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 June 30, 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 July 31, 1996: 2,697,110 shares. MASSBANK CORP. AND SUBSIDIARIES INDEX PART I - FINANCIAL INFORMATION Page ITEM 1. Financial Statements Consolidated Balance Sheets as of June 30, 1996 (unaudited) and December 31, 1995 3 Consolidated Statements of Income (unaudited) for the three months ended June 30, 1996 and 1995 4 and for the six months ended June 30, 1996 and 1995 5 Consolidated Statements of Changes in Stockholders' Equity for the six months ended June 30, 1996 (unaudited) and the year ended December 31, 1995 6 Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 1996 and 1995 7 - 8 Condensed Notes to the Consolidated Financial Statements 9 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 - 20 PART II - OTHER INFORMATION ITEM 1. Legal Proceedings 21 ITEM 2. Changes in Securities 21 ITEM 3. Defaults Upon Senior Securities 21 ITEM 4. Submission of Matters to a Vote of Security Holders 21 ITEM 5. Other Information 21 ITEM 6. Exhibits and Reports on Form 8-K 21 Signature Page 22 MASSBANK CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands except share data) June 30, December 31, 	 1996 1995 (unaudited) Assets: Cash and due from banks $ 9,629 $ 8,150 Short-term investments (Note 3) 96,123 117,505 ______________________________________________________________________________ Total cash and cash equivalents 105,752 125,655 Term federal funds sold -- 5,000 Interest-bearing deposits in banks 1,694 941 Securities held to maturity, at amortized cost 170 402 Securities available for sale, at market value 497,398 456,101 Trading securities, at market value 6,616 6,819 Loans: (Note 4) Mortgage loans 230,758 220,603 Other loans 27,165 28,582 Less: allowance for possible loan losses (2,420) (2,529) ______________________________________________________________________________ Net loans 255,503 246,656 Premises and equipment 4,119 4,226 Real estate acquired through foreclosure 226 255 Accrued interest receivable 7,038 7,280 Other assets 2,018 1,207 ______________________________________________________________________________ Total assets $880,534 $854,542 Liabilities and Stockholders' Equity: Deposits: Demand and NOW $ 66,418 $ 66,413 Savings 358,585 356,598 Time certificates of deposit 354,699 332,057 	 Deposit acquisition premium, net of amortization (1,296) (1,411) ______________________________________________________________________________ Total deposits 778,406 753,657 Escrow deposits of borrowers 954 992 Employee stock ownership plan liability 1,093 1,093 Accrued and deferred income taxes payable -- 4,760 Other liabilities 13,884 3,223 ______________________________________________________________________________ Total liabilities 794,337 763,725 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, 5,463,625 and 5,424,671 shares issued, respectively 5,464 5,425 Additional paid-in capital 57,497 56,842 Retained earnings 62,178 58,773 ______________________________________________________________________________ 125,139 121,040 Treasury stock at cost, 2,743,765 and 2,683,065 shares, respectively (38,392) (36,370) Net unrealized gains on securities available for sale, net of tax effect 543 7,240 Common stock acquired by ESOP (1,093) (1,093) ______________________________________________________________________________ Total stockholders' equity 86,197 90,817 ______________________________________________________________________________ Total liabilities and stockholders' equity $880,534 $854,542 <FN> See accompanying condensed notes to consolidated financial statements. MASSBANK CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) Three months ended June 30, (In thousands except share data) 1996 1995 ______________________________________________________________________________ Interest and dividend income: Mortgage Loans $ 4,273 $ 4,146 Other loans 619 752 Mortgage-backed securities 4,740 3,137 Securities available for sale 3,154 4,004 Trading securities 195 760 Federal funds sold 1,073 1,373 Other investments 336 48 ______________________________________________________________________________ Total interest and dividend income 14,390 14,220 ______________________________________________________________________________ Interest expense: Deposits 8,139 7,680 ______________________________________________________________________________ Total interest expense 8,139 7,680 ______________________________________________________________________________ Net interest income 6,251 6,540 Provision for possible loan losses 35 40 ______________________________________________________________________________ Net interest income after provision for possible loan losses 6,216 6,500 ______________________________________________________________________________ Non-interest income: Deposit account service fees 238 233 Gains (losses) on securities, net 211 35 Other 275 341 ______________________________________________________________________________ Total non-interest income 724 609 ______________________________________________________________________________ Non-interest expense: Salaries and employee benefits 1,792 1,832 Occupancy and equipment 484 500 Data processing 152 153 Professional services 97 118 Deposit insurance 3 440 Other 502 514 ______________________________________________________________________________ Total non-interest expense 3,030 3,557 ______________________________________________________________________________ Income before income taxes 3,910 3,552 Income tax expense 1,540 1,383 ______________________________________________________________________________ Net income $ 2,370 $ 2,169 ______________________________________________________________________________ Weighted average common shares outstanding: Primary 2,754,461 2,789,240 Fully diluted 2,754,461 2,793,671 ______________________________________________________________________________ Earnings per share (in dollars): Primary $ 0.86 $ 0.78 Fully diluted 0.86 0.78 ______________________________________________________________________________ <FN> See accompanying condensed notes to consolidated financial statements. MASSBANK CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) Six months ended June 30, (In thousands except share data) 1996 1995 ______________________________________________________________________________ Interest and dividend income: Mortgage Loans $ 8,472 $ 8,364 Other loans 1,265 1,420 Mortgage-backed securities 8,670 6,225 Securities available for sale 6,481 8,006 Trading securities 395 1,850 Federal funds sold 2,652 2,148 Other investments 579 55 ______________________________________________________________________________ Total interest and dividend income 28,514 28,068 ______________________________________________________________________________ Interest expense: Deposits 16,148 14,868 ______________________________________________________________________________ Total interest expense 16,148 14,868 ______________________________________________________________________________ Net interest income 12,366 13,200 Provision for possible loan losses 65 110 ______________________________________________________________________________ Net interest income after provision for possible loan losses 12,301 13,090 ______________________________________________________________________________ Non-interest income: Deposit account service fees 456 460 Gains (losses) on securities, net 418 39 Other 467 538 ______________________________________________________________________________ Total non-interest income 1,341 1,037 ______________________________________________________________________________ Non-interest expense: Salaries and employee benefits 3,564 3,648 Occupancy and equipment 1,001 1,008 Data processing 305 305 Professional services 206 231 Deposit insurance 6 879 Other 1,004 1,007 ______________________________________________________________________________ Total non-interest expense 6,086 7,078 ______________________________________________________________________________ Income before income taxes 7,556 7,049 Income tax expense 2,963 2,754 ______________________________________________________________________________ Net income $ 4,593 $ 4,295 ______________________________________________________________________________ Weighted average common shares outstanding: Primary 2,768,944 2,793,204 Fully diluted 2,769,458 2,795,752 ______________________________________________________________________________ Earnings per share (in dollars): Primary $ 1.66 $ 1.54 Fully diluted 1.66 1.54 ______________________________________________________________________________ <FN> See accompanying condensed notes to consolidated financial statements. MASSBANK CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY For The Six Months Ended June 30, 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 paid ($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 -- -- 4,593 -- -- -- 4,593 Cash dividends paid ($0.44 per share) -- -- (1,188) -- -- -- (1,188) Purchase of treasury stock -- -- -- (2,022) -- -- (2,022) Exercise of stock options and related tax benefits 39 655 -- -- -- -- 694 Change in net unrealized gains (losses) on securities available for sale, net of tax effect -- -- -- -- (6,697) -- (6,697) _____________________________________________________________________________________________________________________ Balance at June 30, 1996 $ 5,464 $57,497 $62,178 $(38,392) $ 543 $(1,093) $86,197 _____________________________________________________________________________________________________________________ <FN> See accompanying condensed notes to consolidated financial statements. MASSBANK CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) Six Months Ended June 30, 1996 1995 ____ ____ (In thousands) Cash flows from operating activities: Net income $ 4,593 $ 4,295 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 215 241 Amortization of deposit acquisition premium 115 116 Amortization of loan valuation premium 32 32 Decrease in accrued interest receivable 242 407 Increase in other liabilities 661 553 Decrease in accrued and deferred income taxes payable (945) (513) Accretion of discounts on securities, net of amortization of premiums (501) (565) Net trading securities activity 10 79,808 (Gains) losses on securities available for sale (611) (510) (Gains) losses on trading securities 193 422 Increase (decrease) in deferred mortgage loan origination fees, net of amortization 113 (42) Decrease in current and deferred income tax asset, net 236 399 Increase in other assets (103) (316) Loans originated for sale (145) (214) Loans sold 208 214 Provision for possible loan losses 65 110 Provision for losses and writedowns on real estate acquired through foreclosure 40 19 (Decrease) increase in escrow deposits of borrowers (38) 84 ______________________________________________________________________________ Net cash provided by operating activities 4,380 84,540 ______________________________________________________________________________ Cash flows from investing activities: Purchases of term federal funds -- (40,000) Proceeds from maturities of term federal funds 5,000 15,000 Purchases of bank certificates of deposit (753) -- Proceeds from sales of investment securities available for sale 14,323 36,312 Proceeds from maturities of investment securities held to maturity and available for sale 51,225 28,147 Purchases of securities available for sale (24,499) (44,889) Purchases of mortgage-backed securities (100,708) (18,687) Principal repayments of mortgage-backed securities 18,242 8,969 Principal repayments of tax-exempt bonds 8 9 Loans originated (33,286) (9,227) Loan principal payments received 24,006 17,570 Purchases of premises & equipment (108) (225) Proceeds from sales of real estate acquired through foreclosure 149 80 Net advances on real estate acquired through foreclosure -- (7) ______________________________________________________________________________ Net cash (used in) investing activities (46,401) (6,948) ______________________________________________________________________________ MASSBANK CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (continued) (unaudited) Six Months Ended June 30, 1996 1995 ____ ____ (In thousands) Cash flows from financing activities: Net increase (decrease) in deposits 24,634 (12,107) Payments to acquire treasury stock (2,022) (1,644) Issuance of common stock under stock option plan 480 257 Tax benefit resulting from stock options exercised 214 85 Dividends paid on common stock (1,188) (958) ______________________________________________________________________________ Net cash provided by (used in) financing activities 22,118 (14,367) ______________________________________________________________________________ Net increase (decrease) in cash and cash equivalents (19,903) 63,225 Cash and cash equivalents at beginning of period 125,655 32,161 ______________________________________________________________________________ Cash and cash equivalents at end of period $105,752 $95,386 ______________________________________________________________________________ Supplemental cash flow disclosures: Cash transactions: Cash paid during the period for interest $16,139 $14,869 Cash paid during the period for taxes, net of refunds 3,458 2,735 Non-cash transactions: SFAS 115: Increase (decrease) in stockholders' equity (6,697) 6,366 Decrease in deferred tax assets -- 4,832 Decrease in deferred tax liabilities (4,759) -- Transfers from loans to real estate acquired through foreclosure 160 410 Transfers from other assets to securities available for sale -- 66 Securities purchases with a July 1996 settlement date 10,000 -- ______________________________________________________________________________ <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 June 30, 1996 and December 31, 1995, and its operating results for the three and six months ended June 30, 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 year's 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 and six months ended June 30, 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) June 30, 1996 December 31, 1995 ________________________________________________________________________________ Federal funds sold (overnight) $ 81,343 $100,245 Term federal funds sold (with original maturities of 90 days or less) -- 10,000 Money market funds 14,780 7,260 ________________________________________________________________________________ Total short-term investments $ 96,123 $117,505 ________________________________________________________________________________ The investments above are stated at cost which approximates market value and have original maturities of 90 days or less. (4) Commitments At June 30, 1996, the Company had outstanding commitments to originate mortgage loans and to advance funds for construction loans amounting to $2,765,000 and commitments under existing home equity lines of credit and other loans of approximately $19,957,000 which are not reflected on the consolidated balance sheet. In addition, as of June 30, 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. MASSBANK CORP. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS June 30, 1996 GENERAL The following discussion should be read in conjunction with the consolidated financial statements and related notes included in this report. For the quarter ended June 30, 1996, MASSBANK Corp. reported record consolidated net income of $2,370,000 or $0.86 per share. These results represent increases of 9.3% and 10.3%, respectively, from the $2,169,000 in consolidated net income and $0.78 per share earned in 1995's second quarter. The annualized return on average assets for the recent quarter increased to 1.10% from 1.04% for the comparable quarter of 1995. In addition, the Company improved its return on average realized equity for the second quarter of 1996 to 11.16% from 10.78% in the same quarter of 1995. For the six months ended June 30, 1996, the Company reported consolidated net income of $4,593,000 or $1.66 per share, up from $4,295,000 or $1.54 per share earned in the first six months of 1995. MASSBANK Corp.'s increased earnings for the second quarter and year-to- date period can be attributed to a decrease in non-interest expense, due primarily to a sharp decline in deposit insurance premiums, and an increase in net gains on securities. These improvements were partially offset by a decrease in net interest income. Net interest income declined 4.4% to $6,251,000 from $6,540,000 when compared to the second quarter of 1995 and 6.3% to $12,366,000 from $13,200,000 when compared to the six months ended June 30, 1995. This decrease was due primarily to a decrease in the Company's net interest margin partially offset by an increase in the Company's average earning assets. The Company's net interest margin of 2.98% for the quarter and 2.96% for the year-to-date period decreased from 3.21% and 3.24%, respectively, for the same periods in the prior year. Average earnings assets for the second quarter of 1996 increased to $843.3 million from $819.6 million in the corresponding quarter of 1995. For the first six months of 1996 the Company's average earning assets were $841.7 million, up from $818.2 million in the first half of 1995. MASSBANK Corp.'s provision for loan losses was $35,000 for the recent quarter and $65,000 year-to-date. This compares favorably with $40,000 and $110,000, respectively, for the corresponding periods in 1995. Non-performing assets were $2,588,000 or 0.29% of total assets at June 30, 1996. At June 30, 1996, the allowance for loan losses was $2,420,000 representing 102% of non- performing loans. The Company had total assets of $880.5 million at June 30, 1996, an increase of $26.0 million over total assets reported at December 31, 1995. Total deposits at June 30, 1996 were $778.4 million, up $24.7 million from year end 1995. Stockholders' equity at June 30, 1996 equalled $86.2 million representing a book value of $31.69 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 rise in interest rates in the last six months. A more detailed discussion and analysis of the Company's financial condition and results of operations follows. FINANCIAL CONDITION INVESTMENT SECURITIES The amortized cost and estimated market value of investment securities at June 30, 1996 and December 31, 1995 with gross unrealized gains and losses, follows: __________________________________________________________________________________________ Gross Gross (In thousands) At June 30, 1996 Amortized Unrealized Unrealized Market Cost Gains Losses Value __________________________________________________________________________________________ Securities held to maturity: Other bonds and obligations $ 170 $ -- $ -- $ 170 __________________________________________________________________________________________ Total securities held to maturity $ 170 $ -- $ -- $ 170 __________________________________________________________________________________________ Securities available for sale: Debt securities: U.S. Treasury obligations $169,931 $ 1,378 $ (128) $171,181 U.S. Government agency obligations 11,897 46 (136) 11,807 Other bonds and obligations 998 3 -- 1,001 __________________________________________________________________________________________ Total 182,826 1,427 (264) 183,989 __________________________________________________________________________________________ Mortgage-backed securities: Government National Mortgage Association 75,290 469 (965) 74,794 Federal Home Loan Mortgage Corporation 217,531 613 (4,163) 213,981 Federal National Mortgage Association 10,834 368 -- 11,202 Other 518 23 -- 541 __________________________________________________________________________________________ Total mortgage-backed securities 304,173 1,473 (5,128) 300,518 __________________________________________________________________________________________ Total debt securities 486,999 2,900 (5,392) 484,507 __________________________________________________________________________________________ Equity securities 9,393 3,515 (17) 12,891 __________________________________________________________________________________________ Total securities available for sale 496,392 $ 6,415 $ (5,409) $497,398 __________________________________________________________________________________________ Net unrealized gains on securities available for sale 1,006 __________________________________________________________________________________________ Total securities available for sale, net $497,398 __________________________________________________________________________________________ Trading securities $ 6,834 $ 6,616 __________________________________________________________________________________________ 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 __________________________________________________________________________________________ Trading securities $ 6,834 $ 6,819 __________________________________________________________________________________________ INVESTMENT SECURITIES (Continued) The amortized cost and estimated market value of debt securities by contractual maturity at June 30, 1996 and December 31, 1995 are as follows: June 30, 1996 ____________________________________________ Available for Sale Held to Maturity Amortized Market Amortized Market Maturing: Cost Value Cost Value (In thousands) Within 1 year $ 65,943 $ 66,324 $ -- $ -- After 1 year through 5 years 112,897 113,741 -- -- After 5 years through 10 years 3,986 3,924 118 118 After 10 years through 15 years -- -- 52 52 ________ _______ ________ _______ 182,826 183,989 170 170 Mortgage-backed securities 304,173 300,518 -- -- ________ _______ ________ _______ $486,999 $484,507 $ 170 $ 170 December 31, 1995 ____________________________________________ Available for Sale Held to Maturity Amortized Market Amortized Market Maturing: Cost Value Cost Value (In thousands) Within 1 year $ 83,942 $ 84,351 $ 225 $ 225 After 1 year through 5 years 136,834 140,792 -- -- After 5 years through 10 years 2,985 3,148 124 124 After 10 years through 15 years -- -- 53 53 ________ _______ ______ ______ 223,761 228,291 402 402 Mortgage-backed securities 211,523 216,520 -- -- ________ _______ ______ ______ $435,284 $444,811 $ 402 $ 402 Investment securities consisting of securities held to maturity, securities available for sale and trading securities increased $40.9 million from December 31, 1995 to $504.2 million at June 30, 1996. The increase was primarily in higher yielding 15 year mortgage-backed securities designated as available for sale. Rising interest rates during the first half of 1996 eroded the market value of the Company's debt securities. At June 30, 1996 the Company's portfolio of debt securities available for sale had net unrealized losses of $2.5 million compared to net unrealized gains of $9.5 million at December 31, 1995. LOANS The composition of the Bank's loan portfolio is summarized as follows: _______________________________________________________________________________________ At At (In thousands June 30, 1996 December 31, 1995 _______________________________________________________________________________________ Mortgage loans: Residential $223,755 $212,652 Commercial 6,484 6,975 Construction 1,204 1,516 _______________________________________________________________________________________ 231,443 221,143 Add: Premium on loans 356 388 Less: deferred mortgage loan origination fees (1,041) (928) _______________________________________________________________________________________ Total mortgage loans 230,758 220,603 Other loans: Consumer: Installment 1,890 1,988 Guaranteed education 9,953 10,420 Other secured 2,075 2,012 Home equity lines of credit 12,320 13,144 Unsecured 262 265 _______________________________________________________________________________________ Total consumer loans 26,500 27,829 Commercial 665 753 _______________________________________________________________________________________ Total other loans 27,165 28,582 _______________________________________________________________________________________ Total loans $257,923 $249,185 _______________________________________________________________________________________ The Bank's loan portfolio increased during the first six months of 1996 principally in the residential 1-4 family category as loan originations during this period exceeded loan amortization and payoffs. Loan originations in the first half of 1996 increased to $33.4 million from $9.4 million in the corresponding period of 1995. Lower residential mortgage loan rates in the first six months of 1996 when compared to the first six months of 1995 stimulated loan demand which resulted in loan growth for the Bank. NON-PERFORMING ASSETS June 30, December 31, June 30, (In thousands) 1996 1995 1995 ______________________________________________________________________________ Non-Performing Assets: Non-accrual loans $ 2,362 $ 2,428 $ 1,520 Real estate acquired through foreclosure 226 255 430 ______________________________________________________________________________ Total non-performing assets $ 2,588 $ 2,683 $ 1,950 ______________________________________________________________________________ Allowance for possible loan losses $ 2,420 $ 2,529 $ 2,568 Allowance as percent of non-accrual loans 102.5 % 104.2 % 169.0 % Non-accrual loans as percent of total loans 0.92% 0.97% 0.63% Non-performing assets as percent of total assets 0.29% 0.31% 0.23% ______________________________________________________________________________ The Bank 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 nonaccural 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 decreased slightly from December 31, 1995 to June 30, 1996 as noted in the table above. The principal balance of non-accrual loans was $2.4 million, or less than 1% of total loans and real estate acquired through foreclosure was $226 thousand at June 30, 1996. Real estate formally acquired in settlement of loans is recorded at the lower of the carrying value of the loan or the fair value of the property received, less estimated costs to sell the property following foreclosure. The Bank did not have any impaired loans as of June 30, 1996. ALLOWANCE FOR LOAN LOSSES An analysis of the activity in the allowance for possible loan losses is as follows: Six Months Ended June 30, 1996 1995 _______________________________________________________________________________ (In thousands) Balance at beginning of period $ 2,529 $ 2,566 Provision for loan losses 65 110 Recoveries of loans previously charged-off 5 42 Less: Charge-offs (179) (150) _________________________________________________________________________________ Balance at end of period $ 2,420 $ 2,568 _________________________________________________________________________________ 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 effect 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. At June 30, 1996 the balance of the allowance for possible loan losses was $2,420,000 representing 102.5% of total non-performing loans. Management believes that the allowance for possible loan losses is adequate to cover the risks inherent in the portfolio under current conditions. 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 increased by $24.7 million or 3.3% to $778.4 million at June 30, 1996 from $753.7 million at December 31, 1995. The composition of the Bank's total deposits at the dates shown are summarized as follows: June 30, December 31, 1996 1995 ______________________________________________________________________________ (In thousands) Demand and NOW $ 66,418 $ 66,413 Savings and money market accounts 358,585 356,598 Time certificates of deposit 354,699 332,057 Deposit acquisition premium, net of amortization (1,296) (1,411) ________________________________________________________________________________ Total deposits $778,406 $753,657 ________________________________________________________________________________ RESULTS OF OPERATIONS COMPARISON OF THREE AND SIX MONTHS ENDED JUNE 30, 1996 AND 1995 INTEREST AND DIVIDEND INCOME Interest and dividend income from loans and investments increased by $170,000 to $14,390,000 for the three months ended June 30, 1996 from $14,220,000 for the three months ended June 30, 1995. This increase is primarily attributable to a $23.7 million increase in the Company's average earning assets partially offset by a decrease in yield on average earning assets. The Company's average total earning assets increased to $843.3 million in the second quarter of 1996 from $819.6 million in the corresponding quarter of 1995. The yield on the Company's average earning assets for the second quarter of 1996 decreased 11 basis points to 6.84% from 6.95% for the same quarter in 1995. The decrease in the yield on average earning assets when compared to the second quarter of 1995 reflects the reinvestment of securities at lower yields, a decrease in yield on overnight federal funds sold and other similar short-term investments and the downward repricing of adjustable rate real estate loans, home equity lines of credit, and other loans. In addition, the Bank was originating new loans at rates lower than the prior year. Interest and dividend income from loans and investments increased to $28,514,000 for the six months ended June 30, 1996 from $28,068,000 for the six months ended June 30, 1995. This increase is attributable to an increase of $23.5 million in the Company's average earning assets partially offset by a decrease in yield on average earning assets. The Company's total average earning assets for the first half of 1996 were $841.7 million compared to $818.2 million for the same period a year ago. The yield on the Company's average earning assets for the first six months of 1996 decreased by 9 basis points to 6.79% from 6.88% for the same prior year period. Total investments contributed $493,000 in additional income, while interest on loans contributed $37,000 less income when comparing the six months ended June 30, 1996 to the six months ended June 30, 1995. INTEREST EXPENSE Total interest expense increased 6% to $8,139,000 for the three months ended June 30, 1996 from $7,680,000 for the comparable 1995 period. This increase is principally due to the Bank's deposit growth and an increase in its average cost of funds. The average deposit volume for the second quarter of 1996 increased by $18.6 million to $770.8 million from $752.2 million in the second quarter of 1995. The average cost of funds in the recent 1996 quarter was 4.25% compared to 4.10% for the second quarter of 1995. The increase of 15 basis points is due, in part, to a shift of deposits from lower fixed rate savings accounts to higher yielding variable rate savings accounts and time certificates of deposit. The Bank has maintained regular (fixed rate) savings account rates flat while selectively increasing longer term time certificate of deposit rates. In addition, the Bank introduced a new higher yielding variable rate savings account in June 1995. This strategy has negated the need for the Bank to raise its regular savings account rates, but has enticed some bank customers to transfer some of their deposits into the higher yielding accounts and thus contributing to the Bank's higher cost of funds. Total interest expense increased to $16,148,000 for the six months ended June 30, 1996 from $14,868,000 for the six months ended June 30, 1995. The increase in average deposits of $10.3 million from the prior year, and an increase of 27 basis points in the Company's average cost of funds from 3.98% in the first half of 1995 to 4.25% in the first half of 1996 increased interest expense on deposits by $1,280,000. The increase in the Bank's cost of funds is principally due to a shift of deposits from lower fixed rate savings accounts to higher yielding variable rate savings accounts and time certificates of deposit for the reasons previously noted. PROVISION FOR POSSIBLE LOAN LOSSES The provision for possible loan losses represents a charge against current earnings and an addition to the allowance for possible loan losses. The provision is based on management's assessment of many factors including the risk characteristics of the loan portfolio, underlying collateral, current and anticipated economic conditions that may effect the borrowers ability to pay, and trends in loan delinquencies and charge-offs. As a result of management's assessment and analysis, the Bank provided $35,000 and $65,000 for potential loan losses during the three months and six months ended June 30, 1996, a decrease from $40,000 and $110,000 for the same periods a year ago. Loan charge-off net of recoveries were $55,000 and $119,000 for the respective 1996 periods. 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 increased $115,000 or 18.9% to $724,000 in the second quarter of 1996 and increased $304,000 or 29.3% to $1,341,000 for the six months ended June 30, 1996 when compared to the comparable periods of 1995. The increase is due principally to net gains on securities of $211,000 and $418,000 recorded for the three and six months ended June 30, 1996, respectively, as compared to net securities gains of $35,000 and $39,000 recorded for the comparable 1995 periods. NON-INTEREST EXPENSE Non-interest expenses for the second quarter of 1996 decreased 14.8% to $3,030,000 from $3,557,000 for the second quarter of 1995. For the six months ended June 30, 1996, non-interest expenses decreased by $992,000 or 14.0% to $6,086,000 when compared to $7,078,000 for the six months ended June 30, 1995. Non-interest expenses for the 1996 periods have been 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 half of 1995 to an annual minimum premium of $2 thousand paid in the first half 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 $1,540,000 for the three months ended June 30, 1996 from $1,383,000 for the same period in 1995. For the six months ended June 30, 1996 the Company's provision for federal and state income taxes increased to $2,963,000 from $2,754,000 for the same period in 1995. The increase is due principally to higher income before taxes. The Company's combined effective income tax rate for the first half of 1996 is 39.2% as compared to 39.1% for the same period a year ago. 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 June 30, 1996 the Bank had $81.3 million or 9.2% of total assets and $183.0 million or 20.8% 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 June 30, 1996, the Bank had ratios of Tier 1 capital to total assets of 9.49% and qualifying capital to risk-weighted assets of 34.35%. The Company had ratios of Tier 1 capital to total assets of 9.59% and total qualifying capital to risk-weighted assets of 34.71% at June 30, 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 June 30, 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 At the Annual Meeting of Stockholders of MASSBANK Corp. on April 16, 1996, stockholders voted affirmatively on the following proposal: To elect each Class I Director to serve until the 1999 Annual Meeting of Stockholders and until their successors are chosen and qualified. Elected at Meeting Louise A. Hickey Stephen E. Marshall Arthur W. McPherson Donald B. Stackhouse 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 August 13, 1996 /s/Gerard H. Brandi ___________________________ (Signature) Gerard H. Brandi President and CEO Date August 13, 1996 /s/Reginald E. Cormier ___________________________ (Signature) Reginald E. Cormier V.P., Treasurer and CFO