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 March 31, 1996 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 (I.R.S. Employer incorporation or organization) Identification No.) 123 HAVEN STREET Reading, Massachusetts 01867 (Address of principal executive offices, including Zip Code) Registrant's telephone number, including area code: (617) 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. Yes [X] No [ ] 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 April 30, 1996: 2,727,003 shares. MASSBANK CORP. AND SUBSIDIARIES FORM 10-Q FOR QUARTER ENDED MARCH 31, 1996 TABLE OF CONTENTS PART I - FINANCIAL INFORMATION Page ITEM 1. Financial Statements Consolidated Balance Sheets as of March 31, 1996 (unaudited) and December 31, 1995 3 Consolidated Statements of Income (unaudited) for the three months ended March 31, 1996 and 1995 4 Consolidated Statements of Changes in Stockholders' Equity for the three months ended March 31, 1996 (unaudited) and the year ended December 31, 1995 5 Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 1996 and 1995 6 - 7 Condensed Notes to the Consolidated Financial Statements 8 - 11 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 12 - 19 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings 20 ITEM 2. Changes in Securities 20 ITEM 3. Defaults Upon Senior Securities 20 ITEM 4. Submission of Matters to a Vote of Security Holders 20 ITEM 5. Other Information 20 ITEM 6. Exhibits and Reports on Form 8-K 20 Signature Page 21 MASSBANK CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands except share data) March 31, December 31, 	 1996 1995 (unaudited) Assets: Cash and due from banks $ 8,643 $ 8,150 Short-term investments (Note 3) 81,465 117,505 ______________________________________________________________________________ Total cash and cash equivalents 90,108 125,655 Term federal funds sold 5,000 5,000 Interest-bearing deposits in banks 1,667 941 Securities held to maturity, at amortized cost (Note 4) 172 402 Securities available for sale, at market value (Note 4) 460,367 456,101 Trading securities, at market value 41,567 6,819 Loans: (Notes 5 and 6) Mortgage loans 222,250 220,603 Other loans 27,685 28,582 Less: allowance for possible loan losses (2,504) (2,529) ______________________________________________________________________________ Net loans 247,431 246,656 Premises and equipment 4,156 4,226 Real estate acquired through foreclosure 276 255 Accrued interest receivable 6,779 7,280 Other assets 1,399 1,207 ______________________________________________________________________________ Total assets $858,922 $854,542 Liabilities and Stockholders' Equity: Deposits: Demand and NOW $ 65,544 $ 66,413 Savings 360,003 356,598 Time certificates of deposit 341,191 332,057 	 Deposit acquisition premium, net of amortization (1,354) (1,411) ______________________________________________________________________________ Total deposits 765,384 753,657 Escrow deposits of borrowers 1,098 992 Employee stock ownership plan liability (Note 7) 1,093 1,093 Accrued and deferred income taxes payable 1,013 4,760 Other liabilities 3,081 3,223 ______________________________________________________________________________ Total liabilities 771,669 763,725 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, 5,453,327 and 5,424,671 shares issued, respectively 5,453 5,425 Additional paid-in capital 57,339 56,842 Retained earnings 60,399 58,773 ______________________________________________________________________________ 123,191 121,040 Treasury stock at cost, 2,719,765 and 2,683,065 shares, respectively (37,595) (36,370) Net unrealized gains on securities available for sale, net of tax effect 2,750 7,240 Common stock acquired by ESOP (Note 7) (1,093) (1,093) ______________________________________________________________________________ Total stockholders' equity 87,253 90,817 ______________________________________________________________________________ Total liabilities and stockholders' equity $858,922 $854,542 <FN> See accompanying condensed notes to consolidated financial statements. MASSBANK CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) Three months ended March 31, (In thousands except share data) 1996 1995 ______________________________________________________________________________ Interest and dividend income: Mortgage Loans $ 4,199 $ 4,218 Other loans 646 668 Mortgage-backed securities 3,930 3,088 Securities available for sale 3,327 4,002 Trading securities 200 1,090 Federal funds sold 1,579 775 Other investments 243 7 ______________________________________________________________________________ Total interest and dividend income 14,124 13,848 ______________________________________________________________________________ Interest expense: Deposits 8,009 7,188 ______________________________________________________________________________ Total interest expense 8,009 7,188 ______________________________________________________________________________ Net interest income 6,115 6,660 Provision for possible loan losses 30 70 ______________________________________________________________________________ Net interest income after provision for possible loan losses 6,085 6,590 ______________________________________________________________________________ Non-interest income: Deposit account service fees 218 227 Gains (losses) on securities, net 207 4 Other 192 197 ______________________________________________________________________________ Total non-interest income 617 428 ______________________________________________________________________________ Non-interest expense: Salaries and employee benefits 1,772 1,816 Occupancy and equipment 517 508 Data processing 153 152 Professional services 109 113 Deposit insurance 3 439 Other 502 493 ______________________________________________________________________________ Total non-interest expense 3,056 3,521 ______________________________________________________________________________ Income before income taxes 3,646 3,497 Income tax expense 1,423 1,371 ______________________________________________________________________________ Net income $ 2,223 $ 2,126 ______________________________________________________________________________ Weighted average common shares outstanding: Primary 2,783,426 2,797,212 Fully diluted 2,784,454 2,797,856 ______________________________________________________________________________ Earnings per share (in dollars): Primary $ 0.80 $ 0.76 Fully diluted 0.80 0.76 ______________________________________________________________________________ <FN> See accompanying condensed notes to consolidated financial statements. MASSBANK CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For the Three Months Ended March 31, 1996 (unaudited) and the Year Ended December 31, 1995 (In thousands except share data) NET UNREALIZED GAINS (LOSSES) ON SECURITIES COMMON ADDITIONAL AVAILABLE FOR STOCK COMMON PAID-IN RETAINED TREASURY SALE, NET OF ACQUIRED STOCK CAPITAL EARNINGS STOCK TAX EFFECT BY ESOP TOTAL ________ __________ _________ __________ __________ ________ ________ Balance at December 31, 1994 $ 5,352 $55,609 $51,995 $(33,288) $(3,915) $(1,249) $74,504 Net income -- -- 8,759 -- -- -- 8,759 Cash dividends declared ($0.73 per share) -- -- (1,981) -- -- -- ( 1,981) Net decrease in liability to ESOP -- -- -- -- -- 156 156 Amortization of ESOP shares committed to be released -- 51 -- -- -- -- 51 Purchase of treasury stock -- -- -- (3,082) -- -- (3,082) Exercise of stock options and related tax benefits 73 1,182 -- -- -- -- 1,255 Change in net unrealized gains (losses) on securities available for sale, net of tax effect -- -- -- -- 11,155 -- 11,155 ____________________________________________________________________________________________________________________ Balance at December 31, 1995 5,425 56,842 58,773 (36,370) 7,240 (1,093) 90,817 Net Income -- -- 2,223 -- -- -- 2,223 Cash dividends declared ($0.22 per share) -- -- (597) -- -- -- (597) Purchase of treasury stock -- -- -- (1,225) -- -- (1,225) Exercise of stock options and related tax benefits 28 497 -- -- -- -- 525 Change in net unrealized gains (losses) on securities available for sale, net of tax effect -- -- -- -- (4,490) -- (4,490) _____________________________________________________________________________________________________________________ Balance at March 31, 1996 $ 5,453 $57,339 $60,399 $(37,595) $ 2,750 $(1,093) $87,253 _____________________________________________________________________________________________________________________ <FN> See accompanying condensed notes to consolidated financial statements. MASSBANK CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) Three Months Ended March 31, 1995 1994 ____ ____ (In thousands) Cash flows from operating activities: Net income $ 2,223 $ 2,126 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 107 121 Amortization of deposit acquisition premium 57 58 Amortization of loan valuation premium 16 16 Decrease in accrued interest receivable 501 956 Decrease in other liabilities (142) (3,031) Decrease in accrued and deferred income taxes payable (560) (642) Accretion of discounts on securities, net of amortization of premiums (238) (277) Net trading securities activity (34,896) 50,562 (Gains) losses on securities available for sale (355) 395 (Gains) losses on trading securities 148 (399) Increase (decrease) in deferred mortgage loan origination fees, net of amortization 34 (26) Decrease in deferred income tax asset, net 25 342 Increase in other assets (192) (521) Loans originated for sale (45) -- Loans sold 163 -- Provision for possible loan losses 30 70 Provision for losses and writedowns on real estate acquired through foreclosure 8 13 Increase in escrow deposits of borrowers 106 283 ______________________________________________________________________________ Net cash provided by (used in) operating activities (33,010) 50,046 ______________________________________________________________________________ Cash flows from investing activities: Purchases of term federal funds -- (25,000) Purchases of bank certificates of deposit (726) -- Proceeds from sales of investment securities available for sale 11,662 23,757 Proceeds from maturities of investment securities held to maturity and available for sale 36,225 10,083 Purchases of securities available for sale (10,478) (32,850) Purchases of mortgage-backed securities (56,137) (3,918) Principal repayments of mortgage-backed securities 7,578 4,135 Principal repayments of tax-exempt bonds 5 4 Loans originated (12,365) (4,330) Loan principal payments received 11,363 8,146 Purchases of premises & equipment (37) (54) Proceeds from sale of real estate acquired through foreclosure -- 26 Net advances on real estate acquired through foreclosure -- (7) ______________________________________________________________________________ Net cash (used in) investing activities (12,910) (20,008) ______________________________________________________________________________ MASSBANK CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) (unaudited) Three Months Ended March 31, 1996 1995 ____ ____ (In thousands) Cash flows from financing activities: Net increase (decrease) in deposits 11,670 (3,955) Payments to acquire treasury stock (1,225) (119) Issuance of common stock under stock option plan 329 86 Tax benefit resulting from stock options exercised 196 24 Dividends paid on common stock (597) (479) ______________________________________________________________________________ Net cash provided by (used in) financing activities 10,373 (4,443) ______________________________________________________________________________ Net increase (decrease) in cash and cash equivalents (35,547) 25,595 Cash and cash equivalents at beginning of period 125,655 32,161 ______________________________________________________________________________ Cash and cash equivalents at end of period $ 90,108 $ 57,756 ______________________________________________________________________________ Supplemental cash flow disclosures: Cash transactions: Cash paid during the period for interest $ 8,005 $ 7,188 Cash paid during the period for taxes, net of refunds 1,762 1,648 Non-cash transactions: SFAS 115: Increase (decrease) in stockholders' equity (4,490) 3,183 Decrease in deferred tax assets -- 2,415 Decrease in deferred tax liabilities (3,212) -- Transfers from loans to real estate acquired through foreclosure 29 272 Transfers from other assets to securities available for sale -- 66 ______________________________________________________________________________ <FN> See accompanying condensed notes to consolidated financial statements. Disclosure of accounting policy: For purposes of reporting cash flows, cash and cash equivalents consist of cash and due from banks, federal funds sold and term federal funds sold with original maturities of less than 90 days. MASSBANK CORP. 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 generally accepted accounting principles, 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 March 31, 1996 and December 31, 1995, operating results for the three months ended March 31, 1996 and 1995, and cash flows for the three months ended March 31, 1996 and 1995. 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 have been reclassified to permit 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, 1995. (2) Earnings Per Common Share The computation of earnings per common share for the three months ended March 31, 1996 and 1995 is based on the weighted average number of shares of common stock and common stock equivalents outstanding during the period. Stock options, when dilutive are included as common stock equivalents using the Treasury stock method. (3) Short-Term Investments Short-term investments consist of the following: ____________________________________________________________________________________ At At (In thousands) March 31, 1996 December 31, 1995 ____________________________________________________________________________________ Federal funds sold (overnight) $ 56,991 $100,245 Term federal funds sold (with original maturities of 90 days or less) -- 10,000 Money market funds 24,474 7,260 ____________________________________________________________________________________ Total short-term investments $ 81,465 $117,505 ____________________________________________________________________________________ The investments above are stated at cost which approximates market value and have original maturities of 90 days or less. (4) Investment Securities The amortized cost and estimated market value of investment securities are as follows: __________________________________________________________________________________________ Gross Gross (In thousands) At March 31, 1996 Amortized Unrealized Unrealized Market Cost Gains Losses Value __________________________________________________________________________________________ Securities held to maturity: Other bonds and obligations $ 172 $ -- $ -- $ 172 __________________________________________________________________________________________ Total securities held to maturity 172 -- -- 172 __________________________________________________________________________________________ Securities available for sale: Debt securities: U.S. Treasury obligations 171,867 2,290 (40) 174,117 U.S. Government agency obligations 12,896 94 (101) 12,889 Other bonds and obligations 1,997 6 (1) 2,002 __________________________________________________________________________________________ Total 186,760 2,390 (142) 189,008 __________________________________________________________________________________________ Mortgage-backed securities: Government National Mortgage Association 78,929 1,098 (645) 79,382 Federal Home Loan Mortgage Corporation 168,684 942 (2,636) 166,990 Federal National Mortgage Association 11,921 463 -- 12,384 Other 624 37 -- 661 __________________________________________________________________________________________ Total mortgage-backed securities 260,158 2,540 (3,281) 259,417 __________________________________________________________________________________________ Total debt securities 446,918 4,930 (3,423) 448,425 __________________________________________________________________________________________ Equity securities 8,688 3,260 (6) 11,942 __________________________________________________________________________________________ Total securities available for sale 455,606 $ 8,190 $ (3,429) $460,367 __________________________________________________________________________________________ Net unrealized gains on securities available for sale 4,761 __________________________________________________________________________________________ Total securities available for sale, net 460,367 __________________________________________________________________________________________ Total investment securities, net $460,539 __________________________________________________________________________________________ (4) Investment Securities (continued) __________________________________________________________________________________________ Gross Gross (In thousands) At December 31, 1995 Amortized Unrealized Unrealized Market Cost Gains Losses Value __________________________________________________________________________________________ Securities held to maturity: Other bonds and obligations $ 402 $ -- $ -- $ 402 __________________________________________________________________________________________ Total securities held to maturity 402 -- -- 402 __________________________________________________________________________________________ Securities available for sale: Debt securities: U.S. Treasury obligations 207,771 4,387 (43) 212,115 U.S. Government agency obligations 13,994 178 -- 14,172 Other bonds and obligations 1,996 10 (2) 2,004 __________________________________________________________________________________________ Total 223,761 4,575 (45) 228,291 __________________________________________________________________________________________ Mortgage-backed securities: Government National Mortgage Association 81,411 2,160 (19) 83,552 Federal Home Loan Mortgage Corporation 116,500 2,339 (100) 118,739 Federal National Mortgage Association 12,886 574 -- 13,460 Other 726 43 -- 769 __________________________________________________________________________________________ Total mortgage-backed securities 211,523 5,116 (119) 216,520 __________________________________________________________________________________________ Total debt securities 435,284 9,691 (164) 444,811 __________________________________________________________________________________________ Equity securities 8,354 2,961 (25) 11,290 __________________________________________________________________________________________ Total securities available for sale 443,638 $ 12,652 $ (189) $456,101 __________________________________________________________________________________________ Net unrealized gains on securities available for sale 12,463 __________________________________________________________________________________________ Total securities available for sale, net 456,101 __________________________________________________________________________________________ Total investment securities, net $456,503 __________________________________________________________________________________________ (5) Loans The composition of the Bank's loan portfolio is summarized as follows: _______________________________________________________________________________________ At At (In thousands March 31, 1996 December 31, 1995 _______________________________________________________________________________________ Mortgage loans: Residential $214,783 $212,652 Commercial 6,527 6,975 Construction 1,530 1,516 _______________________________________________________________________________________ 222,840 221,143 Add: Premium on loans 372 388 Less: deferred mortgage loan origination fees (962) (928) _______________________________________________________________________________________ Total mortgage loans 222,250 220,603 Other loans: Consumer: Installment 1,849 1,988 Guaranteed education 10,378 10,420 Other secured 1,845 2,012 Home equity lines of credit 12,671 13,144 Unsecured 265 265 _______________________________________________________________________________________ Total consumer loans 27,008 27,829 Commercial 677 753 _______________________________________________________________________________________ Total other loans 27,685 28,582 _______________________________________________________________________________________ Total loans $249,935 $249,185 _______________________________________________________________________________________ (6) Commitments At March 31, 1996, the Company had outstanding commitments to originate mortgage loans and to advance funds for construction loans amounting to $9,046,000 and commitments under existing home equity lines of credit andother loans of approximately $20,076,000 which are not reflected on the consolidated balance sheet. In addition, as of March 31, 1996, the Company had a performance standby letter of credit conveyed to others in the amount of $1,093,000 which is also not reflected on the consolidated balance sheet. (7) Employee Stock Ownership Plan Effective May 28, 1986, the Company established an employee stock ownership plan ("ESOP"). Under the plan, the ESOP has borrowed funds from a third party bank to invest in the Company's common stock. As this obligation will be liquidated primarily through future contributions to the ESOP by the Company, the obligation is reflected as a liability of the Company and a reduction of shareholders' equity on the consolidated balance sheet. As of March 31, 1996 and December 31, 1995, such outstanding liabilities totaled $1,093,000. MASSBANK CORP. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS March 31, 1996 General The following discussion should be read in conjunction with the consolidated financial statements and related notes included in this report. MASSBANK Corp.'s (the "Company's") financial condition and results of operations essentially reflect the operations of its subsidiary, MASSBANK (the "Bank") and the Bank's wholly-owned subsidiaries: Readibank Properties, Inc., Readibank Equipment Corporation, Melbank Investment Corporation and Readibank Investment Corporation. The Company's net income depends largely upon net interest income, which is the difference between interest income from loans and investments ("interest-earning assets") and interest expense on deposits and borrowed funds ("interest-bearing liabilities"). Net interest income is significantly affected by general economic conditions, policies established by regulatory authorities and competition. The Company has consistently maintained positive net interest income. Net income is also affected by the provision for possible loan losses and by the level of non-interest income (including gains or losses on securities), non-interest expenses and income taxes. Each of these major elements of consolidated net income is discussed in succeeding paragraphs. FINANCIAL CONDITION The Company's total assets increased by $4.4 million from $854.5 million at December 31, 1995 to $858.9 million at March 31, 1996. Funding for the asset growth was essentially provided by the growth in deposits. The Bank's total deposits increased by $11.7 million during the recent quarter, reaching $765.4 million by quarters end. Total savings and time certificates of deposit increased while demand and NOW account deposits declined slightly. Stockholders' equity at March 31, 1996 equalled $87.3 million representing a book value of $31.92 per share, a decrease from $90.8 million representing a book value of $33.13 per share at December 31, 1995. This decrease in stockholders' equity resulted primarily from unrealized depreciation in the market value of the Bank's securities available for sale portfolio due to the volatility of the financial markets in the recent quarter. Average earning assets for the first quarter of 1996 were $840.1 million, up from $816.8 million in the first quarter of 1995. Average interest bearing liabilities totaled $757.2 million for the three months ended March 31, 1996 compared to $755.3 million for the three months ended March 31, 1995. Loans The Bank's loan portfolio increased slightly during the first three months of 1996 from $249.2 million at December 31, 1995 to $249.9 million at March 31, 1996. Loan originations during this period exceeded the level of loan amortization and payoffs in the Bank's portfolio. Loan originations in the first three months of 1996 increased to $12.4 million from $4.3 million in the first three months of 1995, due primarily to an increase in loan demand. The decline in residential mortgage loan rates since the first quarter of 1995 has stimulated loan demand resulting in increased loan originations for the Bank. Investments MASSBANK's total investments consisting of investment securities, term federal funds sold, interest-bearing deposits in banks and other short-term investments increased from $586.8 million at December 31, 1995 to $590.2 million at March 31, 1996. The majority of these investments are in federal funds sold, shorter-term U.S. Treasury and government agency obligations, and fifteen year mortgage-backed securities. Nearly all of the Bank's investment securities are classified as available for sale or trading securities. During the first quarter of 1996, the Bank increased its portfolio of mortgage-backed securities by $42.9 million, from $216.5 million at December 31, 1995 to $259.4 million at March 31, 1996, while reducing its portfolio of U.S. Treasury and government agency securities by $39.3 million. The increase in higher yielding longer term mortgage-backed securities will help to improve the yield on the Bank's earning assets. In addition, the Bank's trading securities portfolio increased by $34.7 million in the recent quarter due to the purchase of short-term U.S. Treasury bills. This increase was offset by a comparable reduction in the Bank's short-term investments (primarily federal funds sold). Deposits Deposit accounts of all types have historically 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. Management attempts to manage its deposits through selective pricing. MASSBANK's total deposits increased by $11.7 million in the first three months of 1996, from $753.7 million at December 31, 1995 to $765.4 million at March 31, 1996. ASSET QUALITY Net loans represented 28.8% of total assets at March 31, 1996 as compared to 28.9% of total assets at December 31, 1995. The Bank's securities and other short-term investments, representing 68.7% of total assets at March 31, 1996, consist primarily of U.S. Treasury and government agency obligations, high quality mortgage-backed securities, federal funds sold and other short-term investments. Investments in marketable equity securities and mutual funds totaled approximately $18.6 million at the end of the recent quarter. At March 31, 1996, the Bank's loan portfolio consisted of residential mortgages of $215.7 million, commercial mortgages of $6.5 million, consumer loans of $27.0 million and commercial loans of approximately $0.7 million. Non-performing assets were $2.9 million at March 31, 1996 representing 0.33% of total assets. This compares to $2.7 million, or 0.31% of total assets, at December 31, 1995. At March 31, 1996, the Bank's allowance for possible loan losses was $2.5 million, representing 96.8% of non-performing loans and 1.0% of total loans. The Bank believes that its allowance for possible loan losses is adequate to cover the risks inherent in the loan portfolio under current conditions. Results of Operations for the Three Months Ended March 31, 1996 Compared to the Corresponding Period in 1995 General For the quarter ended March 31, 1996, MASSBANK Corp. reported consolidated net income of $2,223,000 or $0.80 per share, compared with consolidated net income of $2,126,000 or $0.76 per share for the same quarter of 1995. Earnings results for the first quarter of 1996 were favorably impacted by significantly lower deposit insurance costs, a modest reduction in other non-interest expenses, higher securities gains and a lower provision for possible loan losses. These improvements were partially offset by a decrease in the Company's net interest margin. Net Interest Income Net interest income before provision for possible loan losses totaled $6,115,000 in the first quarter of 1996 compared to $6,660,000 in the comparable quarter of 1995. As detailed in the average balance sheets on the following pages, this is the result of a decline in the Company's net interest margin and interest rate spread. The interest rate spread was 2.49% for the first quarter of 1996 compared to 2.94% for the same quarter of 1995. The net interest margin for the three months ended March 31, 1996 and 1995 was 2.93% and 3.28%, respectively. Interest and Dividend Income Interest and dividend income from loans and investments increased by $276,000 or 2.0% to $14,124,000 for the three months ended March 31, 1996 from $13,848,000 for the same period in 1995. This increase is primarily attributable to an increase in the Company's average earning assets partially offset by a decrease in yield on average earning assets. The average total earning assets of the Company increased to $840.1 million in the first quarter of 1996 from $816.8 million for the corresponding quarter of 1995. The yield on the Company's average earning assets for the first quarter of 1996 decreased by 6 basis points to 6.74% from 6.80% for the same quarter in 1995. As can be seen from the average balance sheets on the following pages, the decrease in yield on average assets is due in part to a significant decline in short term market rates. The yield on federal funds sold decreased from 5.87% in the first quarter of 1995 to 5.39% in the first quarter of 1996. The yield on the Company's average earning assets was also negatively affected by a decrease in yield on mortgage loans and mortgage-backed securities, primarily the result of new (lower yielding) volume added to the Bank's portfolios during a period of declining mortgage loan rates. Interest Expense Total interest expense increased 11.4% to $8,009,000 for the three months ended March 31, 1996 from $7,188,000 for the three months ended March 31, 1995. This increase was due principally to an increase of 39 basis points in the Company's average cost of funds from 3.86% in the first quarter of 1995 to 4.25% in the first quarter of 1996. Average deposits and borrowed funds increased to $757.2 million in the recent quarter from $755.3 million a year earlier. The Bank has maintained flat regular savings account deposit rates during the 1994-1996 period while selectively increasing rates on certificates of deposit. This strategy has helped to minimize the effect of rising interest rates on the Company's net interest margin. The strategy has also helped to encourage a shift from savings to time certificates of deposit during this period. During the last twelve months, the Bank's total savings deposits, including money market accounts, declined $46.1 million, from $406.1 million at March 31, 1995 to $360.0 million at March 31, 1996, while its certificates of deposit increased $54.2 million, from $287.0 million at March 31, 1995 to $341.2 million at March 31, 1996. AVERAGE BALANCE SHEETS Three Months Ended March 31, 1996 March 31, 1995 ______________ ______________ (1) Interest Average (1) Interest Average Average Income/ Yield/ Average Income/ Yield/ (In thousands) Balance Expense Rate Balance Expense Rate __________________________________________________________________________________________ Assets: Earning assets: Federal funds sold $117,766 $ 1,579 5.39% $ 53,537 $ 775 5.87% Short-term investments (4) 18,003 240 5.36 -- -- -- Investment securities 212,569 3,366 6.33 261,547 4,041 6.18 Mortgage-backed securities 228,215 3,930 6.89 172,185 3,088 7.17 Trading securities 14,321 200 5.62 80,723 1,090 5.43 Mortgage loans (2) 221,016 4,199 7.60 218,187 4,218 7.73 Other loans (2) 28,172 646 9.18 30,646 668 8.79 __________________________________________________ ________________ Total earning assets 840,062 $14,160 6.74% 816,825 $13,880 6.80% __________________________________________________________________________________________ Allowance for possible loan losses (2,539) (2,575) __________________________________________________________________________________________ Total earning assets less allowance for possible loan losses 837,523 814,250 Other assets 18,717 22,870 __________________________________________________________________________________________ Total assets $856,240 $837,120 __________________________________________________________________________________________ AVERAGE BALANCE SHEETS - Continued Three Months Ended March 31, 1996 March 31, 1995 ______________ ______________ (1) Interest Average (1) Interest Average Average Income/ Yield/ Average Income/ Yield/ (In thousands) Balance Expense Rate Balance Expense Rate __________________________________________________________________________________________ Liabilities: Deposits: Demand and NOW $ 64,355 $ 155 0.97% $ 64,927 $ 164 1.03% Savings 357,018 3,015 3.39 430,186 3,512 3.31 Time certificates of deposit 335,830 4,839 5.80 260,220 3,512 5.47 __________________________________________________ ________________ Total deposits 757,203 8,009 4.25 755,333 7,188 3.86 Other liabilities 7,722 4,852 __________________________________________________________________________________________ Total liabilities 764,925 760,185 __________________________________________________________________________________________ Stockholders' Equity 91,315 76,935 __________________________________________________________________________________________ Total liabilities and stockholders' equity $856,240 $837,120 __________________________________________________________________________________________ Net interest income (tax-equivalent basis) 6,151 6,692 Less adjustment of tax-exempt interest income 36 32 __________________________________________________________________________________________ Net interest income $ 6,115 $ 6,660 __________________________________________________________________________________________ Interest rate spread 2.49% 2.94% __________________________________________________________________________________________ Net interest margin (3) 2.93% 3.28% __________________________________________________________________________________________ (1) Includes the effects of SFAS No. 115. (2) Loans on non-accrual status are included in the average balance. (3) Annualized net interest income (tax equivalent basis) before provision for possible loan losses divided by average interest-earning assets. (4) Short-term investments consist of interest-bearing deposits in banks and investments in money market funds. Provision for Possible Loan Losses Possible losses on loans are provided for under the allowance method of accounting. The allowance is increased by provisions charged to operations based on management's assessment of many factors including the risk characteristics of the portfolio, underlying collateral, current and anticipated economic conditions that may affect the borrowers 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 the information available in establishing the allowance for losses, future adjustments to the allowance may be necessary if economic conditions differ substantially 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 possible loan losses. Such agencies may require the Bank to recognize additions to the allowance based on judgments different from those of management. As a result of management's assessment and analysis, the Bank provided $30,000 for potential loan losses during the first quarter of 1996 compared to $70,000 for the same quarter in 1995. Loan charge-offs net of recoveries, were $55,000 and $39,000 for the respective periods. Non-performing assets increased to $2,862,000 as of March 31, 1996 from $2,683,000 as of December 31, 1995. At March 31, 1996 the balance of the allowance for possible loan losses was $2,504,000, compared to $2,529,000 at the end of 1995. This reserve for loan losses remains strong at 96.8% of total non- performing loans. Non-Performing Assets March 31, December 31, March 31, (In thousands) 1996 1995 1995 ______________________________________________________________________________ Non-Performing Assets: Non-accrual loans $ 2,586 $ 2,428 $ 1,223 Real estate acquired through foreclosure 276 255 370 ______________________________________________________________________________ Total non-performing assets $ 2,862 $ 2,683 $ 1,593 ______________________________________________________________________________ Allowance for possible loan losses $ 2,504 $ 2,529 $ 2,597 Allowance as percent of non-accrual loans 96.8% 104.2% 212.3% Non-accrual loans as percent of total loans 1.03% 0.97% 0.50% Non-performing assets as percent of total assets 0.33% 0.31% 0.19% The Company adopted Statement of Financial Accounting Standards (SFAS) No. 114, "Accounting by Creditors for Impairment of a Loan", and SFAS No. 118 "Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures" effective January 1, 1995. However, the Bank did not have any impaired loans as of March 31, 1996. Non-Interest Income Non-interest income consists of deposit account service fees, net gains or losses on securities and other non-interest income. Non-interest income for the recent quarter was $617,000, up from $428,000 a year ago. The increase is principally due to net gains on securities of $207,000 recorded in the first quarter of 1996 compared to net securities gains of $4,000 recorded in the comparable quarter of 1995. Non-Interest Expense Non-interest expenses for the three months ended March 31, 1996 decreased to $3,056,000 from $3,521,000 for the corresponding period in 1995. Non-interest expenses in the recent quarter were favorably affected by a significantly lower deposit insurance expense and a modest reduction in other expenses. The significant decrease in deposit insurance expense results from a reduction in the Federal Deposit Insurance Corporation ("FDIC") deposit insurance rates for well capitalized banks from $0.23 per hundred dollars of deposits paid in the first quarter of 1995 to an annual minimum of $2 thousand paid in the first quarter of 1996. Income Tax Expense The Company and its subsidiaries file consolidated federal income tax returns on an October 31, year-end. The Parent Company is subject to a State of Delaware Franchise Tax and a State of Massachusetts Bank Excise Tax and the Bank's subsidiaries are subject to a State of Massachusetts Corporate Excise Tax. Provisions for deferred income taxes are made as a result of timing differences between financial and income tax methods of accounting. The provision for federal and state income taxes increased to $1,423,000 for the three months ended March 31, 1996 from $1,371,000 for the same period in 1995. This increase is due to higher income before taxes partially offset by a modest decrease in the Company's combined effective income tax rate from 39.2% for the first quarter of 1995 to 39.0% for the first quarter of 1996. 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 outflow from normal depositor requirements and loan demands. The Bank's primary sources of funds are deposits, loan amortization and prepayments, sales or maturities of investment securities 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, 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 March 31, 1996 the Bank had $57.0 million or 6.6% of total assets and $221.9 million or 25.8% of total assets invested respectively in overnight federal funds sold and United States Treasury and Government agency obligations. The Bank is an 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 CAMEL rating system) are required to maintain Tier 1 capital of at least 3% of their total assets. All other banks are required to have Tier 1 capital of 4% to 5%. The FDIC has authority to impose higher requirements for individual banks. The Bank is also required to maintain a minimum level of risk-based capital. Under the new risk-based capital standards, FDIC insured institutions generally are expected to meet a minimum total qualifying capital to risk-weighted assets ratio of 8.00%. At March 31, 1996, the Bank had ratios of Tier 1 capital to total assets of 9.65% and qualifying capital to risk-weighted assets of 35.17% The Company had ratios of Tier 1 capital to total assets of 9.73% and total qualifying capital to risk-weighted assets of 35.44% at March 31, 1996. Impact of Inflation and Changing Prices MASSBANK Corp.'s financial statements presented herein have been prepared in accordance with generally accepted accounting principles which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time, due to the fact that substantially all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. 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 March 31, 1996, 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 Not Applicable. 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. Exhibits Exhibit No. 11.1: Statement regarding computation of per share earnings. b. Reports on Form 8-K None. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MASSBANK Corp. & Subsidiaries ______________________________ (Registrant) Date May 13, 1996 /s/Gerard H. Brandi ____________ ______________________ (Signature) Gerard H. Brandi President and CEO Date May 13, 1996 /s/Reginald E. Cormier ____________ ______________________ (Signature) Reginald E. Cormier V.P., Treasurer and CFO