,284 | ||||
Mortgage-backed securities | 127,368 | 128,262 | ||||
Total | $ | 426,495 | $ | 422,546 |
December 31, 2004 | ||||||
Available-for-Sale | ||||||
Amortized Cost | Market Value | |||||
(In thousands) | ||||||
Maturing: | ||||||
Within 1 year | $ | 87,905 | $ | 87,748 | ||
After 1 year but within 5 years | 201,620 | 199,913 | ||||
After 5 years but within 10 years | 25,958 | 25,915 | ||||
After 10 years but within 15 years | 40 | 40 | ||||
U.S. Treasury and Government agency obligations (b) | 315,523 | 313,616 | ||||
Mortgage-backed securities | 118,778 | 122,709 | ||||
Total | $ | 434,301 | $ | 436,325 |
(a) | At September 30, 2005 the Company’s debt securities available-for-sale portfolio included U.S. Government agency obligations that can be called prior to maturity with an amortized cost of $173.0 million and a market value of $169.8 million. |
(b) | At December 31, 2004 the Company’s debt securities available-for-sale portfolio included U.S. Government agency obligations that can be called prior to maturity with an amortized cost of $160.0 million and a market value of $158.8 million. |
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INVESTMENT SECURITIES (continued)
The following table presents temporarily impaired investment securities as of September 30, 2005 and December 31, 2004.
Temporarily Impaired Investment Securities (Unaudited)
Temporarily Impaired Less Than 12 Months | Temporarily Impaired 12 Months or Longer | Total | |||||||||||||||||||
(In thousands) | Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | Fair Value | Gross Unrealized Losses | |||||||||||||||
At September 30, 2005 | |||||||||||||||||||||
Debt Securities: | |||||||||||||||||||||
U.S. Treasury obligations | $ | 64,241 | $ | (633 | ) | $ | 12,940 | $ | (297 | ) | $ | 77,181 | $ | (930 | ) | ||||||
U.S. Government agency obligations | 128,041 | (1,944 | ) | 82,018 | (1,982 | ) | 210,059 | (3,926 | ) | ||||||||||||
Mortgaged-backed securities | 59,891 | (524 | ) | 3,123 | (113 | ) | 63,014 | (637 | ) | ||||||||||||
Total debt securities | 252,173 | (3,101 | ) | 98,081 | (2,392 | ) | 350,254 | (5,493 | ) | ||||||||||||
Equity securities | 2,428 | (186 | ) | — | — | 2,428 | (186 | ) | |||||||||||||
Total temporarily impaired investment securities at: | |||||||||||||||||||||
September 30, 2005 | $ | 254,601 | $ | (3,287 | ) | $ | 98,081 | $ | (2,392 | ) | $ | 352,682 | $ | (5,679 | ) | ||||||
December 31, 2004 | $ | 206,136 | $ | (1,777 | ) | $ | 21,557 | $ | (442 | ) | $ | 227,693 | $ | (2,219 | ) | ||||||
The gross unrealized losses on temporarily impaired investment securities at September 30, 2005 represents 1.3% of the total amortized cost of total investment securities. These unrealized losses were primarily attributable to an increase in interest rates. The Company has the ability to hold the securities for the time necessary to recover amortized cost.
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LOANS
The composition of the Bank’s loan portfolio is summarized as follows:
(In thousands) | At September 30, 2005 | At December 31, 2004 | ||||||
Mortgage loans: | ||||||||
Residential | $ | 217,519 | $ | 224,587 | ||||
Commercial | 2,319 | 1,623 | ||||||
Construction | 897 | 84 | ||||||
220,735 | 226,294 | |||||||
Premium on loans | 3 | 5 | ||||||
Deferred mortgage loan origination fees, net | (16 | ) | (102 | ) | ||||
Total mortgage loans | 220,722 | 226,197 | ||||||
Other loans: | ||||||||
Consumer: | ||||||||
Installment | 244 | 327 | ||||||
Guaranteed education | 1,302 | 1,616 | ||||||
Other secured | 677 | 504 | ||||||
Home equity lines of credit | 7,880 | 7,284 | ||||||
Unsecured | 158 | 161 | ||||||
Total consumer loans | 10,261 | 9,892 | ||||||
Commercial | 90 | 109 | ||||||
Total other loans | 10,351 | 10,001 | ||||||
Total loans | $ | 231,073 | $ | 236,198 | ||||
The Bank’s loan portfolio decreased $5.1 million during the first nine months of 2005, from $236.2 million at December 31, 2004 to $231.1 million at September 30, 2005. Mortgage loans decreased $5.5 million and consumer loans increased $0.4 million.
The Bank originated $17.5 million in loans during the recent quarter, up $6.6 million or over 60% from the $10.9 million originated in the same quarter last year. For the first nine months of 2005, loan originations totaled $40.0 million compared to $44.3 million in the first nine months of 2004.
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NON-PERFORMING ASSETS
The following table shows the composition of the Bank’s non-performing assets at September 30, 2005 and 2004, and December 31, 2004:
(In thousands) | At September 30, 2005 | At December 31, 2004 | At September 30, 2004 | |||||||||
Non-Performing Assets: | ||||||||||||
Non-accrual loans | $ | 267 | $ | 74 | $ | 182 | ||||||
Real estate acquired through foreclosure | — | — | — | |||||||||
Total non-performing assets | $ | 267 | $ | 74 | $ | 182 | ||||||
Allowance for loan losses | $ | 1,253 | $ | 1,307 | $ | 1,363 | ||||||
Allowance as a percent of non-accrual loans | 469.3 | % | 1,766.2 | % | 748.9 | % | ||||||
Allowance as a percent of total loans | 0.54 | % | 0.55 | % | 0.57 | % | ||||||
Non-accrual loans as a percent of total loans | 0.12 | % | 0.03 | % | 0.08 | % |
The Bank generally does not accrue interest on loans which are 90 days or more past due. It is the Bank’s policy to place such loans on non-accrual status and to reverse from income all interest previously accrued but not collected and to discontinue all amortization of deferred loan fees.
Non-performing assets increased from December 31, 2004 to September 30, 2005 as noted in the table above. The principal balance of non-accrual loans was $267,000, or approximately 0.12% of total loans at September 30, 2005.
The Bank did not have any impaired loans as of September 30, 2005.
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ALLOWANCE FOR LOAN LOSSES
An analysis of the activity in the allowance for loan losses is as follows:
Nine Months Ended September 30, | ||||||||
2005 | 2004 | |||||||
(In thousands) | ||||||||
Balance at December 31, 2004 and 2003 | $ | 1,307 | $ | 1,554 | ||||
Provision (credit) for loan losses | (53 | ) | (187 | ) | ||||
Recoveries of loans previously charged-off | — | — | ||||||
Charge-offs | (1 | ) | (4 | ) | ||||
Balance at September 30, | $ | 1,253 | $ | 1,363 | ||||
The Company maintains an allowance for probable losses that are inherent in the Company’s loan portfolio. The allowance for loan losses is increased by provisions charged to operations based on the estimated loan loss exposure inherent in the portfolio. Management uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the portfolio for purposes of establishing a sufficient allowance for loan losses. The methodology includes three elements: an analysis of individual loans deemed to be impaired, general loss allocations for various loan types based on loss experience factors and an unallocated allowance which is maintained based on management’s assessment of many factors including the risk characteristics of the portfolio, concentrations of credit, current and anticipated economic conditions that may effect the borrower’s ability to pay, and trends in loan delinquencies and charge-offs. Realized losses, net of recoveries, are charged directly to the allowance. While management uses currently available information in establishing the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ from the assumptions used in making the evaluation. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on judgments different from those of management.
At September 30, 2005 the balance of the allowance for loan losses was $1,253,000 representing 469.3% of non-accrual loans and 0.54% of total loans. Management believes that the allowance for loan losses is adequate to cover the risks inherent in the portfolio under current conditions.
The Company also maintains an allowance for probable losses on its outstanding loan commitments that totaled $588,000 and $616,000 at September 30, 2005 and 2004, respectively. The allowance for loan losses on off-balance sheet credit exposures (shown separately on the balance sheet) is maintained based on expected drawdowns of committed loans and their loss experience factors and management’s assessment of various other factors including current and anticipated economic conditions that may effect the borrowers’ ability to pay, and trends in loan delinquencies and charge-offs.
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DEPOSITS
Deposit accounts of all types have traditionally been the primary source of funds for the Bank’s lending and investment activities. The Bank’s deposit flows are influenced by prevailing interest rates, competition and other market conditions. The Bank’s management attempts to manage its deposits through selective pricing and marketing.
The Bank’s total deposits decreased $46.9 million to $802.6 million at September 30, 2005 from $849.5 million at December 31, 2004.
The composition of the Bank’s total deposits as of the dates shown are summarized as follows:
September 30, 2005 | December 31, 2004 | |||||
(In thousands) | ||||||
Demand and NOW | $ | 87,810 | $ | 87,653 | ||
Savings and money market accounts | 471,054 | 561,313 | ||||
Time certificates of deposit | 243,733 | 200,499 | ||||
Total deposits | $ | 802,597 | $ | 849,465 | ||
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QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT RISK
Market Risk
Market risk is the risk of loss in a financial instrument arising from adverse changes in prices. The Company’s investment securities portfolio includes equity securities with a market value of $7.5 million at September 30, 2005. Movements in equity prices affect the value of the equity portfolio and affect the amount of securities gains or losses that the Company realizes from the sale of equity securities. The Company’s debt securities available for sale portfolio and trading account have a market value of $422.5 million and $22.8 million, respectively, at September 30, 2005. Interest rate changes affect the value of these portfolios. Rising interest rates would generally reduce the value of these portfolios.
Interest Rate Risk
Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change the interest income and expense streams associated with the Company’s financial instruments also change, which impacts net interest income, the primary component of the Company’s earnings. The ongoing monitoring and management of this risk is an important component of the Company’s asset/liability management process. For additional information about the Company’s asset/liability management and interest rate risk, see the Management Discussion and Analysis section of the Company’s Form 10-K for the year ended December 31, 2004.
Liquidity and Capital Resources
The Bank must maintain a sufficient amount of cash and assets which can readily be converted into cash in order to meet cash outflows from normal depositor requirements and loan demands. The Bank’s primary sources of funds are deposits, loan and mortgage-backed securities amortization and prepayments, sales or maturities of investment securities, investment securities called before maturity and income on earning assets. In addition to loan payments and maturing investment securities, which are relatively predictable sources of funds, the Bank maintains a high percentage of its assets invested in overnight federal funds sold and money market funds, which can be immediately converted into cash and United States Treasury and Government agency securities, which can be sold or pledged to raise funds. At September 30, 2005 the Bank had $181.7 million or 19.7% of total assets and $315.1 million or 34.2% of total assets invested, respectively, in overnight federal funds sold and money market funds, and United States Treasury and Government agency obligations.
The Bank is a Federal Deposit Insurance Corporation (“FDIC”) insured institution subject to the FDIC regulatory capital requirements. The FDIC regulations require all FDIC insured institutions to maintain minimum levels of Tier 1 capital. Highly rated banks (i.e., those with a composite rating of 1 under the CAMELS rating system) are required to maintain a minimum leverage ratio of Tier 1 capital to total assets of at least 3.00%. An additional 100 to 200 basis points are required for all but these most highly rated institutions. The Bank is also required to maintain a minimum level of risk-based capital. Under the risk-based capital standards, FDIC insured institutions must maintain a Tier 1 capital to risk-weighted assets ratio of 4.00% and are generally expected to meet a minimum total qualifying capital to risk-weighted assets ratio of 8.00%. The risk-based capital guidelines take into consideration risk factors, as defined by the regulators, associated with various categories of assets, both on and off the balance sheet. Under the guidelines, capital strength is measured in two tiers which are used in conjunction with risk adjusted assets to determine the risk-based capital ratios.
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Liquidity and Capital Resources (continued)
Tier II components include supplemental capital components such as qualifying allowance for loan losses and qualifying subordinated debt and up to 45 percent of the pre-tax net unrealized holding gains on certain available for sale equity securities. Tier I capital plus the Tier II capital components are referred to as total qualifying capital.
The capital ratios of the Bank and the Company currently exceed the minimum regulatory requirements. At September 30, 2005, the Bank had a leverage Tier I capital to average assets ratio of 11.22%, a Tier I capital to risk-weighted assets ratio of 38.13% and a total capital to risk-weighted assets ratio of 38.89%. The Company, on a consolidated basis, had ratios of leverage Tier I capital to average assets of 11.60%, Tier I capital to risk-weighted assets of 39.41% and total capital to risk-weighted assets of 40.18% at September 30, 2005.
Controls and Procedures
(a)Evaluation of disclosure controls and procedures. Our principal executive officer and our principal financial officer have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report. Based upon that evaluation, such officers have concluded that our disclosure controls and procedures are effective as of the end of such period.
(b)Changes in internal controls over financial reporting. There have been no changes during the period covered by this Quarterly Report in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II – OTHER INFORMATION
Item 1. | Legal Proceedings |
From time to time, MASSBANK Corp. and/or the Bank are involved as a plaintiff or defendant in various legal actions incident to their business. As of September 30, 2005, none of these actions individually or in the aggregate is believed by management to be material to the financial condition of MASSBANK Corp. or the Bank.
Item 2. | Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities. |
Issuer Purchases of Equity Securities
The following table sets forth purchases made by the Company of its shares of common stock under the stock repurchase program during the three months ended September 30, 2005:
Period | Total Number of Shares Purchased | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Repurchase Program (1) | Maximum Number of Shares That May Yet Be Purchased Under the Repurchase Program | ||||||
June 30, 2005 | — | — | — | 63,817 | (1) | |||||
August 1 – August 31, 2005 | 49,000 | $ | 34.30 | 49,000 | 14,817 | |||||
September 1 – September 30, 2005 | 6,500 | $ | 33.60 | 6,500 | 8,317 | |||||
55,500 | $ | 34.22 | 55,500 | |||||||
(1) | On January 22, 2004, the Registrant announced that its Board of Directors had authorized management to repurchase up to 100,000 shares of its common stock in the open market or through private transactions during the next twelve months. On January 19, 2005 the Registrant announced that its Board of Directors had extended, for another year, the stock repurchase program which it authorized in January 2004. Additionally, the Board approved an increase of 100,000 in the number of shares of the Registrant’s common stock authorized for repurchase in the current program, bringing the total shares available for repurchase to 126,177. During the first and second quarter 2005, the Company repurchased 62,360 shares further reducing the total shares available for repurchase to 63,817 at June 30, 2005. |
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Item 3. | Defaults Upon Senior Securities |
Not Applicable.
Item 4. | Submission of Matters to a Vote of Security Holders |
None
Item 5. | Other Information |
None.
Item 6. | Exhibits and Reports on Form 8-K |
a. | Exhibit Index |
31.1 | Section 302 Certification of Chief Executive Officer. (filed herewith) | |
31.2 | Section 302 Certification of Chief Financial Officer. (filed herewith) | |
32.1 | Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Gerard H. Brandi, Chief Executive Officer of the Company. (filed herewith) | |
32.2 | Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, signed by Reginald E. Cormier, Chief Financial Officer of the Company. (filed herewith) |
b. | Reports on Form 8-K |
On July 22, 2005, the Company filed a current report on Form 8-K, reporting under Item 4.02 and 9.01, announcing the Company’s second quarter 2005 earnings results.
On August 11, 2005, the Company filed a current report on Form 8-K, furnishing under Item 9.01 the following exhibits:
10.5.1 | Amended and Restated Deferred Compensation Plan for Directors of MASSBANK Corp. (the “Company”) and MASSBANK (the “Bank”) dated August 10, 2005. | |
10.6.1 | Amended and Restated Terms and Conditions of Deferred Compensation Program for employees of MASSBANK (the “Bank”) dated August 10, 2005. |
On October 20, 2005, the Company filed a current report on Form 8-K, reporting under Item 4.02 and 9.01, announcing the Company’s third quarter 2005 earnings results.
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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.
MASSBANK Corp. & Subsidiaries (Registrant) | ||||
Date: November 7, 2005 | /S/ GERARD H. BRANDI | |||
(Signature) Gerard H. Brandi President and CEO | ||||
Date: November 7, 2005 | /S/ REGINALD E. CORMIER | |||
(Signature) Reginald E. Cormier Sr. V.P., Treasurer and CFO |
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