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Exhibit 13
FINANCIAL HIGHLIGHTS
Massbank Corp. and Subsidiaries
Selected Consolidated Financial Data
(In thousands) At December 31, 2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
BALANCE SHEET DATA:
Total assets $1,008,983 $ 971,168 $ 938,702 $ 924,716 $ 946,625
Mortgage loans 302,788 296,469 272,951 288,580 283,654
Other loans 16,011 34,548 37,196 36,785 21,335
Allowance for loan losses 2,655 2,643 2,594 2,555 2,450
Investments(1) 669,875 618,545 607,096 578,543 624,082
Real estate acquired through foreclosure -- -- -- 62 86
Deposits 883,928 849,684 823,625 818,057 824,031
Stockholders' equity 117,285 114,904 108,243 101,479 110,489
---------- ---------- ---------- ---------- ----------
(In thousands) Years ended December 31, 2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
OPERATING DATA:
Interest and dividend income $ 47,103 $ 55,117 $ 60,280 $ 58,206 $ 59,834
Interest expense 22,701 32,391 35,397 33,204 34,320
---------- ---------- ---------- ---------- ----------
Net interest income 24,402 22,726 24,883 25,002 25,514
Provision for loan losses -- 40 60 140 193
Gains on securities, net 1,718 4,363 3,525 4,033 2,893
Other non-interest income 1,205 1,450 1,463 1,529 1,697
Non-interest expense 12,037 11,721 12,513 12,566 12,515
---------- ---------- ---------- ---------- ----------
Income before income taxes 15,288 16,778 17,298 17,858 17,396
Income tax expense 5,474 6,019 6,187 6,547 6,482
---------- ---------- ---------- ---------- ----------
Net income $ 9,814 $ 10,759 $ 11,111 $ 11,311 $ 10,914
========== ========== ========== ========== ==========
---------- ---------- ---------- ---------- ----------
Years ended December 31, 2002 2001 2000 1999 1998
---------- ---------- ---------- ---------- ----------
OTHER DATA:
Yield on average interest-earning assets 4.85% 5.88% 6.67% 6.32% 6.56%
Cost of average interest-bearing liabilities 2.61 3.87 4.32 4.02 4.23
---------- ---------- ---------- ---------- ----------
Interest rate spread 2.24 2.01 2.35 2.30 2.33
Net interest margin 2.52 2.43 2.76 2.72 2.81
Non-interest expense to average assets(4) 1.21 1.23 1.35 1.34 1.35
Efficiency ratio(2)(4) 43.9 40.9 41.7 40.9 41.4
Return on assets (net income/average assets) 0.99 1.13 1.20 1.20 1.17
Return on equity (net income/average
stockholders' equity) 8.39 9.53 10.93 10.66 10.05
Return on average realized equity(3) 8.92 10.25 10.95 11.35 11.08
Percent non-performing loans to total loans 0.13 0.19 0.18 0.24 0.33
Percent non-performing assets to total assets 0.04 0.07 0.06 0.09 0.12
Stockholders' equity to assets, at year-end 11.62 11.83 11.53 10.97 11.67
Book value per share, at year-end(5) $ 25.45 $ 24.34 $ 22.83 $ 20.43 $ 21.05
Earnings per share:(5)
Basic 2.09 2.30 2.30 2.23 2.06
Diluted 2.04 2.24 2.25 2.17 1.98
Cash dividends paid per share(5) 0.88 0.84 0.79 0.74 0.68
Dividend payout ratio 42% 37% 34% 33% 33%
(1) Consists of securities held to maturity and available for sale, trading
securities, short-term investments, term federal funds sold and
interest-bearing deposits in banks.
(2) Determined by dividing non-interest expense by fully taxable equivalent
net interest income plus non-interest income.
(3) Excludes average net unrealized gains or losses on securities available
for sale.
(4) Includes non-recurring non-interest expense of $363 thousand in 2000
related to the successful litigation to protect the Company's principal
trademark.
(5) All share information presented has been adjusted to reflect the 3-for-2
split of the Company's common stock effective April 19, 2002.
3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The following discussion should be read in conjunction with the consolidated
financial statements and related notes included in this report. Certain amounts
reported for prior years have been reclassified to conform to the 2002
presentation.
The financial condition and results of operations of MASSBANK Corp. (the
"Company") essentially reflect the operations of its subsidiary, MASSBANK (the
"Bank").
The Company's consolidated 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's earnings results are also affected by the provision for loan
losses; non-interest income, such as fee-based revenues and net securities gains
or losses; non-interest expense; and income taxes.
FORWARD-LOOKING STATEMENT DISCLOSURE
This annual report may contain forward-looking information, including
information concerning the Company's expectations of future business prospects.
These forward-looking statements are made pursuant to the safe harbor provision
of the Private Securities Litigation Reform Act of 1995. These forward-looking
statements involve known and unknown risks, uncertainties and other factors that
may cause the Company's actual results or performance to be materially different
from the results and performance expressed or implied by the forward-looking
statements. Forward-looking statements include, but are not limited to,
statements concerning the Company's belief, expectations or intentions
concerning the Company's future performance, the financial outlook of the
markets it serves and the performance and activities of its competitors. These
statements reflect the Company's current views, are based on numerous
assumptions and are subject to numerous risks and uncertainties, including
unexpected fluctuations in market interest rates, unexpected fluctuations in the
markets for equities, bonds, federal funds and other financial instruments, an
increase in the level of nonperforming assets, an increase in competitive
pricing pressures within the Company's market, adverse legislative or regulatory
developments, adverse impacts resulting from the continuing war on terrorism, an
increase in medical insurance and other employee-related costs, the impact of
inflation, and other factors described in the Company's annual report.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements have been prepared in accordance
with accounting principles generally accepted in the United States of America.
As such, the Company is required to make estimates and assumptions that affect
the reported amounts of assets and liabilities at the balance sheet dates and
the reported amounts of income and expense during the reporting periods. Actual
amounts could differ from such estimates.
The Company believes that the following accounting policies are among the
most critical because they involve significant judgments and uncertainties and
could potentially result in materially different results under different
assumptions and conditions.
PROVISION FOR LOAN LOSSES
The provision for loan losses represents a charge against current earnings and
an addition to the allowance for loan losses. In determining the amount to
provide for loan losses, the key factor is the adequacy of the allowance for
loan losses. Management uses a methodology to systematically measure the amount
of estimated loan loss exposure inherent in the portfolio for purposes of
establishing a sufficient allowance for loan losses. The methodology includes
three elements: an analysis of individual loans deemed to be impaired, general
loss allocations for various types of loans based on loss experience factors and
an unallocated allowance. The unallocated allowance is maintained based on
management's assessment of many factors including the risk characteristics of
the portfolio, concentrations of credit, current and anticipated economic
conditions that may affect borrowers' ability to pay, and trends in loan
delinquencies and charge-offs. Any significant change in these assumptions and
conditions could result in higher than estimated loan losses that could
adversely affect the Company's earnings results. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Bank's allowance for loan losses. Such agencies may require the Bank to
recognize additions to the allowance based on judgments different from those of
management. This could also adversely affect the Company's earnings results.
13
INVESTMENT SECURITIES OTHER THAN TEMPORARILY IMPAIRED
Management judgment is involved in the evaluation of declines in value of
individual investment securities held by the Company. Declines that are deemed
other than temporary are recognized in the income statement through write-downs
in the recorded value of the affected securities. Management considers many
factors in their analysis, such as the financial condition, earnings capacity
and near term prospects of the company in which MASSBANK has invested and the
length of time and extent to which market value has been less than cost.
Whenever a debt or equity security is deemed to be "other than temporarily
impaired" due to a fundamental deterioration in its financial condition as
determined by managements analysis, it is written down to its current fair
market value. If "due to general market conditions" an investment security
declines in price by a certain percentage from its cost for more than a
specified period of time, it is written down to its current fair market value.
Any unfavorable change in general market conditions could cause an increase in
the Company's impairment write downs of investment securities. This would have
an adverse effect on the Company's earnings results.
FINANCIAL CONDITION
The Company's total assets were $1.009 billion at December 31, 2002 compared to
$971.2 million at December 31, 2001, an increase of$37.8 million, or 3.9%. Asset
growth was primarily due to increases in securities and short-term investments
funded by a $34.2 million or 4.0% increase in deposits.
INVESTMENTS
At December 31, 2002, the Company's investment portfolio, consisting of
securities available for sale and trading, short-term investments and
interest-bearing bank deposits totaled $669.9 million or 66.4% of total assets,
an increase of $51.4 million or 8.3%, compared to $618.5 million representing
63.7% of total assets at December 31, 2001. The increase in investments was
essentially due to an increase in trading securities, consisting primarily of
U.S. Treasury obligations. While the investment securities available for sale
portfolio remained relatively flat, the mix shifted from a larger concentration
of mortgage-backed securities to U.S. Treasury and government agency
obligations, including callable government agency securities totaling $73.8
million as of year-end 2002. For further information concerning the composition,
maturity and market value of the Company's investment securities, see Notes 3
and 4 of Notes to Consolidated Financial Statements.
LOANS
The loan portfolio, net of allowance for loan losses, decreased $12.2 million or
3.7% year-over-year. At December 31, 2002, the loan portfolio, net of allowance
for loan losses, was $316.2 million representing 31.3% of total assets compared
to $328.4 million representing 33.8% of total assets at December 31, 2001. The
decrease in loans was primarily due to the repayment of a $15.0 million
commercial loan made to a single borrower which we chose not to renew due to the
low interest rate.
The majority of loans in the portfolio are residential mortgages.
Residential mortgage loans amounted to $300.5 million at December 31, 2002,
representing 94.2% of the loan portfolio. At year-end 2002, 89.5% and 10.5% of
the Company's residential mortgage loans were fixed rate and variable rate
loans, respectively. See Note 5 of Notes to Consolidated Financial Statements
for a table setting forth the composition of the loan portfolio at year-end 2002
and 2001.
The historically low interest rate environment in 2002 and 2001 resulted
in heavy mortgage refinancing activity for the bank. As a result, the Bank
originated over $100 million in loans for the second consecutive year. In 2002,
the Bank originated $104.6 million in loans compared to $103.2 million the prior
year. This heavy mortgage refinancing activity also resulted in significant loan
payoffs for the Bank. Consequently, the Bank was not able to grow the portfolio
in 2002
NON-PERFORMING ASSETS
Non-accrual loans, generally those loans that are 90 days or more delinquent,
declined to $420 thousand at December 31, 2002 from $644 thousand at December
31, 2001. This represents 0.13% of total loans at December 31, 2002.
There was no provision for loan losses in 2002 compared to a provision for
loan losses of $40 thousand in the prior year. The bank received net recoveries
of $12 thousand and $9 thousand, respectively, in 2002 and 2001.
The bank's allowance for loan losses at December 31, 2002 totaled
approximately $2.7 million representing 632% of non-accrual loans and .83% of
total loans. The bank believes that its allowance for loan losses is adequate to
cover the risks inherent in the loan portfolio under current conditions. The
bank has no real estate acquired through foreclosure at year-end 2002.
14
DEPOSITS
Deposits have historically been the Bank's primary source of funds for lending
and investment activities. MASSBANK attracts deposits within its primary market
area by offering a variety of deposit instruments including demand and NOW
accounts, money market accounts, different types of savings accounts,
certificates of deposit and retirement savings plans. Deposit flows vary
significantly and are influenced by prevailing interest rates, market
conditions, economic conditions and competition. The Bank's management attempts
to manage its deposits through selective pricing and marketing.
Total deposits increased $34.2 million or 4.0% to $883.9 million at
December 31, 2002, from $849.7 million at December 31, 2001. With the equity
markets in a third year of decline the Bank's regular savings, silver savings
and smart savings accounts provided a safe haven and a competitive rate. As a
result, savings deposits increased by $165.0 million or 43.0% from $383.9
million at December 31, 2001 to $548.9 million at December 31, 2002. Conversely,
certificates of deposit decreased by $134.0 million or 34.9% as many customers
shifted their deposits upon maturity from certificates of deposit to savings
accounts seeking liquidity and attractive rates in a declining interest rate
environment. Demand and NOW account deposits increased year-over-year by $3.2
million to $85.3 million. For information concerning deposit balances at
year-end 2002 and 2001, their average cost and the maturity distribution and
related rate structure of the Bank's time certificates of deposit, see Note 10
of Notes to Consolidated Financial Statements.
STOCKHOLDERS' EQUITY
Total stockholders' equity increased $2.4 million to $117.3 million at December
31, 2002, representing a book value per share of $25.45, from $114.9 million
representing a book value per share of $24.34 at December 31, 2001. This
represents an increase in book value per share of $1.11 or 4.6% year-over-year.
The change in stockholders' equity was essentially the result of the net
income for the year of $9.8 million, the increase in other comprehensive income
of $1.2 million and the payments and related tax benefits received from the
exercise of stock options by the Company's officers and directors of $2.3
million. This was partially offset by the repurchase of 243,448 shares of
treasury stock at a cost of $7.2 million and the payment of dividends to
stockholders of $4.1 million. Employee Stock Ownership Plan activity also
contributed $0.4 million to stockholders' equity during 2002.
RESULTS OF OPERATIONS
COMPARISON OF THE YEARS 2002 AND 2001
MASSBANK Corp. reported consolidated net income of $9.8 million or $2.04 in
diluted earnings per share in 2002 compared to net income of $10.8 million or
$2.24 in diluted earnings per share in 2001. Basic earnings per share for 2002
were $2.09 compared to $2.30 in the prior year. The net income for the year
ended December 31, 2002 represents a return on average assets of 0.99% and a
return on average realized equity of 8.92%, compared to 1.13% and 10.25%,
respectively, for the year ended December 31, 2001.
The Company's net income in 2002 compared to 2001 primarily reflects an
improvement of $1.7 million in net interest income after provision for loan
losses offset by a decline in securities gains of $2.6 million. Earnings results
for 2002 also reflect a decrease in other non-interest income of $245 thousand,
an increase in non-interest expense of $316 thousand and a reduction in income
tax expense of $545 thousand.
NET INTEREST INCOME
Net interest income on a fully taxable equivalent basis totaled $24.5 million in
2002 compared to $22.8 million in 2001. This increase was primarily attributable
to an improvement in net interest margin and asset growth. The Company's net
interest margin for the year ended December 31, 2002 increased to 2.52% from
2.43% in the prior year. Average earning assets increased $35.1 million or 3.7%
to $973.2 million in 2002, from $938.1 million in 2001.
The tables on pages 23 and 24 set forth, among other things, the extent to
which changes in interest rates and changes in the average balances of
interest-earning assets and interest-bearing liabilities have affected interest
income and expense during the years indicated. For each category of
interest-earning assets and interest-bearing liabilities, information is
provided on changes due to (1) changes in volume and (2) changes in interest
rates.
15
INTEREST AND DIVIDEND INCOME
Interest and dividend income on a fully taxable equivalent basis totaled $47.2
million for the year ended December 31, 2002, compared to $55.2 million for the
year ended December 31, 2001. The decrease in interest and dividend income was
the result of a decline in yield on average earning assets partially offset by
the increased interest income from higher average earning assets. The yield on
average earning assets dropped 103 basis points to 4.85% in 2002 from 5.88% the
prior year, due primarily to a decline in market interest rates in 2002. The
average total earning assets of the Company increased $35.1 million in 2002.
As shown in the rate/volume analysis table on page 24, the decline in
yield on average earning assets in 2002 resulted in decreased interest and
divided income of $8.4 million from 2001 levels. Conversely, the total effect of
higher average earning assets and a change in mix of the Company's average
earning assets on interest and dividend income in 2002 was a $0.4 million
increase from 2001. This resulted in a net decrease in interest and dividend
income of $8.0 million compared to the prior year.
INTEREST EXPENSE
Total interest expense decreased $9.7 million or 29.9% to $22.7 million for the
year ended December 31, 2002 from $32.4 million for the year ended December 31,
2001. The decrease in interest expense is due primarily to the lower interest
rate environment in 2002 and a shift in the deposit mix from certificate of
deposit accounts to savings accounts. This resulted in a decrease in the
Company's average cost of funds, from 3.87% in 2001 to 2.61% in 2002. The
decrease in the Company's average cost of funds was partially offset by an
increase in interest expense resulting from an increase in the Company's average
deposits. Average deposits in 2002 increased $34.1 million or 4.1% to $870.7
million, from $836.6 million in the prior year.
As shown in the rate/volume analysis table on page 24, the effect on total
interest expense from changes in interest-bearing deposit rates was a decrease
of $9.3 million from 2001 levels. Conversely, the total effect of higher average
deposits and change in deposit mix on interest expense in 2002 was a decrease of
$0.4 million from the prior year. This resulted in a net decrease in total
interest expense of $9.7 million compared to 2001.
PROVISION FOR LOAN LOSSES
The provision for loan losses represents a charge against current earnings and
an addition to the allowance for loan losses. There was no provision for loan
losses in 2002 compared to a provision for loan losses of $40 thousand in 2001.
In determining the amount to provide for loan losses, the key factor is the
adequacy of the allowance for loan losses. Management uses a methodology to
systematically measure the amount of estimated loan loss exposure inherent in
the portfolio for the purposes of establishing a sufficient allowance for loan
losses. The methodology includes three elements: an analysis of individual loans
deemed to be impaired in accordance with the terms of Statement of Financial
Accounting Standard ("SFAS") No. 114, "Accounting by Creditors for Impairment of
a Loan," general loss allocations for various loan types based on loss
experience factors, and an unallocated allowance which is maintained based on
management's assessment of many factors including the risk characteristics of
the portfolio, concentrations of credit, current and anticipated economic
conditions that may affect borrowers' ability to pay, and trends in loan
delinquencies and charge-offs. At December 31, 2002, the allowance for loan
losses was $ 2.7 million representing 632% of non-accrual loans. Non-accrual
loans totaled $420 thousand at December 31, 2002, down from $644 thousand a year
earlier. The bank recorded $12 thousand in net loan recoveries in 2002 compared
to $9 thousand in 2001.
NON-INTEREST INCOME
Non-interest income consists of gains or losses on securities, deposit account
service fees and other non-interest income.
Non-interest income for the year ended December 31, 2002 decreased $2.9
million or approximately 50% to $2.9 million, from $5.8 million for the year
ended December 31, 2001. The decrease is due primarily to a decrease in net
gains on securities available for sale and trading of approximately $2.7
million, from $4.4 million in 2001 to $1.7 million in 2002. Net securities gains
in 2002 were comprised of $1.2 million in net gains on equity securities and
$0.5 million in net gains on debt securities. This compares to net gains on
equity securities of $4.2 million and net gains on debt securities of $0.2
million in 2001. The decline in net gains on equity securities is primarily
attributable to the decline in equity securities prices in 2002. Management
believes that the equity markets will provide more moderate returns in the near
future. This is expected to result in lower realized equity securities gains or
losses in 2003.
Deposit account service fees and other non-interest income combined
declined $245 thousand to $1.2 million for the year ended December 31, 2002 from
$1.5 million the prior year.
16
NON-INTEREST EXPENSE
Non-interest expense totaled $12.0 million for the twelve months ended December
31, 2002 compared to $11.7 million for the prior year, an increase of $316
thousand or 2.7%. Salaries and employee benefits, the largest component of
non-interest expense, increased $575 thousand or 8.6% to $7.3 million in 2002
from $6.7 million in 2001. The increase in salaries and employee benefits is
primarily the result of increases in pension and health insurance costs as well
as general salary increases, partially offset by a reduction in bonus payments
awarded to employees in 2002. The expense for professional services increased
$100 thousand or 23.5% in 2002 due primarily to higher legal fees. The Company's
amortization of intangibles decreased $298 thousand in 2002 compared to the
prior year. This expense decreased for two reasons: 1) the deposit acquisition
premium that the Bank recorded in 1992 in connection with its acquisition of the
deposits and certain assets of the former Central Savings Bank of Lowell was
fully amortized as of February 2002, and 2) the Company no longer amortizes the
goodwill on its balance sheet but reviews it for impairment periodically in
accordance with Statement of Financial Accounting Standard No. 142, "Goodwill
and Other Intangible Assets." The Company's occupancy and equipment, data
processing, advertising and marketing, deposit insurance and other expenses
combined totaled $4.2 million in 2002 reflecting a decrease of $61 thousand
compared to the prior year.
INCOME TAX EXPENSE
The Company recorded income tax expense of $5.5 million in 2002, a decrease of
$545 thousand compared to the prior year. The decrease in income tax expense is
primarily due to lower income before taxes and a decline in the Company's
effective income tax rate. The Company's effective income tax rate for the year
ended December 31, 2002 was 35.81%, down from 35.87% for the year ended December
31, 2001.
RESULTS OF OPERATIONS
COMPARISON OF THE YEARS 2001 AND 2000
MASSBANK Corp. reported consolidated net income of $10.8 million or $2.24 in
diluted earnings per share in 2001 compared to net income of $11.1 million or
$2.25 in diluted earnings per share in 2000. Basic earnings per share for 2001
were $2.30 unchanged from the prior year. Return on average assets and return on
average realized equity were 1.13% and 10.25%, respectively, in 2001, compared
to 1.20% and 10.95%, respectively, in 2000.
The decrease in net income in 2001 reflects the continued pressure
throughout 2001 on the Company's net interest margin from declining interest
rates and the Federal Reserve Bank's multiple interest rate reductions during
the year. The Federal Open Market Committee of the Federal Reserve Bank lowered
the Federal Funds Rate eleven times in 2001, from 6.50% to 1.75%, bringing the
total decline in the targeted rate to 475 basis points for the year. Being
asset-sensitive in 2001, MASSBANK was particularly susceptible to the negative
effects of a falling interest rate environment. The Company's net interest
margin in 2001 dropped to 2.43% from 2.76% in 2000. This drop contributed to
lower than anticipated net interest income and reduced earnings per share for
the year, despite higher than expected securities gains, effective cost control
and loan growth of 6.7% year-over-year. However, the Company anticipates
sequential margin expansion in the coming year. The Company expects that due to
the current low interest rate environment in the overnight federal funds market,
it will invest a greater portion of its funds in higher yielding alternate
investments. Although these investments will necessarily bear greater interest
rate risk, the Company believes that the incurrence of this additional risk is
warranted by the higher margin opportunities available from alternative
investments.
Additionally, the Company's earnings per share performance in 2001 was
positively affected by the reduced number of average common shares outstanding
as a result of the Company's repurchase during 2001 of 90,300 shares of its
common stock pursuant to its stock repurchase program.
NET INTEREST INCOME
Net interest income on a fully taxable equivalent basis totaled $22.8 million in
2001 compared to $25.0 million in 2000. This decrease was primarily attributable
to a decrease in net interest margin, as noted above, partially offset by an
increase in average earning assets. Average earning assets increased $32.4
million to $938.1 million in 2001, from $905.7 million in 2000.
The tables on pages 23 and 24 set forth, among other things, the extent to
which changes in interest rates and changes in the average balances of
interest-earning assets and interest-bearing liabilities have affected interest
income and expense during the years indicated. For each category of
interest-earning assets and interest-bearing liabilities, information is
provided on changes due to (1) changes in volume (2) and changes in interest
rates.
17
INTEREST AND DIVIDEND INCOME
Interest and dividend income on a fully taxable equivalent basis totaled $55.2
million for the year ended December 31, 2001, compared to $60.4 million for the
year ended December 31, 2000. The yield on average earning assets dropped 79
basis points to 5.88% in 2001 from 6.67% the prior year. The average total
earning assets of the Company increased $32.4 million in 2001.
As shown in the rate/volume analysis table on page 24, the decline in
yield on average earning assets in 2001 resulted in decreased interest and
dividend income of $6.7 million from 2000 levels. Conversely, the total effect
of higher average earning assets on interest and dividend income in 2001 was a
$1.5 million increase from 2000, resulting in a net decrease in interest and
dividend income of $5.2 million from the prior year.
INTEREST EXPENSE
Total interest expense decreased $3.0 million or 8.5% to $32.4 million for the
year ended December 31, 2001 from $35.4 million for the year ended December 31,
2000. This decrease is due to a drop of 45 basis points in the Company's average
cost of funds, from 4.32% in 2000 to 3.87% in 2001, resulting primarily from a
falling interest rate environment in 2001. The Company's average deposits in
2001 increased $18.0 million to $836.6 million, from $818.6 million in the prior
year.
As shown in the rate/volume analysis table on page 24, the effect on total
interest expense from changes in interest-bearing deposit rates was a decrease
of $3.5 million from 2000 levels. Conversely, the total effect of higher average
deposits on interest expense in 2001 was an increase of $0.5 over the prior
year, resulting in a net decrease in total interest expense of $3.0 million from
2000.
PROVISION FOR LOAN LOSSES
The provision for loan losses represents a charge against current earnings and
an addition to the allowance for loan losses. The provision for loan losses in
2001 was $40 thousand compared to $60 thousand in 2000. In determining the
amount to provide for loan losses, the key factor is the adequacy of the
allowance for loan losses. Management uses a methodology to systematically
measure the amount of estimated loan loss exposure inherent in the portfolio for
purposes of establishing a sufficient allowance for loan losses. The methodology
includes three elements: an analysis of individual loans deemed to be impaired
in accordance with the terms of Statement of Financial Accounting Standard No.
114, "Accounting by Creditors for Impairment of a Loan," general loss
allocations for various loan types based on loss experience factors, and an
unallocated allowance which is maintained based on management's assessment of
many factors including the risk characteristics of the portfolio, concentrations
of credit, current and anticipated economic conditions that may affect
borrowers' ability to pay, and trends in loan delinquencies and charge-offs. At
December 31, 2001, the allowance for loan losses was $2.6 million representing
410% of non-accrual loans. Non-accrual loans totaled $644 thousand at December
31, 2001, up from $565 thousand a year earlier. The Bank received $9 thousand in
net loan recoveries in 2001 compared to $21 thousand in net charge-offs in 2000.
NON-INTEREST INCOME
Non-interest income consists of gains or losses on securities, deposit account
service fees and other non-interest income.
Non-interest income increased $0.8 million to $5.8 million for the year
ended December 31, 2001, from $5.0 million for the year ended December 31, 2000.
The increase is due primarily to an increase in securities gains from $3.5
million in 2000 to $4.4 million in 2001. While the Company's equity securities
portfolio has produced increased realized gains in recent years, management does
not expect this trend to continue. Management believes that the equity markets
will provide more moderate returns in the near future. This will result in lower
realized equity securities gains in 2002.
All other non-interest income combined declined modestly compared to the
prior year.
NON-INTEREST EXPENSE
Non-interest expense totaled $11.7 million in 2001, a decrease of $0.8 million
or 6.3% compared with $12.5 million in 2000. Most of this expense decline was
due to the net litigation expenses of $363 thousand that the Bank incurred in
2000 in connection with its successful litigation to protect its principal
trademark and a decrease in salaries and employee benefit expenses. Salaries and
employee benefits, the largest component of non-interest expense, decreased $277
thousand or 4.0% to $6.7 million in 2001 from $7.0 million in 2000. Part of this
improvement resulted from a decrease of $144 thousand in payments awarded to
employees under the Company's profit sharing and incentive compensation bonus
plans as a result of the Company not achieving its net income performance
objectives in 2001. Also contributing to the lower salaries and employee benefit
expenses was an increase of $137 thousand in loan origination related salary
expenses being deferred and amortized over the life of the loans. More loan
origination expenses were deferred in 2001 than the prior year because of a
significant increase in mortgage origination activity in 2001.
INCOME TAX EXPENSE
The Company recorded income tax expense of $6.0 million in 2001, a decrease of
$168 thousand when compared to the prior year. The decrease in income tax
expense is primarily due to lower pretax earnings. The Company's effective
income tax rate for the year ended December 31, 2001 was 35.87%, up slightly
from 35.77% in the prior year.
18
LIQUIDITY AND CAPITAL RESOURCES
The Bank must maintain a sufficient level of cash and assets which can readily
be converted into cash in order to meet cash outflows from normal depositor
requirements and loan demands. The Bank's primary sources of funds are deposits,
loan and mortgage-backed securities amortization and prepayments, sales, calls
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 and money market funds, which can be
immediately converted into cash, and United States Treasury and Government
agency securities, which can be sold or pledged to raise funds. At December 31,
2002, the Bank had $248.7 million or 24.6% of total assets and $213.3 million or
21.1% of total assets invested, respectively, in overnight federal funds sold
and money market funds, and United States obligations.
The Bank is a Federal Deposit Insurance Corporation insured institution
subject to the FDIC regulatory capital requirements. The FDIC regulations
require all FDIC insured institutions to maintain minimum levels of Tier I
capital. Highly rated banks (i.e., those with a composite rating of 1 under the
CAMELS rating system) are required to maintain a minimum leverage ratio of Tier
I capital to total average assets of at least 3.00% . An additional 100 to 200
basis points are required for all but these most highly rated institutions. The
Bank is also required to maintain a minimum level of risk-based capital. Under
the risk-based capital standards, FDIC insured institutions must maintain a Tier
I capital to risk-weighted assets ratio of 4.00% and are generally expected to
meet a minimum total qualifying capital to risk-weighted assets ratio of 8.00%.
The risk-based capital guidelines take into consideration risk factors, as
defined by the regulators, associated with various categories of assets, both on
and off the balance sheet. Under the guidelines, capital strength is measured in
two tiers which are used in conjunction with risk adjusted assets to determine
the risk-based capital ratios. Tier II capital components include supplemental
capital components such as qualifying allowance for loan losses, qualifying
subordinated debt and up to 45 percent of the pretax net unrealized holding
gains on certain available for sale equity securities. Tier I capital plus the
Tier II capital components are referred to as total qualifying capital.
The capital ratios of the Bank and the Company currently exceed the
minimum regulatory requirements. At December 31, 2002, the Bank had a leverage
Tier I capital to average assets ratio of 10.32%, a Tier I capital to
risk-weighted assets ratio of 30.76% and a total capital to risk-weighted assets
ratio of 31.57%. The Company, on a consolidated basis, had ratios of leverage
Tier I capital to average assets of 10.96%, Tier I capital to risk-weighted
assets of 32.47% and total capital to risk-weighted assets of 33.27% at December
31, 2002.
ASSET AND LIABILITY MANAGEMENT
The goal of asset/liability management is to ensure that liquidity, capital and
market risk are prudently managed. Asset/liability management is governed by
policies reviewed and approved annually by the Bank's Board of Directors (the
"Board"). The Board establishes policy limits for long-term interest rate risk
assumption and delegates responsibility for monitoring and measuring the
Company's exposure to interest rate risk to the Risk Management and
Asset/Liability Committee (the "Committee"). The Committee which is comprised of
members of the Company's Board of Directors, members of senior management and
the Bank's comptroller, generally meets three times a year to review the
economic environment and the volume, mix and maturity of the Company's assets
and liabilities.
19
INTEREST RATE RISK
The primary goal of interest-rate risk management is to control the Company's
exposure to interest rate risk both within limits approved by the Board and
within narrower guidelines approved by the Risk Management and Asset/Liability
Committee. These limits and guidelines reflect the Company's tolerance for
interest rate risk over both short-term and long-term time horizons. The Company
monitors its interest rate exposures using a variety of financial tools. It also
produces a GAP analysis quarterly, reflecting the known or assumed maturity,
repricing and other cash flow characteristics of the Company's interest-earning
assets and interest-bearing liabilities.
Interest rate risk materializes in two forms, market value risk and
reinvestment risk.
Financial instruments calling for future cash flows show market value
increases or decreases when rates change. Management monitors the potential
change in market value of the Company's debt securities assuming an immediate
(parallel) shift in interest rates of up to 200 basis points up or down. Results
are calculated using industry standard modeling analytics and securities data
from The Bloomberg. The Company uses the results to review the potential changes
in market value resulting from immediate rate shifts and to manage the effect of
market value changes on the Company's capital position.
Reinvestment risk occurs when an asset and the liability funding the asset
do not reprice and/or mature at the same time. The difference or mismatch with
respect to repricing frequency and/or maturity is a risk to net interest income.
Complicating management's efforts to control the Company's exposure to
interest rate risk is the fundamental uncertainty of the maturity, repricing
and/or runoff characteristics of a significant portion of the Company's assets
and liabilities. This uncertainty often reflects optional features embedded in
these financial instruments. The most important optional features are embedded
in the Company's deposits, loans, mortgage-backed securities and callable U.S.
Government agency securities.
For example, many of the Company's interest-bearing deposit products
(e.g., savings, money market deposit accounts and NOW accounts) have no
contractual maturity. Customers have the right to withdraw funds from these
deposit accounts freely. Deposit balances may therefore run off unexpectedly due
to changes in competitive or market conditions. In addition, when market
interest rates rise, customers with time certificates of deposit ("CDs") often
pay a penalty to redeem their CDs and reinvest at higher rates. Given the
uncertainties surrounding deposit runoff and repricing, the interest rate
sensitivity of the Company's liabilities cannot be determined precisely.
Similarly, customers have the right to prepay loans, particularly
residential mortgage loans, usually without penalty. As a result, the Company's
mortgage based assets (i.e., mortgage loans and mortgage-backed securities) are
subject to prepayment risk. This risk tends to increase when interest rates fall
due to the benefits of refinancing. Since the future prepayment behavior of the
Company's customers is uncertain, the interest rate sensitivity of mortgage
based assets cannot be determined exactly. Additionally, some of the Company's
callable U.S. Government agency securities may be called prior to maturity. As a
result, the interest rate sensitivity of these investment securities cannot be
determined precisely.
Management monitors and adjusts the difference between the Company's
interest-earning assets and interest-bearing liabilities repricing within
various time frames ("GAP position").
GAP analysis provides a static view of the maturity and repricing
characteristics of the Company's balance sheet positions. The interest rate GAP
is prepared by scheduling all interest-earning assets and interest-bearing
liabilities according to scheduled or anticipated repricing or maturity. The GAP
analysis identifies the difference between an institution's assets and
liabilities that will react to a change in market rates. GAP analysis theory
postulates that if the GAP is positive and rates increase, the institution's net
interest spread will increase as more assets than liabilities react to the rate
change. If the GAP is negative, more liabilities than assets will react to a
change in market rates. If rates rise, the institution's net interest spread
will fall as more liabilities react to market rates than assets.
In contrast, however, the Company's one-year GAP position while positive
as of year end 2002 has been negative in years past and its net interest spread
has moved in the same direction as the change in market rates rather than in the
opposite direction as GAP analysis theory postulates. One of the more
significant reasons for this is the fact that a GAP presentation does not
reflect the degrees to which interest earning assets and deposit costs respond
to changes in market interest rates. The rates on all financial instruments do
not always move by the same amount as the general change in market rates. In
addition, the Company has elected, in recent years, either not to reduce or
raise rates or to reduce or raise rates by a modest amount on its savings and
transaction-oriented accounts in response to a change in market rates. It should
be noted that for the above two reasons, among others, the Company's net
interest spread has moved in the same direction as market interest rates in the
past and may in the future.
20
INTEREST RATE RISK (continued)
The Company has historically managed its interest rate GAP primarily by
lengthening or shortening the maturity structure of its securities portfolio, by
continually modifying the composition of its securities portfolio and by
selectively pricing and marketing its various deposit products. In anticipation
of a rise in interest rates in the latter part of 2003 and the current level of
the Bank's savings deposits, the Company has shortened the maturity structure
and mix of its investments. As a result, the Company's one-year cumulative GAP
position is more asset sensitive at year-end 2002 than it was at year-end 2001.
The following table presents the amounts of interest-earning assets and
interest-bearing liabilities at December 31, 2002 that are assumed to mature or
reprice during the periods indicated. The table also summarizes the Company's
GAP position at December 31, 2002. As of this date, the Company's one-year
cumulative GAP position was positive $325.8 million, representing approximately
32.3% of total assets compared to 78.7 million or 8.1% of total assets at
December 31, 2001. The cumulative GAP-asset ratio measures the direction and
extent of imbalance between an institution's assets and liabilities repricing
through the end of a particular period.
INTEREST SENSITIVITY PERIODS
3 Months 3 to 6 6 Months 1 to 5 Over 5
(IN THOUSANDS) or Less Months to 1 Year Years Years Total
--------- --------- --------- --------- --------- ---------
Interest-earning assets:
Loans (3) $ 32,421 $ 17,002 $ 30,627 $ 160,406 $ 78,343 $ 318,799
Short-term investments:
Federal funds sold 221,586 -- -- -- -- 221,586
Investment in money market funds 27,077 -- -- -- -- 27,077
Interest-bearing deposits in banks 87 1,427 636 2,791 -- 4,941
Securities available for sale (3) 72,678 41,903 64,777 186,088 14,576 380,022
Trading securities 36,249 -- -- -- -- 36,249
--------- --------- --------- --------- --------- ---------
Total interest-earning assets $ 390,098 $ 60,332 $ 96,040 $ 349,285 $ 92,919 $ 988,674
--------- --------- --------- --------- --------- ---------
Interest-bearing liabilities:
Deposits(1)(2)(4) $ 139,576 $ 43,387 $ 37,740 $ 46,346 $ 590,232 $ 857,281
--------- --------- --------- --------- --------- ---------
Total interest-bearing liabilities $ 139,576 $ 43,387 $ 37,740 $ 46,346 $ 590,232 $ 857,281
--------- --------- --------- --------- --------- ---------
GAP for period $ 250,522 $ 16,945 $ 58,300 $ 302,939 $(497,313) $ 131,393
Cumulative GAP--December 3l, 2002 $ 250,522 $ 267,467 $ 325,767 $ 628,706 $ 131,393
Cumulative GAP as a percent of total assets 24.8% 26.5% 32.3% 62.3% 13.0%
--------- --------- --------- --------- --------- ---------
Cumulative GAP--December 3l,2001 $ 127,936 $ 90,899 $ 78,680 $ 418,745 $ 127,142
========= ========= ========= ========= ========= =========
(1) Excludes non-interest bearing demand accounts of $28,034.
(2) Includes escrow deposits of borrowers of $1,387
(3) Loans and mortgage-backed securities reflect regular amortization of
principal and prepayment estimates. Callable U.S., Government agency
securities of $73,794 thousand are shown in the respective periods
assuming that the securities are redeemed at the initial call date.
(4) Savings and NOW accounts have been assumed to decay at a nominal rate
of $800 thousand per year in this historically low interest rate
environment.
21
INTEREST RATE RISK (continued)
The following table shows the Company's financial instruments that are sensitive
to changes in interest rates, categorized by initial call date or expected
maturity, and the instruments' fair values as of December 31, 2002.
EXPECTED MATURITY DATE
AT DECEMBER 31, 2002
Fair Value
(IN THOUSANDS) 2003 2004 2005 2006 2007 Thereafter Total at 12/31/02
-------- -------- -------- -------- -------- -------- -------- --------
Interest sensitive assets:
Fixed rate securities $165,017 $103,549 $ 40,540 $ 21,342 $ 20,657 $ 14,576 $365,681 $365,681
Average interest rate(1) 2.18% 2.06% 2.65% 2.77% 2.77% 2.99% 2.30%
Variable rate securities(2) 50,082 -- -- -- -- 508 50,590 50,590
Average interest rate(1) 2.14% -- -- -- -- 3.68% 2.16%
Fixed rate loans 54,216 44,431 37,628 30,085 25,809 78,348 270,517 276,180
Average interest rate 6.39% 6.39% 6.40% 6.42% 6.53% 6.40% 6.41%
Variable rate loans 3,954 3,348 2,489 2,201 1,822 34,468 48,282 49,118
Average interest rate 8.26% 8.29% 8.57% 8.04% 7.129% 6.01% 6.62%
Other fixed rate assets(4) 2,063 1,777 1,014 -- -- -- 4,854 4,854
Average interest rate 3.15% 3.41% 3.49% -- -- -- 3.31%
Other variable rate assets(3) 248,750 -- -- -- -- -- 248,750 248,750
Average interest rate 1.19% -- -- -- -- -- 1.19%
-------- -------- -------- -------- -------- -------- -------- --------
Total interest sensitive assets $524,082 $153,105 $ 81,671 $ 53,628 $ 48,288 $127,900 $988,674 $995,173
======== ======== ======== ======== ======== ======== ======== ========
Interest sensitive liabilities:
Savings and money market
deposit accounts $ 2,169 $ 2,033 $ 1,911 $ 1,801 $ 1,735 $539,298 $548,947 $548,947
Average interest rate 1.47% 1.50% 1.54% 1.57% 1.59% 2.26% 2.25%
Fixed rate certificates of deposit 125,564 31,745 9,616 917 868 1,817 170,527 172,385
Average interest rate 2.60% 2.95% 3.39% 4.18% 4.24% 4.33% 2.75%
Variable rate certificates of deposit 33,901 17,175 14,316 13,719 16 -- 79,127 79,127
Average interest rate 2.34% 1.87% 2.01% 2.02% 2.02% -- 2.12%
NOW accounts -- -- -- -- -- 57,293 57,293 57,293
Average interest rate -- -- -- -- -- 0.65% 0.65%
Escrow deposits of borrowers 1,387 -- -- -- -- -- 1 ,387 1,387
Average interest rate 0.25% -- -- -- -- -- 0.25%
======== ======== ======== ======== ======== ======== ======== ========
Total interest sensitive liabilities $163,021 $ 50,953 $ 25,843 $ 16,437 $ 2,619 $598,048 $857,281 $859,139
======== ======== ======== ======== ======== ======== ======== ========
(1) Securities rates presented are on a tax equivalent basis.
(2) Includes equity securities.
(3) Consists of overnight Federal funds sold, money market funds and
interest-bearing deposits in banks.
(4) Consists of interest-bearing deposits in banks.
The Company uses certain assumptions to estimate fair values and expected
maturities. For interest-sensitive assets, except callable government agency
securities, expected maturities are based upon contractual maturity, and
projected repayments and prepayments of principal. For callable government
agency securities expected maturities are based upon the initial call dates. For
interest-sensitive deposit liabilities, maturities are based on contractual
maturity and estimated deposit runoff based on the Bank's own historical
experience. The actual maturity of the Company's financial instruments could
vary significantly from what has been presented in the above table if actual
experience differs from the assumptions used.
OTHER MARKET RISKS
The Company's investment securities portfolio includes equity securities with a
market value of approximately $13.8 million at December 31, 2002. The net
unrealized losses on these securities totaled $1.7 million at year-end 2002.
Movements in equity prices may effect the amount of securities gains or losses
which the Company realizes from the sale of these securities and thus may have
an impact on earnings.
22
AVERAGE BALANCE SHEETS
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2002 2001 2000
- -------------------------------------------------------------- -------------------------------- -------------------------------
Interest Average Interest Average Interest Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense(1) Rate Balance Expense(1) Rate Balance Expense(1) Rate
--------- --------- ---- --------- --------- ---- --------- --------- ----
Assets:
Earning assets:
Federal funds sold $ 183,968 $ 2,974 1.62% $ 196,041 $ 7,444 3.80% $ 135,728 $ 8,595 6.33%
Short-term investments(4) 31,063 671 2.16 30,215 1,217 4.03 7,646 441 5.77
Investment securities(2) 158,978 5,815 3.66 106,478 5,596 5.26 166,264 9,332 5.61
Mortgage-backed
securities(2) 233,627 14,863 6.36 284,932 18,847 6.61 273,464 19,015 6.95
Trading securities 31,814 685 2.15 2,984 158 5.29 5,020 310 6.18
Mortgage loans(3) 308,710 20,819 6.74 281,492 19,631 6.97 280,732 19,670 7.01
Other 1oans(3) 25,022 1,362 5.44 35,964 2,315 6.44 36,838 3,035 8.24
--------- --------- --------- --------- --------- ---------
Total earning assets 973,182 47,189 4.85% 938,106 55,208 5.88% 905,692 60,398 6.67%
========= ========= ==== ========= ========= ==== ========= ========= ====
Allowance for loan losses (2,644) (2,612) (2,571)
--------- --------- ---------
Total earning assets
less
allowance for
loan losses 970,538 935,494 903,121
Other assets 22,410 20,518 20,450
--------- --------- ---------
Total assets $ 992,948 $ 956,012 $ 923,571
========= ========= =========
Liabilities:
Deposits:
Demand and NOW $ 82,964 366 0.44% $ 80,848 461 0.57% $ 75,956 488 0.64%
Savings 471,734 12,161 2.58 353,622 11,495 3.25 343,079 11,711 3.41
Time certificates of
deposit 315,987 10,174 3.22 402,155 20,435 5.08 399,554 23,198 5.81
--------- --------- --------- --------- --------- ---------
Total deposits 870,685 22,701 2.61% 836,625 32,391 3.87% 818,589 35,397 4.32%
--------- --------- ---- --------- --------- ---- --------- --------- ----
Other liabilities 5,225 6,545 3,310
--------- --------- ---------
Total liabilities 875,910 843,170 821,899
========= ========= =========
Stockholders' Equity: 117,038 112,842 101,672
Total liabilities and
stockholders' equity $ 992,948 $ 956,012 $ 923,571
========= ========= =========
Net interest income (tax
equivalent basis) 24,488 22,817 25,001
Less adjustment of
tax-exempt interest
income 86 91 118
--------- ----------- -----------
Net interest income $ 24,402 $ 22,726 $ 24,883
--------- ----------- -----------
Interest rate spread(5) 2.24% 2.01% 2.35%
---- ---- ----
Net interest margin(6) 2.52% 2.43% 2.76%
==== ==== ====
(1) Income on equity securities and municipal bonds is included on a tax
equivalent basis.
(2) Averages balances include net unrealized gains on securities available for
sale.
(3) Loans on non-accrual status are included in average balances.
(4) Short-term investments consist of interest-bearing deposits in banks and
investments in money market funds.
(5) Interest rate spread represents the difference between the yield on
earning assets and the cost of the Company's deposits.
(6) Net interest margin represents net interest income (tax equivalent basis)
divided by average interest earning assets.
23
RATE/VOLUME ANALYSIS
The following table presents, for the years indicated, the changes in interest
and dividend income and the changes in interest expense attributable to changes
in interest rates and changes in the volume of earning assets and
interest-bearing liabilities. A change attributable to both volume and rate has
been allocated proportionately to the change due to volume and the change due to
rate.
2002 COMPARED TO 2001 2001 COMPARED TO 2000
(IN THOUSANDS) INCREASE (DECREASE) INCREASE (DECREASE)
YEARS ENDED DECEMBER 31, DUE TO DUE TO
------------------------------------ ------------------------------------
Volume Rate Total Volume Rate Total
-------- -------- -------- -------- -------- --------
Interest and dividend income:
Federal funds sold $ (433) $ (4,037) $ (4,470) $ 3,015 $ (4,166) $ (1,151)
Short-term investments 33 (579) (546) 945 (169) 776
Investment securities 2,205 (1,981) 224 (3,126) (583) (3,709)
Mortgage-backed securities (3,287) (697) (3,984) 779 (947) (168)
Trading securities 673 (146) 527 (112) (40) (152)
Mortgage loans 1,851 (663) 1,188 53 (92) (39)
Other loans (632) (321) (953) (70) (650) (720)
-------- -------- -------- -------- -------- --------
Total interest and dividend income 410 (8,424) (8,014) 1,484 (6,647) (5,163)
-------- -------- -------- -------- -------- --------
Interest expense:
Deposits:
Demand and NOW 12 (107) (95) 30 (57) (27)
Savings 3,349 (2,683) 666 353 (569) (216)
Time certificates of deposit (3,787) (6,474) (10,261) 150 (2,913) (2,763)
-------- -------- -------- -------- -------- --------
Total interest expense (426) (9,264) (9,690) 533 (3,539) (3,006)
-------- -------- -------- -------- -------- --------
Net interest income $ 836 $ 840 $ 1,676 $ 951 $ (3,108) $ (2,157)
======== ======== ======== ======== ======== ========
IMPACT OF INFLATION AND CHANGING PRICES
MASSBANK Corp.'s financial statements presented herein have been prepared in
accordance with accounting principles generally accepted in the United States of
America 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.
RECENT ACCOUNTING PRONOUNCEMENTS
GOODWILL AND OTHER INTANGIBLE ASSETS
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standard ("SFAS") No. 142, "Goodwill and Other
Intangible Assets:" SFAS 142 requires that upon adoption of the Statement, any
goodwill recorded on an entity's balance sheet would no longer be amortized.
This would include existing goodwill (i.e., recorded goodwill at the date the
financial statement is issued), as well as goodwill arising subsequent to the
effective date of the Statement. Goodwill will not be amortized but will be
reviewed for impairment periodically or upon the occurrence of certain
triggering events. This Statement is effective for fiscal years beginning after
December 15, 2001. The Company adopted the new standard on January 1, 2002. At
December 31, 2002, the Company had $1,090,000 of goodwill on its balance sheet.
In 2001, the Company's goodwill was being amortized at a rate of $99,000
annually.
ACCOUNTING FOR STOCK-BASED COMPENSATION -- TRANSITION AND DISCLOSURE
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure," an amendment of FASB Statement No.
123. This Statement amends FASB Statement No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for a voluntary
change to the fair value method of accounting for stock-based employee
compensation. In addition, this Statement amends the disclosure requirements of
Statement No. 123 to require prominent disclosures in both annual and interim
financial statements. Certain of the disclosure modifications are required for
fiscal years ending after December 15, 2002 and are included in the notes to
these consolidated financial statements.
24
INDEPENDENT AUDITORS' REPORT
[LOGO OF KPMG]
The Board of Directors and Stockholders
MASSBANK Corp.:
We have audited the accompanying consolidated balance sheets of MASSBANK
Corp. and subsidiaries as of December 31, 2002 and 2001, and the related
consolidated statements of income, changes in stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 2002.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of MASSBANK
Corp. and subsidiaries as of December 31, 2002 and 2001, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 2002, in conformity with accounting principles
generally accepted in the United States of America.
Boston, Massachusetts
January 9, 2003
25
MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE DATA) AT DECEMBER 31, 2002 2001
----------- -----------
Assets:
Cash and due from banks $ 8,356 $ 8,945
Short-term investments (Note 2) 248,663 236,382
----------- -----------
Total cash and cash equivalents 257,019 245,327
----------- -----------
Interest-bearing deposits in banks 4,941 6,490
Securities available for sale, at market value
(amortized cost of $367,650 in 2002 and $362,076 in 2001) (Note 3) 380,022 372,584
Trading securities, at market value (Note 4) 36,249 3,089
Loans (Notes 5, 7 and 11):
Mortgage loans 302,788 296,469
Other loans 16,011 34,548
----------- -----------
Total loans 318,799 331,017
Allowance for loan losses (Note 6) (2,655) (2,643)
----------- -----------
Net loans 316,144 328,374
----------- -----------
Premises and equipment (Note 9) 6,795 6,927
Accrued interest receivable 3,926 3,950
Goodwill (Note 1) 1,090 1,090
Current income tax asset, net 199 208
Other assets 2,598 3,129
----------- -----------
Total assets $ 1,008,983 $ 971,168
=========== ===========
Liabilities and Stockholders' Equity:
Deposits (Notes 10 and 11):
Demand and NOW $ 85,327 $ 82,143
Savings 548,947 383,960
Time certificates of deposit 249,654 383,610
Deposit acquisition premium, net of amortization -- (29)
----------- -----------
Total deposits 883,928 849,684
Escrow deposits of borrowers 1,387 1,403
Employee stock ownership plan liability (Note 15) -- 156
Deferred income taxes (Note 12) 2,671 2,275
Other liabilities 3,712 2,746
----------- -----------
Total liabilities 891,698 856,264
----------- -----------
Commitments and contingent liabilities (Notes 8 and 9) -- --
Stockholders' equity (Notes 12, 14, 15 and 16):
Preferred stock, par value $1.00 per share; 2,000,000 shares authorized,
none issued -- --
Common stock, par value $1.00 per share; 10,000,000 shares
authorized, 7,610,195 and 7,494,980 shares issued, respectively 7,610 7,495
Additional paid-in capital 53,297 62,875
95,243 99,996
----------- -----------
Retained earnings 156,150 170,366
Treasury stock at cost, 3,026,129 and 4,362,289 shares, respectively (46,557) (61,749)
Accumulated other comprehensive income (Note 1) 7,692 6,443
Common stock acquired by ESOP (Note 15) -- (156)
----------- -----------
Total stockholders' equity 117,285 114,904
----------- -----------
Total liabilities and stockholders' equity $ 1,008,983 $ 971,168
=========== ===========
See accompanying notes to consolidated financial statements.
26
MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS EXCEPT SHARE DATA) YEARS ENDED DECEMBER 31, 2002 2001 2000
---------- ---------- ----------
Interest and dividend income:
Mortgage loans $ 20,819 $ 19,631 $ 19,670
Other loans 1,362 2,315 3,035
Securities available for sale:
Mortgage-backed securities 14,863 18,847 19,015
Other securities 5,729 5,502 9,203
Trading securities 685 158 310
Federal funds sold 2,974 7,444 8,595
Other investments 671 1,220 452
---------- ---------- ----------
Total interest and dividend income 47,103 55,117 60,280
---------- ---------- ----------
Interest expense:
Deposits:
NOW 366 461 488
Savings 12,161 11,495 11,711
Time certificates of deposit 10,174 20,435 23,198
---------- ---------- ----------
Total interest expense 22,70 1 32,391 35,397
---------- ---------- ----------
Net interest income 24,402 22,726 24,883
Provision for loan losses (Note 6) -- 40 60
---------- ---------- ----------
Net interest income after provision for loan losses 24,402 22,686 24,823
---------- ---------- ----------
Non-interest income:
Deposit account service fees 567 638 688
Gains on securities available for sale, net 1,566 4,263 3,049
Gains on trading securities, net 152 100 476
Other 638 812 775
---------- ---------- ----------
Total non-interest income 2,923 5,813 4,988
---------- ---------- ----------
Non-interest expense:
Salaries and employee benefits 7,298 6,723 7,000
Occupancy and equipment 1,998 2,056 2,079
Data processing 528 494 473
Professional services 526 426 959
Advertising and marketing 168 192 198
Amortization of intangibles 29 327 330
Deposit insurance 182 173 185
Other 1,308 1,330 1,289
---------- ---------- ----------
Total non-interest expense 12,037 11,721 12,513
---------- ---------- ----------
Income before income taxes 15,288 16,778 17,298
Income tax expense (Note 12) 5,474 6,019 6,187
---------- ---------- ----------
Net income $ 9,814 $ 10,759 $ 11,111
========== ========== ==========
Weighted average common shares outstanding:
Basic 4,697,826 4,685,873 4,830,585
Diluted 4,822,501 4,809,665 4,940,952
Earnings per share (in dollars):
Basic $ 2.09 $ 2.30 $ 2.30
Diluted 2.04 2.24 2.25
---------- ---------- ----------
See accompanying notes to consolidated financial statements.
27
MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2002 2001 2000
--------- --------- ---------
Cash flows from operating activities:
Net income $ 9,814 $ 10,759 $ 11,111
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization 658 892 866
Loan interest capitalized (33) (37) (46)
Tax benefit resulting from stock options exercised 590 238 250
Amortization of ESOP shares committed to be released 202 151 93
Tax benefit resulting from dividends paid on unallocated shares
held by the ESOP 4 7 10
Decrease (increase) in accrued interest receivable 24 1,805 (710)
Increase (decrease) in other liabilities 966 29 (319)
Decrease in current income tax asset, net 9 76 8
Amortization of premiums (accretion of discounts)
on securities, net 450 (643) (847)
Net trading securities activity (33,008) 17,389 (13,228)
Valuation writedowns of equity securities available for sale 67 -- --
Gains on securities available for sale (1,633) (4,263) (3,049)
Gains on trading securities (152) (100) (476)
Decrease in deferred mortgage loan origination fees,
net of amortization (344) (44) (167)
Deferred income tax benefit (219) (195) (103)
Decrease (increase) in other assets (42) 1,035 (1,213)
Provision for loan losses -- 40 60
Gains on sales of real estate acquired through foreclosure -- -- (8)
Gains on sales of premises and equipment -- (4) --
Increase (decrease) in escrow deposits of borrowers (16) 16 (90)
--------- --------- ---------
Net cash (used in) provided by operating activities (22,663) 27,151 (7,858)
--------- --------- ---------
Cash flows from investing activities:
Purchases of term federal funds -- (10,000) (50,000)
Proceeds from maturities of term federal funds -- 40,000 20,000
Net (increase) decrease in interest-bearing bank deposits 1,549 (4,812) 2,163
Proceeds from sales of investment securities available for sale 50,158 32,819 55,063
Proceeds from maturities and redemption of investment securities
held to maturity and available for sale 76,500 87,230 56,000
Purchases of investment securities available for sale (209,923) (72,548) (89,621)
Purchases of mortgage-backed securities (19,977) (54,143) (43,750)
Principal repayments of mortgage-backed securities 99,266 81,231 47,002
Principal repayments of securities available for sale 90 4 4
Loans originated (104,631) (103,246) (32,989)
Loan principal payments received 117,207 82,412 48,346
Purchases of premises and equipment (465) (3,507) (288)
Proceeds from sale of premises and equipment -- 4 --
Proceeds from sale of real estate acquired through foreclosure -- -- 70
--------- --------- ---------
Net cash provided by investing activities 9,774 75,444 12,000
--------- --------- ---------
(Continued)
28
MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2002 2001 2000
--------- --------- ---------
Cash flows from financing activities:
Net increase in deposits 34,215 25,832 5,337
Payments to acquire treasury stock (7,285) (2,045) (5,814)
Purchase of company stock for deferred compensation plan 55 56 366
Issuance of common stock under stock option plan 1,735 803 415
Cash dividends paid on common stock (4,139) (3,935) (3,829)
--------- --------- ---------
Net cash provided by (used in) financing activities 24,581 20,711 (3,525)
--------- --------- ---------
Net increase in cash and cash equivalents 11,692 123,306 617
Cash and cash equivalents at beginning of year 245,327 122,021 121,404
--------- --------- ---------
Cash and cash equivalents at end of year $ 257,019 $ 245,327 $ 122,021
--------- --------- ---------
Supplemental cash flow disclosures:
Cash transactions:
Cash paid during the year for interest 522,765 $ 35,484 $ 35,382
Cash paid during the year for taxes, net of refunds 5,080 5,898 6,022
--------- --------- ---------
See accompanying notes to consolidated financial statements.
29
MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(IN THOUSANDS EXCEPT SHARE DATA) YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Accumulated Common
Additional other stock
Common paid-in Retained Treasury comprehensive acquired
stock capital earnings stock income by ESOP Total
------ ---------- -------- -------- ------------- -------- ---------
Balance at December 31, 1999 $7,407 $ 60,591 $ 85,873 $(53,890) $1,966 $(468) $ 101,479
Net Income -- -- 11,111 -- -- -- 11,111
Other comprehensive income, net of tax:
Unrealized gains on securities, net of
reclassification adjustment (Note 1) -- -- -- -- 4,006 -- 4,006
Comprehensive income -- -- -- -- -- -- 15,117
Cash dividends paid ($0.79 per share) -- -- (3,829) -- -- -- (3,829)
Tax benefit resulting from dividends paid
on unallocated shares held by the ESOP -- -- 10 -- -- -- 10
Net decrease in liability to ESOP -- -- -- -- -- 156 156
Amortization of ESOP shares
committed to be released -- 93 -- -- -- -- 93
Purchase of treasury stock -- -- -- (5,448) -- -- (5,448)
Purchase of company stock for
deferred compensation plan -- 366 -- (366) -- -- --
Exercise of stock options and
related tax benefits 41 624 -- -- -- -- 665
------ -------- -------- -------- ------ ----- ---------
Balance at December 3l, 2000 7,448 61,674 93,165 (59,704) 5,972 (312) 108,243
Net Income -- -- 10,759 -- -- -- 10,759
Other comprehensive income, net of tax:
Unrealized gains on securities, net of
reclassification adjustment (Note 1) -- -- -- -- 471 -- 471
Comprehensive income -- -- -- -- -- -- 11,230
Cash dividends paid ($0.84 per share) -- -- (3,935) -- -- -- (3,935)
Tax benefit resulting from dividends paid
on unallocated shares held by the ESOP -- -- 7 -- -- -- 7
Net decrease in liability to ESOP -- -- -- -- -- 156 156
Amortization of ESOP shares
committed to be released -- 151 -- -- -- -- 151
Purchase of treasury stock -- -- -- (1,989) -- -- (1,989)
Purchase of company stock for
deferred compensation plan -- 56 -- (56) -- -- --
Exercise of stock options and
related tax benefits 47 994 -- -- -- -- 1,041
------ -------- -------- -------- ------ ----- ---------
Balance at December 31, 2001 7,495 62,875 99,996 (61,749) 6,443 (156) 114,904
Net Income -- -- 9,814 -- -- -- 9,814
Other comprehensive income, net of tax:
Unrealized gains on securities, net of
reclassification adjustment (Note 1) -- -- -- -- 1,249 -- 1,249
Comprehensive income -- -- -- -- -- -- 11,063
Cash dividends paid ($0.88 per share) -- -- (4,139) -- -- -- (4,139)
Tax benefit resulting from dividends paid
on unallocated shares held by the ESOP -- -- 4 -- -- -- 4
Net decrease in liability to ESOP -- -- -- -- -- 156 156
Amortization of ESOP shares
committed to be released -- 202 -- -- -- -- 202
Purchase of treasury stock -- -- -- (7,230) -- -- (7,230)
Purchase of company stock for
deferred compensation plan -- 55 -- (55) -- -- --
Exercise of stock options and
related tax benefits 115 2,210 -- -- -- -- 2,325
Transfer resulting from
three-for-two stock split -- (12,045) (10,432) 22,477 -- -- --
------ -------- -------- -------- ------ ----- ---------
BALANCE AT DECEMBER 3l, 2002 $7,610 $ 53,297 $ 95,243 $(46,557) $7,692 $ -- $ 117,285
====== ======== ======== ======== ====== ===== =========
See accompanying notes to consolidated financial statements.
30
MASSBANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
MASSBANK Corp. (the "Company") is a Delaware chartered holding company
whose principal subsidiary is MASSBANK (the "Bank"). The Bank operates
fifteen full service banking offices in Reading, Melrose, Stoneham,
Wilmington, Medford, Chelmsford, Tewksbury, Westford, Dracut, Lowell and
Everett, Massachusetts providing a variety of deposit, lending and trust
services. As a Massachusetts chartered savings bank whose deposits are
insured by the Federal Deposit Insurance Corporation ("FDIC") and the
Depositor Insurance Fund ("DIF"), the activities of the Bank are subject
to regulation, supervision and examination by federal and state regulatory
authorities, including, but not limited to the FDIC, the Massachusetts
Commissioner of Banks and the DIF. In addition, as a bank holding company,
the Company is subject to supervision, examination and regulation by the
Board of Governors of the Federal Reserve System.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary MASSBANK and its subsidiaries: Readibank
Properties, Inc., Readibank Investment Corporation and Melbank Investment
Corporation.
The Company has one reportable operating segment. All significant
intercompany balances and transactions have been eliminated in
consolidation. The accounting and reporting policies of the Company
conform to accounting principles generally accepted in the United Stares
of America and to general practices within the banking industry. In
preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the reported amounts of assets
and liabilities at the balance sheet date and income and expenses for the
period. Material estimates that are particularly susceptible to change in
the near term relate to the determination of the allowance for loan losses
and other than temporary declines in value of investment securities
requiring impairment write downs due to general market conditions or other
factors.
Certain amounts in the prior years' consolidated financial
statements were reclassified to facilitate comparison with the current
fiscal year.
INVESTMENTS IN DEBT AND EQUITY SECURITIES
Under its investment policy, management determines the appropriate
classification of securities at the time of purchase. Those debt securities that
the Company has the intent and the ability to hold to maturity are classified as
securities held to maturity and are carried at amortized historical cost. Those
securities held for indefinite periods of time and not intended to be held to
maturity are classified as available for sale. Securities held for indefinite
periods of time include securities that management intends to use as part of its
asset/liability management strategy and that may be sold in response to changes
in market conditions, interest rates, changes in prepayment risk, the need to
increase regulatory capital and other factors The Company records investment
securities available for sale at aggregate market value with the net unrealized
holding gains or losses reported, net of tax effect, as a separate component of
stockholders' equity until realized. As of December 31, 2002, stockholders'
equity included approximately $77 million, representing the net unrealized gains
on securities available for sale, less applicable income taxes. Investments
classified as trading securities are stated at market value with unrealized
gains and losses included in earnings.
Income on debt securities is accrued and included in interest and
dividend income. The specific identification method is used to determine
realized gains or losses on sales of securities available for sale which
are also reported in non-interest income under the caption "gains on
securities available for sale, net." When a security suffers a loss in
value which is considered other than temporary, such loss is recognized by
a charge to earnings.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
On January 1, 2001, the Company adopted Statement of Financial Accounting
Standard ("SFAS") No. 133, "Accounting for Derivative Instruments and
Certain Hedging Activities" and SFAS No. 138, "Accounting for Certain
Derivative Instruments and Certain Hedging Activity," an amendment of SFAS
133. SFAS Nos. 133 and 138 require that all derivative instruments be
recorded on the balance sheet at their respective fair values. The
adoption of these statements did nor have a material effect on the
Company's consolidated financial statements.
31
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
LOANS
Loans are reported at the principal amount outstanding, net of unearned
fees. Loan origination fees and related direct incremental loan
origination costs are offset and the resulting net amount is deferred and
amortized over the life of the loan using the level-yield method.
The Bank generally does not accrue interest on loans which are 90
days or more past due. When a loan is placed on nonaccrual status, all
interest previously accrued but not collected is reversed from income and
all amortization of deferred loan fees is discontinued. Interest received
on nonaccrual loans is either applied against principal or reported as
income according to management's judgment as to the collectibility of
principal. Interest accruals are resumed on such loans only when they are
brought current with respect to interest and principal and when, in the
judgment of management, the loans are estimated to be fully collectible as
to both principal and interest.
Impairment on loans for which it is probable that the creditor will
be unable to collect all amounts due according to the contractual terms of
the loan agreement are measured on a discounted cash flow method, or at
the loan's observable market price, or at the fair value of the collateral
if the loan is collateral dependent. However, impairment must be measured
based on the fair value of the collateral if it is determined that
foreclosure is probable. Impaired loans consist of all nonaccrual
commercial loans.
ALLOWANCE FOR LOAN LOSSES
The Company maintains an allowance for probable losses that are inherent
in the Company's loan portfolio. The allowance for loan losses is
increased by provisions charged to operations based on the estimated loan
loss exposure inherent in the portfolio. Management uses a methodology to
systematically measure the amount of estimated loan loss exposure inherent
in the portfolio for purposes of establishing a sufficient allowance for
loan losses. The methodology includes three elements: an analysis of
individual loans deemed to be impaired in accordance with the terms of
Statement of Financial Accounting Standard No. 114, "Accounting by
Creditors for Impairment of a Loan", general loss allocations for various
loan types based on loss experience factors and an unallocated allowance
which is maintained based on management's assessment of many factors
including the risk characteristics of the portfolio, concentrations of
credit, current and anticipated economic conditions that may affect
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 loan losses, future adjustments to the
allowance may be necessary if economic conditions differ from the
assumptions used in making the evaluation. In addition, various regulatory
agencies, as an integral part of their examination process, periodically
review the Bank's allowance for loan losses. Such agencies may require the
Bank to recognize additions to the allowance based on judgments different
from those of management.
PREMISES AND EQUIPMENT
Land is carried at cost. Premises, equipment and leasehold improvements
are stated at cost, less accumulated depreciation and amortization
computed primarily by use of the straight-line method over the estimated
useful lives of the related assets or terms of the related leases.
STOCK OPTION PLAN
The Company applies the intrinsic-value-based method of accounting
prescribed by Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations
including FASB Interpretation No. 44, "Accounting for Certain Transactions
involving Stock Compensation," an interpretation APB Opinion No. 25,
issued in March 2000, to account for its fixed-plan stock options. Under
this method, compensation expense is recorded on the date of grant only if
the current market price of the underlying stock exceeded the exercise
price. SFAS No. 123, "Accounting for Stock-Based Compensation,"
established accounting and disclosure requirements using a
fair-value-based method of accounting for stock-based employee
compensation plans. As allowed by SFAS No. 123, the Company has elected to
continue to apply the intrinsic-value-based method of accounting described
above, and has adopted only the disclosure requirements of SFAS No. 123.
The following table illustrates the effect on net income if the
fair-value-based method had been applied to all stock options awarded in
each period.
(IN THOUSANDS EXCEPT PER SHARE DATA) YEARS ENDED DECEMBER 31, 2003 2002 2001
---------- ---------- ----------
Net income, as reported $ 9,814 $ 10,759 $ 11,111
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all stock option awards,
net of related tax effects (75) (90) (144)
---------- ---------- ----------
Pro forma net income $ 9,739 $ 10,669 $ 10,967
---------- ---------- ----------
Earnings per share:
Basic - as reported $ 2.09 $ 2.30 $ 2.30
Basic - pro forms 2.07 2.28 2.27
---------- ---------- ----------
Diluted - as reported $ 2.04 $ 2.24 $ 2.25
Diluted - pro forms 2.02 2.22 2.22
---------- ---------- ----------
32
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
GOODWILL AND OTHER INTANGIBLES
The excess of purchase price over the fair value of net assets of acquired
companies is classified and reported as goodwill. For 2001 and prior
years, goodwill was being amortized using the straight-line method, over
15 years. The deposit acquisition premium arising from acquisitions was
reported net of accumulated amortization. Such premium was being amortized
on a straight-line basis over 10 years. Goodwill and other intangible
assets were reviewed for possible impairment when it was determined that
events or changed circumstances may affect the underlying basis of the
asset.
In July 2001, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standard ("SFAS") No. 142,
"Goodwill and Other Intangible Assets." SFAS 142 requires that upon
adoption of the Statement, any goodwill recorded on an entity balance
sheet would no longer be amortized. This would include existing goodwill
(i.e., recorded goodwill at the date the financial statement is issued),
as well as goodwill arising subsequent to the effective date of the
Statement. Goodwill will not be amortized but will be reviewed for
impairment periodically or upon the occurrence of certain triggering
events. This Statement is effective for fiscal years beginning after
December 15, 2001. The Company adopted the new standard on January 1,
2002. At December 31, 2002, the Company had $1,090,000 of goodwill on its
balance sheet. In 2001, the Company's goodwill was being amortized at a
rate of $99,000 annually.
PENSION PLAN
The Bank accounts for pension benefits on the net periodic pension cost
method for financial reporting purposes. This method recognizes the
compensation cost of an employee's pension benefit over that employee's
approximate service period. Pension costs are funded in the year of
accrual using the aggregate cost method.
EMPLOYEES' STOCK OWNERSHIP PLAN ("ESOP")
The Company recognizes compensation cost equal to the fair value of the
ESOP shares committed to be released. Dividends on unallocated ESOP shares
are reported as a reduction of accrued interest on the ESOP loan. The
Company reports loans from outside lenders to its ESOP as a liability on
its balance sheet and reports interest cost on the debt. For earnings per
share (EPS) computations, ESOP shares that have been committed to be
released are considered outstanding. ESOP shares that have not been
committed to be released are not considered outstanding.
EARNINGS PER COMMON SHARE
Basic EPS is computed by dividing net income by the weighted average
number of shares of common stock outstanding during the year reduced by
the weighted average number of unallocated shares held by the Employee
Stock Ownership Plan ("ESOP"). Diluted EPS reflects the effect on the
weighted average shares outstanding of the number of additional shares
outstanding if dilutive stock options were converted into common stock
using the treasury stock method.
The treasury shares acquired in connection with the Company's
directors deferred compensation plan are considered outstanding in the
computation of earnings per share and book value per share.
A reconciliation of the weighted average shares outstanding for the
years ended December 31, 2002, 2001 and 2000 follows:
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2002 2001 2000
----- ----- -----
Basic shares(1) 4,698 4,686 4,831
Dilutive impact of stock options(1) 125 124 110
----- ----- -----
Diluted shares(1) 4,823 4,810 4,941
----- ----- -----
(1) All share information presented has been adjusted to reflect the
3-for-2 split of the Company's common stock effective April 19,
2002.
33
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)
COMPREHENSIVE INCOME
Comprehensive income is defined as "the change in equity of a business
enterprise during a period from transactions and other events and
circumstances from non-owner sources." It includes all changes in equity
during a period except those resulting from investments by and
distributions to shareholders. The term "comprehensive income" describes
the total of all components of comprehensive income including net income.
The Company's other comprehensive income and related tax effect for the
years ended December 31, 2002 and 2001 is as follows:
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2002 2001
-------------------------------------- --------------------------------------
Tax Net- Tax Net-
Before-Tax (Expense) of-Tax Before-Tax (Expense) of-Tax
Amount or Benefit Amount Amount or Benefit Amount
---------- ----------- ------ ---------- ----------- ------
Unrealized gains on securities:
Unrealized holding gains
arising during period $3,429 $(1,266) $2,163 $4,785 $(1,833) $2,952
Less: reclassification adjustment for
gains realized in net income 1,566 (652) 914 4,262 (1,781) 2,481
------ ------- ------ ------ ------- ------
Net unrealized gains 1,863 (614) 1,249 523 (52) 471
------ ------- ------ ------ ------- ------
Other comprehensive income $1,863 $ (614) $1,249 $ 523 $ (52) $ 471
------ ------- ------ ------ ------- ------
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents consist of
cash and due from banks, and short-term investments with original
maturities of less than 90 days.
As a regulated financial institution, the Bank is required to maintain
certain reserve requirements of vault cash and/or deposits with the
Federal Reserve Bank of Boston. The amount of this reserve requirement,
included in "Cash and Due from Banks," was $5.6 million and $5.7 million
at December 31, 2002 and 2001, respectively.
INCOME TAXES
The Bank recognizes income taxes under the asset and liability method.
Under this method, deferred tax assets and liabilities are established for
the temporary differences between the accounting basis and the tax basis
of the Bank's assets and liabilities at enacted tax rates expected to be
in effect when the amounts related to such temporary differences are
realized or settled. The Bank's deferred tax asset is reviewed and
adjustments to such asset are recognized as deferred income tax expense or
benefit based upon management's judgment relating to the realizability of
such asset. Based on the Bank's historical and current pretax earnings,
management believes it is more likely than not that the, Bank will realize
its existing gross deferred tax asset.
2. SHORT-TERM INVESTMENTS
Short-term investments consist of the following:
(IN THOUSANDS) AT DECEMBER 31, 2002 2001
-------- --------
Federal funds sold (overnight) $221,586 $204,294
Money market funds 27,077 32,088
-------- --------
Total short-term investments $248,663 $236,382
======== ========
The investments above are stated at cost which approximates market value.
34
3. INVESTMENT SECURITIES
The amortized cost and market value of investment securities follows:
Gross Gross
Amortized Unrealized Unrealized Market
(IN THOUSANDS) AT DECEMBER 31, 2002 Cost Gains Losses Value
--------- ---------- ---------- --------
Securities available for sale:
Debt securities:
U.S. Treasury obligations $101,017 $ 2,229 $ -- $103,246
U.S. Government agency obligations 73,044 794 -- 73,838
-------- ------- ------- --------
Total 174,061 3,023 -- 177,084
-------- ------- ------- --------
Mortgage-backed securities:
Government National Mortgage Association 15,613 1,178 -- 16,791
Federal Home Loan Mortgage Corporation 161,167 9,857 -- 171,024
Federal National Mortgage Association 788 34 -- 822
Collateralized mortgage obligations 454 14 -- 468
-------- ------- ------- --------
Total mortgage-backed securities 178,022 11,083 -- 189,105
-------- ------- ------- --------
Total debt securities 352,083 14,106 -- 366,189
-------- ------- ------- --------
Equity securities 15,567 383 (2,117) 13,833
-------- ------- ------- --------
Total securities available for sale 367,650 $14,489 $(2,117) $380,022
-------- ------- ------- --------
Net unrealized gains on securities
available for sale 12,372
-------- ------- ------- --------
Total securities available for sale, net 380,022
-------- ------- ------- --------
Total investment securities, net $380,022
======== ======= ======= ========
The amortized cost and market value of investment securities follows:
Gross Gross
Amortized Unrealized Unrealized Market
(IN THOUSANDS) AT DECEMBER 31, 2001 Cost Gains Losses Value
--------- ---------- ---------- --------
Securities available for sale:
Debt securities:
U.S. Treasury obligations $ 79,932 $ 1,165 $ (214) $ 80,883
U.S. Government agency obligations 10,142 115 (4) 10,253
-------- ------- ------- --------
Total 90,074 1,280 (218) 91,136
-------- ------- ------- --------
Mortgage-backed securities:
Government National Mortgage Association 22,499 1,025 -- 23,524
Federal Home Loan Mortgage Corporation 231,603 7,062 (31) 238,634
Federal National Mortgage Association 1,346 38 (1) 1,383
Collateralized mortgage obligations 1,452 38 -- 1,490
-------- ------- ------- --------
Total mortgage-backed securities 256,900 8,163 (32) 265,031
-------- ------- ------- --------
Total debt securities 346,974 9,443 (250) 356,167
-------- ------- ------- --------
Equity securities 15,102 3,931 (2,616) 16,417
-------- ------- ------- --------
Total securities available for sale 362,076 $13,374 $(2,866) $372,584
-------- ------- ------- --------
Net unrealized gains on securities
available for sale 10,508
-------- ------- ------- --------
Total securities available for sale, net 372,584
-------- ------- ------- --------
Total investment securities, net $372,584
======== ======= ======= ========
35
3. INVESTMENT SECURITIES (continued)
During the years ended December 31, 2002, 2001 and 2000, the Company
realized gains and losses on sales and recorded other-than-temporary
impairment writedowns of securities available for sale as follows:
(IN THOUSANDS) AT DECEMBER 31, 2002 2001 2000
------------------------------ ----------------- ----------------- -----------------
Realized Realized Realized
Gains Losses Gains Losses Gains Losses
------ ------- ------ ------- ------ -------
Sales:
U.S. Treasury obligations $ 363 $ -- $ 135 $ -- $ 66 $ (328)
Marketable equity securities 4,721 (3,451) 5,160 (1,032) 4,130 (819)
Other-than-temporary impairment writedowns:
Marketable equity securities -- (67) -- -- -- --
------ ------- ------ ------- ------ -------
Total realized gains (losses) $5,084 $(3,518) $5,295 $(1,032) $4,196 $(1,147)
====== ======= ====== ======= ====== =======
Proceeds from sales of debt securities available for sale during 2002, 2001 and
2000 were $35.0 million, $20.6 million and $38.7 million, respectively. Proceeds
from sales of equity securities available for sale during 2002, 2001 and 2000,
were $14.6 million, $14.2 million and $21.7 million, respectively.
There were no sales of investment securities held-to-maturity during 2002,
2001 and 2000.
The amortized cost and market value of debt securities available for sale by
contractual maturity are as follows:
(IN THOUSANDS) AT DECEMBER 31, 2002 2001
------------------------------ --------------------- ---------------------
Amortized Market Amortized Market
Cost Value Cost Value
--------- -------- --------- --------
Investment securities available for sale:
U.S. Treasury obligations:
Maturing within 1 year $ 29,996 $ 30,443 $ 28,993 $ 29,531
Maturing after 1 year but within 5 years 71,021 72,803 50,939 51,352
-------- -------- -------- --------
Total 101,017 103,246 79,932 80,883
-------- -------- -------- --------
U.S. Government agency obligations:
Maturing within 1 year 10,000 10,000 -- --
Maturing after 1 year but within 5 years 59,000 59,719 10,000 10,115
Maturing after 5 years but within 10 years 4,000 4,075 -- --
Maturing after 10 years but within 15 years 44 44 -- --
Maturing after 15 years -- -- 142 138
-------- -------- -------- --------
Total 73,044 73,838 10,142 10,253
-------- -------- -------- --------
Mortgage-backed securities:
Maturing within 1 year 35 35 159 160
Maturing after 1 year but within 5 years 4,469 4,771 1,162 1,216
Maturing after 5 years but within 10 years 70,525 75,376 88,871 92,482
Maturing after 10 years but within 15 years 102,104 108,003 164,731 169,157
Maturing after 15 years 889 920 1,977 2,016
Total 178,022 189,105 256,900 265,031
-------- -------- -------- --------
Total debt securities available for sale 352,083 366,189 346,974 356,167
======== ======== ======== ========
Net unrealized gains on debt securities available
for sale 14,106 -- 9,193 --
-------- -------- -------- --------
Total debt securities available for sale, net
carrying value $366,189 $366,189 $356,167 $356,167
======== ======== ======== ========
Maturities of mortgage-backed securities are shown at final contractual maturity
but are expected to have shorter lives because borrowers have the right to
prepay obligations without prepayment penalties.
Included in U.S. Government agency obligations are investments that can be
called prior to final maturity with an amortized cost of $73.0 million and a
market value of $73.8 million at December 31, 2002 and an amortized cost of
$10.0 million and a market value of $10.1 million at December 31, 2001.
36
3. INVESTMENT SECURITIES (continued)
The amortized cost and market value of U.S. Government agency securities
available for sale that can be called prior to maturity by scheduled maturity
and initial call dates are as follows:
(IN THOUSANDS) AT DECEMBER 31, 2002 2001
------------------------------ --------------------- --------------------
Amortized Market Amortized Market
Based on Scheduled Maturity Cost Value Cost Value
--------------------------- --------- -------- --------- -------
Investment securities available for sale
U.S. Government agency obligations:
Maturing within 1 year $10,000 $ 10,000 $ -- $ --
Maturing after 1 but within 2 years 6,000 6,030 4,000 4,003
Maturing after 2 but within 3 years 22,000 22,127 2,000 2,025
Maturing after 3 but within 4 years 21,000 21,231 4,000 4,087
Maturing after 4 but within 5 years 10,000 10,332 -- --
Maturing after 5 but within 10 years 4,000 4,074 -- --
--------- -------- --------- -------
Total $73,000 $73,794 $ 10,000 $10,115
========= ======= ========= =======
Amortized Market Amortized Market
Based on Initial Call Dates Cost Value Cost Value
--------------------------- --------- -------- --------- -------
Investment securities available for sale
U.S. Government agency obligations:
Callable within 1 year $63,000 $63,346 $ 8,000 $ 8,065
Callable after 1 but within 2 years 6,000 6,232 2,000 2,050
Callable after 2 but within 3 years 4,000 4,216 -- --
--------- -------- --------- -------
Total $73,000 $73,794 $10,000 $10,115
========= ======== ========= =======
4. TRADING SECURITIES
The carrying amount and market value of securities are as follows: trading
(IN THOUSANDS) AT DECEMBER 31, 2002 2001
------------------------------ --------------------- --------------------
Carrying Market Carrying Market
Amount Value Amount Value
--------- -------- --------- -------
U.S. Treasury obligations $36,228 $36,228 $3,086 $3,086
Marketable equity securities 19 19 -- --
Investments in mutual funds 2 2 3 3
--------- -------- --------- -------
Total trading securities $36,249 $36,249 $3,089 $3,089
========= ======== ========= =======
During the years ended December 31, 2002, 2001 and 2000, the Company realized
gains and losses on sales of trading securities as follows:
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2002 2001 2000
--------------------------------------- --------------- --------------- ---------------
Realized Realized Realized
Gains Losses Gains Losses Gains Losses
----- ------ ----- ------ ----- ------
U.S. Treasury obligations $ 77 $(50) $ 32 $ -- $ -- $ (1)
Marketable equity securities 30 -- 104 (28) 500 (29)
Investments in mutual funds -- -- -- -- -- (33)
----- ------ ----- ------ ----- ------
Total realized gains (losses) $107 $(50) $136 $(28) $500 $(63)
===== ====== ===== ====== ===== ======
Proceeds from sales of trading securities during 2002, 2001 and 2000 were $49.5
million, $27.3 million and $10.8 million, respectively. Mark-to-market
adjustments included in income in 2002, 2001 and 2000 were $95 thousand, $(8)
thousand and $39 thousand, respectively.
37
5. LOANS
The Bank's lending activities are conducted principally in the local
communities in which it operates banking offices, and to a lesser extent,
in selected areas of Massachusetts and southern New Hampshire.
The Bank offers single family and multi-family residential mortgage
loans and a variety of consumer loans. The Bank also offers mortgage loans
secured by commercial or investment property such as apartment buildings
and commercial or corporate facilities; loans for the construction of
residential homes, multi-family properties and for land development; and
business loans for other commercial purposes. Most loans granted by the
Bank are either collateralized by real estate or guaranteed by federal or
local governmental authorities. The ability of single family residential
and consumer borrowers to honor their repayment commitments is generally
dependent on the level of overall economic activity within the borrowers'
geographic areas. The ability of commercial real estate and commercial
loan borrowers to honor their repayment commitments is generally dependent
on the economic health of the real estate sector in the borrowers'
geographic areas and the overall economy. The composition of the Bank's
loan portfolio is summarized as follows:
(IN THOUSANDS) AT DECEMBER 31, 2002 2001
------------------------------ --------- ---------
Mortgage loans:
Residential:
Conventional:
Fixed rate $ 268,984 $ 257,381
Variable rate 31,544 36,383
FHA and VA 133 259
Commercial 2,348 2,641
Construction 654 993
--------- ---------
Total mortgage loans 303,663 297,657
Premium on loans 20 51
Deferred mortgage loan origination fees (895) (1,239)
--------- ---------
Mortgage loans, net 302,788 296,469
--------- ---------
Other loans:
Consumer:
Installment 798 1,178
Guaranteed education 3,293 4,937
Other secured 515 873
Home equity lines of credit 11,102 12,271
Unsecured 187 201
--------- ---------
Total consumer loans 15,895 19,460
Commercial 116 15,088
--------- ---------
Total other loans 16,011 34,548
--------- ---------
Total loans $ 318,799 $ 331,017
========= =========
In the ordinary course of business, the Bank makes loans to its directors,
officers and their associates and affiliated companies ("related parties") at
substantially the same terms as those prevailing at the time of origination for
comparable transactions with unrelated borrowers. An analysis of total related
party loans for the year ended December 31, 2002 follows:
(IN THOUSANDS)
--------------
Balance at December 31, 2001 $ 952
Additions 970
Repayments (1,122)
-------
Balance at December 31, 2002 $ 800
=======
38
6. ALLOWANCE FOR LOAN LOSSES
An analysis of the activity in the allowance for loan losses is as
follows:
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2002 2001 2000
-------------------------------------- ------- ------- -------
Balance at beginning of year $ 2,643 $ 2,594 $ 2,555
Provision for loan losses -- 40 60
Recoveries of loans previously charged-off 16 31 3
------- ------- -------
Total 2,659 2,665 2,618
------- ------- -------
Charge-offs:
Mortgage loans -- --
Other loans (4) (22) (24)
------- ------- -------
Balance at end of year $ 2,655 $ 2,643 $ 2,594
======= ======= =======
The following table shows the allocation of the allowance for loan losses
by category of loans at December 31, 2002, 2001 and 2000.
(IN THOUSANDS) AT DECEMBER 31, 2002 2001 2000
------------------------------ ---- ---- ----
Percentage Percentage Percentage
of Loans of Loans of Loans
Amount to Total Amount to Total Amount to Total
------ -------- ------ -------- ------ --------
Mortgage loans:
Residential $1,310 94% $ 960 89% $1,317 87%
Commercial 9 1 8 1 9 1
Consumer loans 504 5 256 6 162 7
Commercial loans 69 -- 347 4 324 5
Unallocated 763 -- 1,072 -- 782
------ -------- ------ -------- ------ --------
Total $2,655 100% $2,643 100% $2,594 100%
====== ======== ====== ======== ====== ========
An integral component of the Company's risk management process is to
ensure the proper allocation of the allowance for loan losses based upon
an analysis of risk characteristics, demonstrated losses and other
factors. The unallocated component of the allowance for loan losses
represents management's view that given the complexities of the loan
portfolio, there are probable losses that have been incurred within the
portfolio but have not yet been specifically identified. The unallocated
portion of the allowance for loan losses is based on management's
assessment of many factors including the risk characteristics of the loan
portfolio, concentrations of credit, current and anticipated economic
conditions that may affect borrowers' ability to pay, and trends in loan
delinquencies and charge-offs. The unallocated portion of the allowance
for loan losses may change periodically after evaluating factors impacting
assumptions utilized in the calculation of the allocated portion of the
allowance for loan losses. In addition, various regulatory agencies, as an
integral part of their examination process, periodically review the
Bank's allowance for loan losses. Such agencies may require the Bank to
recognize additions to the allowance based on judgments different from
those of management.
7. NON-PERFORMING ASSETS
The following schedule summarizes non-performing assets at the dates
shown:
(IN THOUSANDS) AT DECEMBER 31, 2002 2001 2000
------------------------------ ---- ---- ----
Total nonaccrual loans $420 $644 $565
Total real estate acquired through foreclosure -- --
---- ---- ----
Total non-performing assets $420 $644 $565
==== ==== ====
Percent of non-performing loans to total loans 0.13% 0.19% 0.18%
Percent of non-performing assets to total assets 0.04% 0.07% 0.06%
The reduction in interest income associated with nonaccrual loans is as
follows:
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2002 2001 2000
--------------------------------------- ---- ---- ----
Interest income that would have been recorded under original terms $ 31 $ 60 $ 48
Interest income actually recorded 27 37 36
---- ---- ----
Reduction in interest income $ 4 $ 23 $ 12
==== ==== ====
During 2002, 2001 and 2000 the Company had no impaired loans.
39
commitments to extend credit and involve, to varying degrees, elements of credit
risk in excess of the amount recognized in the consolidated balance sheet. The
contract or notional amounts reflect the extent of involvement the Bank has in
particular classes of these instruments. The Banks exposure to credit loss in
the event of nonperformance by the other party to the financial instrument is
represented by the contractual or notional amount of those instruments. The Bank
uses the same credit policies in making commitments and conditional obligations
as it does for on-balance sheet instruments.
- -------------------------------------------------------------------------------
CONTRACT OR NATIONAL AMOUNT
(IN THOUSANDS) AT DECEMBER 31, 2002 2001
- -------------------------------------------------------------------------------
Financial instruments whose contract amounts
represent credit risk:
Commitments to originate residential
mortgage loans $ ll,331 $ 17,710
Unadvanced portions of construction loans 111 457
Unused credit lines, including unused
portions of equity lines of credit 40,929 37,804
- -------------------------------------------------------------------------------
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee by the customer. Since many of the commitments are
expected to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Bank evaluates each
customer's credit-worthiness on a case-by-case basis. The amount of collateral
obtained, if any, is based on management's credit evaluation of the borrower.
At December 31, 2002 the Bank also had commitments to purchase when-issued
investment securities in the amount of $4.0 million.
9. PREMISES AND EQUIPMENT
A summary of premises and equipment and their estimated useful lives used
for depreciation purposes is as follows:
- ---------------------------------------------------------------------------------------------
USEFUL LIFE
(IN THOUSANDS) AT DECEMBER 31, 2002 2001 (IN YEARS)
- ---------------------------------------------------------------------------------------------
Premises:
Land $ 2,227 $ 2,215 --
Buildings 5,824 5,714 25--45
Building and leasehold improvements 2,396 2,200 1-30
Equipment 4,564 4,417 3-15
15,011 14,546 3-15
Less: accumulated depreciation and amortization 8,216 7,619
- ----------------------------------------------------------------------------------------------
Total premises and equipment, net $ 6,795 $ 6,927
- ----------------------------------------------------------------------------------------------
The Bank is obligated under a number of noncancelable operating leases for
various banking offices. These operating leases expire at various dates through
2012 with options for renewal. Rental expenses for the years ended December 31,
2002, 2001 and 2000 amounted to $277 thousand, $391 thousand and $533 thousand,
respectively.
The minimum rental commitments, with initial or remaining terms of one
year or more exclusive of operating costs and real estate taxes to be paid by
the Bank under these leases, as of December 31, 2002, are as follows:
- ----------------------------------------------------------
(IN THOUSANDS) YEARS ENDING DECEMBER 31, PAYMENTS
- ----------------------------------------------------------
2003 $ 242
2004 127
2005 122
2006 116
2007 89
LATER YEARS 393
- ----------------------------------------------------------
Total $ 1,089
- ----------------------------------------------------------
10. DEPOSITS
Deposits are summarized as follows:
(IN THOUSANDS) AT DECEMBER 31, 2002 2001
------------------------------ ---- ----
Amount Rate Amount Rate
--------- ---- --------- ----
Demand and NOW:
NOW accounts $ 57,293 0.65% $ 53,476 0.66%
Demand accounts 28,034 -- 28,667 --
--------- ---- --------- ----
Total demand and NOW 85,327 0.43 82,143 0.43
--------- ---- --------- ----
Savings:
Regular savings and special notice accounts 535,122 2.28 368,631 2.77
Money-market accounts 13,825 1.00 15,329 1.99
--------- ---- --------- ----
Total savings 548,947 2.25 383,960 2.74
--------- ---- --------- ----
Time certificates:
Fixed rate certificates 170,527 2.75 287,773 4.17
Variable rate certificates 79,127 2.12 95,837 3.05
--------- ---- --------- ----
Total time certificates 249,654 2.55 383,610 3.89
--------- ---- --------- ----
Deposit acquisition premium, net of amortization -- -- (29) --
--------- ---- --------- ----
Total deposits $ 883,928 2.16% $ 849,684 3.03%
========= ==== ========= ====
The maturity distribution and related rate structure of the Bank's time
certificates at December 31, 2002 follows:
(IN THOUSANDS) AT DECEMBER 31, 2002
------------------------------ -------------------------
Average
Amount Interest Rate
-------- -------------
Due within 3 months $ 64,958 2.57%
Due within 3-6 months 51,507 2.46
Due within 6-12 months 43,000 2.61
Due within 1-2 years 48,920 2.57
Due within 2-3 years 23,932 2.57
Due within 3-5 years 15,520 2.27
Thereafter 1,817 4.33
-------- -------------
Total $249,654 2.55%
-------- -------------
At December 31, 2002 and 2001, the Bank had individual time certificates
of deposit of $100 thousand or more maturing as follows:
(IN THOUSANDS) AT DECEMBER 31, 2002 2001
------------------------------ ------- -------
Due within 3 months $17,174 $20,262
Due within 3-6 months 9,308 19,736
Due within 6-l2 months 9,657 28,339
Due within 1-2 years 11,458 16,525
Due within 2-3 years 7,600 3,487
Due within 3-5 years 4,085 5,948
Thereafter 1,234 --
------- -------
Total $60,516 $94,297
======= =======
41
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires that the Bank disclose estimated fair values for its financial
instruments. Fair value estimates, methods, and assumptions are set forth
below for the Bank's financial instruments.
CASH AND DUE FROM BANKS, SHORT-TERM INVESTMENTS AND ACCRUED INTEREST
RECEIVABLE
The carrying amounts for these financial instruments approximate fair
value because of the short-term nature of these financial instruments.
INTEREST-BEARING DEPOSITS IN BANKS AND TERM FEDERAL FUNDS SOLD
The carrying amounts of the interest-bearing deposits in banks reported in
the balance sheet at December 31, 2002 and 2001 approximate fair value.
SECURITIES
The fair value of investment securities is estimated based on bid prices
published in financial newspapers or bid quotations received from
securities dealers.
Statement 107 specifies that fair values should be calculated based
on the value of one unit without regard to any premium or discount that
may result from concentrations of ownership of a financial instrument,
possible tax ramifications, or estimated transaction costs.
The carrying amount and estimated fair values of the Company's
investment securities are as follows:
(IN THOUSANDS) AT DECEMBER 31, 2002 2001
------------------------------ ---- ----
Carrying Calculated Carrying Calculated
Amount Fair Value Amount Fair Value
-------- ---------- -------- ----------
Securities available for sale $380,022 $380,022 $372,584 $372,584
Trading securities 36,249 36,249 3,089 3,089
-------- ---------- -------- ----------
Total securities $416,271 $416,271 $375,673 $375,673
======== ========== ======== ==========
LOANS
Fair values are estimated for portfolios of loans with similar financial
characteristics. Loans are segregated by type such as residential
mortgage, commercial real estate, consumer and commercial.
The fair values of residential and commercial real estate, and
certain consumer loans are calculated by discounting scheduled cash flows
through the estimated maturity using estimated market discount rates that
reflect the credit and interest rate risk inherent in the loan. The
estimate of maturity is based on the Bank's historical experience with
repayments for each loan classification, modified, as required, by an
estimate of the effect of current economic and lending conditions. For
variable rate commercial loans and certain variable rate consumer loans,
including home equity lines of credit, carrying value approximates fair
value. Assumptions regarding credit risk, cash flows, and discount rates
are judgmentally determined using available market information.
The following table presents information for loans:
(IN THOUSANDS) AT DECEMBER 31, 2002 2001
------------------------------ ------------------------- -------------------------
Carrying Calculated Carrying Calculated
Amount Fair Value Amount Fair Value
--------- ---------- --------- ----------
Real estate:
Residential:
Variable $ 31,526 $ 32,222 $ 36,341 $ 36,551
Fixed 268,925 274,606 257,499 260,031
Commercial:
Variable 2,126 2,150 2,415 2,446
Fixed 211 211 214 209
Consumer 15,895 16,010 19,460 19,618
Commercial 116 99 15,088 15,077
--------- ---------- --------- ----------
Total loans 318,799 325,298 331,017 333,932
Allowance for loan losses (2,655) -- (2,643) --
--------- ---------- --------- ----------
Net loans $ 316,144 $ 325,298 $ 328,374 $ 333,932
========= ========== ========= ==========
42
11. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)
DEPOSITS
Under Statement 107, the fair value of deposits with no stated maturity,
such as demand deposits, NOW accounts, regular savings and special notice
accounts, and money market accounts, is equal to the amount payable on
demand as of December 31, 2002 and 2001. The fair value of certificates of
deposit is based on the discounted value of contractual cash flows. The
discount rate is estimated using the rates currently offered for deposits
of similar remaining maturities.
(IN THOUSANDS) AT DECEMBER 31, 2002 2001
------------------------------ ------------------------ -------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
--------- ---------- --------- ----------
Demand accounts $ 28,034 $ 28,034 $ 28,667 $ 28,667
NOW accounts 57,293 57,293 53,476 53,476
Regular savings and special notice accounts $ 535,122 535,122 368,631 368,631
Money market accounts 13,825 13,825 15,329 15,329
Time certificates 249,654 251,512 383,610 385,344
Deposit acquisition premium, net of amortization -- -- (29) --
--------- --------- --------- ---------
Total deposits 883,928 885,786 849,684 851,447
Escrow deposits of borrowers 1,387 1,387 1,403 1,403
--------- --------- --------- ---------
Total $ 885,315 $ 887,173 $ 851,087 $ 852,850
========= ========= ========= =========
The fair value estimates and the carrying amounts above do not include the
benefit that results from the low-cost funding provided by the deposit
liabilities compared to the cost of borrowing funds in the market.
COMMITMENTS TO EXTEND CREDIT
The fair value of commitments to extend credit is estimated using the fees
currently charged to enter into similar agreements, taking into account
the remaining terms of the agreements and the present creditworthiness of
the counterparties. For fixed rate loan commitments, fair value also
considers the difference between current levels of interest rates and the
committed rates.
The Bank estimates the fair value of the cost to terminate
commitments to advance funds on construction loans and for residential
mortgage loans in the pipeline at December 31, 2002 and 2001 to be
immaterial. Unused credit lines, including unused portions of equity lines
of credit, are at floating interest rates and therefore there is no fair
value adjustment.
LIMITATIONS
Fair value estimates are made at a specific point in time, based on
relevant market information and information about the financial
instrument. These estimates do not reflect any premium or discount that
could result from offering for sale at one time the Bank's entire holdings
of a particular financial instrument. Because no active market exists for
a portion of the Bank's financial instruments, fair value estimates are
based on judgments regarding future expected loss experience, current
economic conditions, risk characteristics of various financial instruments
and other factors. These estimates are subjective in nature and involve
uncertainties and matters of significant judgment and therefore cannot be
determined with precision. Changes in assumptions could significantly
affect the estimates.
Fair value estimates are determined without attempting to estimate
the value of anticipated future business and the value of assets and
liabilities that are not considered a financial instruments. For example,
the Bank has a trust department that contributes fee income annually. The
trust department is not considered a financial instrument, and its value
has not been incorporated into the fair value estimates. Other significant
assets and liabilities that are not considered financial assets or
liabilities include deferred tax liabilities, premises and equipment and
goodwill. In addition, the tax ramifications related to the realization of
the unrealized gains and losses can have a significant effect on fair
value estimates and have not been considered in any of the estimates.
43
12. INCOME TAXES
Income tax expense (benefit) was allocated as follows:
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2002 2001 2000
--------------------------------------- ------- ------- -------
Current income tax expense:
Federal $ 5,210 $ 5,891 $ 5,934
State 438 367 356
------- ------- -------
Total current tax expense 5,648 6,258 6,290
======= ======= =======
Deferred income tax benefit:
Federal (132) (181) (79)
State (42) (58) (24)
------- ------- -------
Total deferred tax benefit (174) (239) (103)
------- ------- -------
Total income tax expense $ 5,474 $ 6,019 $ 6,187
======= ======= =======
Income tax expense attributable to income from operations for the years
ended December 31, differed from the amounts computed by applying the
federal income tax rate of 35 percent as a result of the following:
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2002 2001 2000
--------------------------------------- ------- ------- -------
Computed "expected" income tax expense at statutory rate $ 5,351 $ 5,872 $ 6,054
Increase (reduction) in income taxes resulting from:
Reduction in federal income tax rate (101) -- --
State and local income taxes, net of federal benefit 257 201 216
Dividends received deduction (57) (59) (75)
Other 24 5 (8)
------- ------- -------
Income tax expense $ 5,474 $ 6,019 $ 6,187
------- ------- -------
Effective income tax rate 35.81% 35.87% 35.77%
======= ======= =======
44
12. INCOME TAXES (continued)
At December 31, 2002 and 2001, the Bank had gross deferred tax assets and
gross deferred tax liabilities as follows:
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2002 2001
--------------------------------------- ------ ------
Deferred tax assets:
Loan losses $ 997 $ 879
Deferred loan fees, net 30 58
Deferred compensation and pension cost 671 508
Depreciation 40 27
Purchase accounting 347 431
Other 84 38
------ ------
Gross deferred tax asset 2,169 1,941
------ ------
Deferred tax liabilities:
Valuation of securities 4,680 4,065
Other unrealized securities gains 106 106
Other 54 45
------ ------
Gross deferred tax liability 4,840 4,216
------ ------
Net deferred tax liability $2,671 $2,275
====== ======
Based on the Company's historical and current pretax earnings, management
believes it is more likely than not that the Company will realize the
gross deferred tax asset existing at December 31, 2002. The primary
sources of recovery of the gross federal deferred tax asset are federal
income taxes paid in 2002, 2001 and 2000 that are available for carryback
and the expectation that the existing net deductible temporary differences
will reverse during periods in which the Company generates net taxable
income. Since there is no carryback provision for state income tax
purposes, management believes the existing net deductible temporary
differences which give rise to the gross deferred state income tax asset
will reverse during periods in which the Company generates net taxable
income. There can be no assurance, however, that the Company will generate
any earnings or any specific level of continuing earnings.
As a result of the Tax Reform Act of 1996, the special tax bad debt
provisions were amended to eliminate the reserve method. However, the tax
effect of the pre-1988 bad debt reserve amount of approximately $7.3
million remains subject to recapture in the event that the Bank pays
dividends in excess of its reserves and profits.
13. EARNINGS PER SHARE
The following is a calculation of earnings per share for the years
indicated:
YEARS ENDED DECEMBER 31, 2002 2001 2000
------------------------ ------------------------ ------------------------ ------------------------
(IN THOUSANDS EXCEPT SHARE DATA) Basic Diluted Basic Diluted Basic Diluted
-------------------------------- --------- --------- --------- --------- --------- ---------
Net income $9,814 $9,814 $10,759 $10,759 $11,111 $11,111
Average shares outstanding 4,708,783 4,708,783 4,710,030 4,710,030 4,867,948 4,867,948
Dilutive stock options -- 124,675 -- 123,792 -- 110,367
Unallocated Employee Stock
Ownership Plan ("ESOP") shares
not committed to be released (10,957) (10,957) (24,157) (24,157) (37,363) (37,363)
--------- --------- --------- --------- --------- ---------
Weighted average shares outstanding 4,697,826 4,822,501 4,685,873 4,809,665 4,830,585 4,940,952
Earnings per share (in dollars) $ 2.09 $ 2.04 $ 2.30 $ 2.24 $ 2.30 $ 2.25
========= ========= ========= ========= ========= =========
45
14. STOCKHOLDERS' EQUITY
The Company may not declare or pay cash dividends on its shares of common
stock if the effect thereof would cause its stockholders' equity to be
reduced below or to otherwise violate legal or regulatory requirements.
Substantially all of the Company's retained earnings are unrestricted at
December 31, 2002.
The Bank is a Federal Deposit Insurance Corporation insured
institution subject to the FDIC regulatory capital requirements. The FDIC
regulations require all FDIC insured institutions to maintain minimum
levels of Tier I capital. Highly rated banks (i.e., those with a composite
rating of 1 under the CAMELS rating system) are required to maintain a
minimum leverage ratio of Tier I capital to total average assets of at
least 3.00%. An additional 100 to 200 basis points are required for all
but these most highly rated institutions. The Bank is also required to
maintain a minimum level of risk-based capital. Under the new risk-based
capital standards, FDIC insured institutions must maintain a Tier I
capital to risk-weighted assets ratio of 4.00% and are generally expected
to meet a minimum total qualifying capital to risk-weighted assets ratio
of 8.00%. The new risk-based capital guidelines take into consideration
risk factors, as defined by the regulators, associated with various
categories of assets, both on and off the balance sheet. Under the
guidelines, capital strength is measured in two tiers which are used in
conjunction with risk adjusted assets to determine the risk-based capital
ratios. Tier II capital components include supplemental capital components
such as qualifying allowance for loan losses, qualifying subordinated debt
and up to 45 percent of the pretax net unrealized holding gains on certain
available for sale equity securities. Tier I capital plus the Tier II
capital components are referred to as total qualifying capital.
The capital ratios of the Company and its principal subsidiary
"MASSBANK" set forth below currently exceed the minimum ratios for "well
capitalized" banks as defined by federal regulators.
As of December 31, 2002, the most recent notification from the FDIC
categorized the Bank as well capitalized under the regulatory framework
for prompt corrective action. To be categorized as well capitalized, the
Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I
leverage ratios as set forth in the following table. There are no
conditions or events since that notification that management believes
would cause a change in the Bank's categorization.
--------------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS) FOR CAPITAL TO BE WELL
AT DECEMBER 31, 2002 ACTUAL ADEQUACY PURPOSES CAPITALIZED (1)
--------------------------------------------------------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
--------------------------------------------------------------------------------------------------------------------------
Tier I Capital (to Average Assets):
MASSBANK Corp. (consolidated) $107,494 10.96% $29,414 3.00% N/A --
MASSBANK (the "Bank") 101,857 10.32 29,606 3.00 $49,343 5.00%
Tier I Capital (to Risk-Weighted Assets):
MASSBANK Corp. (consolidated) 107,494 32.47 13,242 4.00 N/A --
MASSBANK (the "Bank") 101,857 30.76 13,243 4.00 19,865 6.00
Total Capital (to Risk-Weighted Assets):
MASSBANK Corp. (consolidated) 110,149 33.27 26,483 8.00 N/A --
MASSBANK (the "Bank") 104,512 31.57 26,486 8.00 33,108 10.00
--------------------------------------------------------------------------------------------------------------------------
(1) This column presents the minimum amounts and ratios that a financial
institution must have to be categorized as well capitalized.
--------------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS) FOR CAPITAL TO BE WELL
AT DECEMBER 31, 2002 ACTUAL ADEQUACY PURPOSES CAPITALIZED (1)
--------------------------------------------------------------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
--------------------------------------------------------------------------------------------------------------------------
Tier I Capital (to Average Assets):
MASSBANK Corp. (consolidated) $107,342 11.40% $28,251 3.00% N/A --
MASSBANK (the "Bank") 103,158 10.93 28,328 3.00 $47,213 5.00%
Tier I Capital (to Risk-Weighted Assets):
MASSBANK Corp. (consolidated) 107,342 30.62 14,025 4.00 N/A --
MASSBANK (the "Bank") 103,158 29.47 14,001 4.00 21,001 6.00
Total Capital (to Risk-Weighted Assets):
MASSBANK Corp. (consolidated) 110,577 31.54 28,049 8.00 N/A --
MASSBANK (the "Bank") 106,393 30.40 28,002 8.00 35,002 10.00
--------------------------------------------------------------------------------------------------------------------------
(1) This column presents the minimum amounts and ratios that a financial
institution must have to be categorized as well capitalized.
46
15. EMPLOYEE BENEFITS
PENSION PLAN
The Bank sponsors a noncontributory defined benefit pension plan that
covers all employees who meet specified age and length of service
requirements, which is administered by the Savings Banks Employees
Retirement Association ("SBERA"). The plan provides for benefits to be
paid to eligible employees at retirement based primarily upon their years
of service with the Bank and compensation levels near retirement.
Contributions to the plan reflect benefits attributed to employees'
service to date, as well as services expected to be earned in the future.
Pension plan assets consist principally of government and agency
securities, equity securities (primarily common stocks) and short-term
investments.
The following table sets forth the plan's funded status and amounts
recognized in the Company's consolidated financial statements for the plan
years ended October 31, 2002, 2001, and 2000, the plan's latest valuation
dates:
------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2002 2001 2000
------------------------------------------------------------------------------------------------------------------
Actuarial present value of vested benefits $ 5,929 $ 5,700 $ 4,787
Total accumulated benefit obligation 5,969 5,730 4,811
Change in benefit obligation:
Projected benefit obligation at beginning of year $ 7,009 $ 6,432 $ 5,906
Service cost 386 375 386
Interest cost 493 499 458
Amendments 129 -- --
Actuarial loss (gain) (173) (130) 95
Benefits paid (199) (167) (413)
------------------------------------------------------------------------------------------------------------------
Projected benefit obligation at end of year $ 7,645 $ 7,009 $ 6,432
------------------------------------------------------------------------------------------------------------------
Change in plan assets:
Fair value of plan assets at beginning of year $ 6,804 $ 7,785 $ 7,175
Actual return on plan assets (643) (843) 1,023
Employer contribution -- 29 --
Benefits paid (199) (167) (413)
Other 1 -- --
------------------------------------------------------------------------------------------------------------------
Fair value of plan assets at end of year $ 5,963 $ 6,804 $ 7,785
------------------------------------------------------------------------------------------------------------------
(Deficiency) excess of plan assets over projected benefit obligation $(1,682) $ (205) $ 1,353
------------------------------------------------------------------------------------------------------------------
Certain changes in the items shown are not recognized as they occur, but are amortized systematically over
subsequent periods. Unrecognized amounts to be amortized and the amounts included in the consolidated balance
sheets are shown below:
Unrecognized net actuarial gain (loss) $ (915) $ 85 $ 1,654
Transition asset 106 126 148
Past service cost (129) -- --
Accrued benefit cost (744) (416) (449)
------------------------------------------------------------------------------------------------------------------
(Deficiency) excess of plan assets over projected benefit obligation $(1,682) $ (205) $ 1,353
------------------------------------------------------------------------------------------------------------------
Assumptions used in determining the actuarial present value of the projected benefit obligation were as follows:
Discount rate 6.75% 7.00% 7.75%
Rate of compensation increase 4.00% 4.50% 5.00%
Assumptions used to develop the
net periodic benefit cost data were:
Discount rate 7.00% 7.75% 7.75%
Expected return on plan assets 7.75% 7.75% 8.00%
Rate of compensation increase 4.50% 5.00% 4.50%
Components of net periodic pension (benefit) expense:
Service cost $ 386 $ 375 $ 386
Interest cost 494 498 458
Expected return on plan assets (527) (603) (574)
Transition obligation (21) (21) (21)
Recognized net actuarial gain (4) (253) (236)
------------------------------------------------------------------------------------------------------------------
Net periodic pension (benefit) expense $ 328 $ (4) $ 13
------------------------------------------------------------------------------------------------------------------
47
15. EMPLOYEE BENEFITS (continued)
PROFIT SHARING AND INCENTIVE COMPENSATION BONUS PLANS
The Bank's Profit Sharing arid Incentive Compensation Bonus Plans provide
for payments to employees under certain circumstances based upon a
year-end measurement of the Company's net income and attainment of
individual goals and objectives by certain key officers. Payments of $302
thousand were awarded under the plans in 2000. Because some of the target
goals and individual goals and objectives were met in 2002 and 2001,
bonuses were awarded to officers of the Bank. There were no profit sharing
distributions in 2002 and 2001 because the criteria for making such
distributions were not met. However, based on other factors the Board of
Directors decided to pay a special bonus to non-officer employees of the
Bank in 2002 and 2001. Payments of $67 thousand and $158 thousand were
awarded to officers and non-officers of the Bank in 2002 and 2001,
respectively.
EMPLOYEE STOCK OWNERSHIP PLAN
The Bank has an Employees' Stock Ownership Plan ("ES0P") for the benefit
of each employee who has completed at least 1,000 hours of service with
the Company in the previous twelve months. 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 Bank, the obligation is reflected as a
liability of the Company and a reduction of stockholders' equity on the
consolidated balance sheet. There was no outstanding liability as of
December 31, 2002. The principal balance of the ESOP loan was repaid in
2002. Such outstanding liability totaled $156 thousand at December 31,
2001.
Shares of the Company's common stock purchased with the loan
proceeds are held in a suspense account. As the loan is repaid, a
proportionate number of shares are released for, allocation to plan
participants. The shares are allocated to plan participants annually on a
pro rata basis, based on compensation.
The ESOP acquired unallocated shares in 1986 when the plan was first
established and more recently in 1993. At December 31, 2002, the ESOP held
212,467 shares which have been allocated to participants and no
unallocated shares.
Dividends on unallocated shares are used to offset a portion of the
interest paid on the ESOP loan. Dividends on allocated shares held by the
ESOP are allocated to plan participants proportionately based on the
number of shares in the participant's allocated accounts.
Total compensation and interest expense applicable to the ESOP
amounted to $373 thousand, $328 thousand and $289 thousand for the years
ended December 31, 2002, 2001 and 2000, respectively.
EMPLOYEE AGREEMENTS
The Bank has entered into employment agreements with certain executive
officers which provide that the officer will receive a minimum amount of
annual compensation from the Bank for a specified period. The agreements
also provide for the continued payment of compensation to the officer for
a specified period after termination under certain circumstances,
including if the officer's termination follows a "change of control,"
generally defined to mean a person or group attaining ownership of 25% or
more of the shares of the Company.
EXECUTIVE SUPPLEMENTAL RETIREMENT AGREEMENTS
The Bank maintains executive supplemental retirement agreements for
certain executive officers. These agreements provide retirement benefits
designed to supplement benefits available through the Bank's retirement
plan for employees. Total expenses for benefits payable under the
agreements amounted to $(2) thousand, $82 thousand and $173 thousand in
2002, 2001 and 2000, respectively.
DIRECTORS' DEFERRED COMPENSATION PLAN
In 1988. the Company, established a deferred compensation plan for its
directors. The plan allows the Company's directors to defer receipt of all
or a portion of their compensation until the earlier of: (1) their
attaining the age of 72, or (2) their termination as a director of the
Company. In 2000, the plan was amended to allow the directors'
compensation to be invested in Company stock held in an irrevocable trust.
At December 31, 2002, the trust held 24,000 shares of MASSBANK Corp. stock
that the Company has classified as treasury stock. The treasury shares are
considered outstanding in the computation of earnings per share and book
value per share.
48
15. EMPLOYEE BENEFITS (continued)
STOCK OPTION PLAN
Effective May 28, 1986, the Board of Directors of the Bank adopted a stock
option plan for the benefit of its officers and other employees. In
January, 1991, the plan was amended to authorize the grant of options to
non-employee Directors of the Company. All but 8 of the 1,035,000 shares
reserved for issuance under the plan were issued. On April 19, 1994,
shareholders approved and the Bank adopted the Company's 1994 Stock
Incentive Plan. The total number of shares of common stock that can be
issued under this plan is 540,000 shares. Both incentive stock options and
non-qualified stock options may be granted under the plans. As of December
31, 2002, there were 148,291 non-qualified stock options and 227,831
incentive stock options granted and outstanding to purchase shares under
the plans. The maximum option term is ten years. Further stock options may
be granted pursuant to the 1994 Stock Incentive Plan and will generally
have an exercise price equal to, or in excess of, the fair market value of
a share of common stock of the Company on the date the option is granted.
A summary of the status of the Company's fixed stock option plan as
of December 31, 2002, 2001 and 2000, and changes during the years ended on
those dates is presented below. All share information presented has been
adjusted to reflect the 3-for-2 split of the Company's common stock
effective April 19, 2002.
-----------------------------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2002 2001 2000
-----------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Shares Average Shares Average Shares Average
Under Exercise Under Exercise Under Exercise
FIXED OPTIONS Option Price Option Price Option Price
-----------------------------------------------------------------------------------------------------------------------------
Outstanding at beginning of year 475,651 $17.09 519,526 $16.21 544,976 $15.16
Granted 32,250 27.63 32,625 20.67 54,000 19.00
Exercised (130,277) 13.26 (70,497) 11.39 (60,825) 6.83
Forfeited (1,502) 28.55 (6,003) 27.25 (18,625) 24.36
-----------------------------------------------------------------------------------------------------------------------------
Outstanding at end of year 376,122 $19.27 475,651 $17.09 519,526 $16.21
-----------------------------------------------------------------------------------------------------------------------------
Options exercisable at year-end 376,122 475,651 519.526
-----------------------------------------------------------------------------------------------------------------------------
The following table summarizes information about fixed stock options
outstanding and exercisable at December 31, 2002:
-----------------------------------------------------------------------------------------------------------------------------
AT DECEMBER 31, 2002 OPTIONS OUTSTANDING OPTIONS EXERCISABLE
-----------------------------------------------------------------------------------------------------------------------------
Weighted Avg. Weighted Avg. Weighted Avg.
RANGE OF Number Remaining Exercise Number Exercise
EXERCISE PRICES Outstanding Contractual Life Price Exercisable Price
-----------------------------------------------------------------------------------------------------------------------------
$10.67 to $12.19 97,635 1.l years $ 11.30 97,635 $11.30
13.25 to 16.63 48,987 3.1 years 15.46 48,987 15.46
19.00 to 20.67 116,625 6.0 years 19.83 116,625 19.83
25.00 to 29.50 112,875 6.4 years 27.26 112,875 27.26
-----------------------------------------------------------------------------------------------------------------------------
$10.67 to $29.50 376,122 4.5 years $ 19.27 376,122 $ 19.27
-----------------------------------------------------------------------------------------------------------------------------
49
16. SHAREHOLDER RIGHTS PLAN
The Company has in effect a Shareholder Rights Plan, pursuant to which the
Board of Directors authorized the issuance of one preferred stock purchase
right for each share of common stock of the Company outstanding. Under the
Plan, the Rights automatically become part of and trade with the Company's
shares of common stock. Although the Rights are not exercisable initially,
they become exercisable if a person becomes an "acquiring person" by
acquiring 11% or more of the Company's common stock or if a person
commences a tender offer that could result in that person owning 11% or
more of the common stock of MASSBANK Corp. In the event that a person
becomes an "acquiring person," each holder of a Right (other than the
acquiring person) would be entitled to acquire such number of shares of
preferred stock which are equivalent to MASSBANK Corp. common stock having
a value of twice the exercise price of the Right. The exercise price of a
Right initially shall be $136.00 per one one-thousandth of a share of the
Company's preferred stock. If MASSBANK Corp. is acquired in a merger or
other business combination transaction after any such event, each holder
of a Right would be entitled to purchase, at the then-current exercise
price, shares of the acquiring company's common stock having a value of
twice the exercise price of the Right. The Rights will expire on January
19, 2010, but may be redeemed at the option of the Board of Directors for
$0.01 per Right at any time prior to the time at which any person becomes
an acquiring person or until the expiration date of the Shareholder Rights
Plan.
17. PARENT COMPANY FINANCIAL STATEMENTS
The following are the condensed financial statements for MASSBANK Corp.
(the "Parent Company") only:
BALANCE SHEETS
----------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS EXCEPT SHARE DATA) AT DECEMBER 31, 2002 2001
----------------------------------------------------------------------------------------------------------------------
Assets:
Cash $ 8 $ 10
Interest-bearing deposits in banks 6,401 4,264
Investment in subsidiaries 111,648 110,876
Other assets 382 212
----------------------------------------------------------------------------------------------------------------------
Total assets $118,439 $ 115,362
----------------------------------------------------------------------------------------------------------------------
Liabilities:
Employee stock ownership plan liability (Note 15) $ -- $ 156
Due to subsidiaries 42 288
Other liabilities 1,112 14
----------------------------------------------------------------------------------------------------------------------
Total liabilities 1,154 458
----------------------------------------------------------------------------------------------------------------------
Stockholders' Equity (Notes 12, 14, 15 and 16):
Preferred stock, par value $1.00 per share; 2,000,000 shares authorized, none issued
Common stock, par value $1.00 per share; 10,000,000 shares
authorized, 7,610,195 and 7,494,980 shares issued, respectively 7,610 7,495
Additional paid-in capital 53,297 62,875
Retained earnings 95,243 99,996
----------------------------------------------------------------------------------------------------------------------
156,150 170,366
Treasury stock at cost, 3,026,129 and 4,362,289 shares, respectively (46,557) (61,749)
Accumulated other comprehensive income (Note 1) 7,692 6,443
Common stock acquired by ESOP (Note 15) -- (156)
----------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 117,285 114,904
----------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $118,439 $ 115,362
----------------------------------------------------------------------------------------------------------------------
50
17. PARENT COMPANY FINANCIAL STATEMENTS (continued)
STATEMENTS OF INCOME
---------------------------------------------------------------------------------------------------------------
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2002 2001 2000
---------------------------------------------------------------------------------------------------------------
Income:
Dividends received from subsidiaries $ 11,000 $ 8,800 $ 8,800
Interest and dividend income 76 41 23
---------------------------------------------------------------------------------------------------------------
Total interest and dividend income 11,076 8,841 8,823
Non-interest expense 172 123 115
---------------------------------------------------------------------------------------------------------------
Income before income taxes 10,904 8,718 8,708
Income tax benefit 40 16 23
---------------------------------------------------------------------------------------------------------------
Income before equity in undistributed earnings of
subsidiaries 10,944 8,734 8,731
Equity in undistributed earnings of subsidiaries (1,130) 2,025 2,380
---------------------------------------------------------------------------------------------------------------
Net income $ 9,814 $ 10,759 $ 11,111
---------------------------------------------------------------------------------------------------------------
The Parent Company only Statements of Changes in Stockholders' Equity are
identical to the consolidated statements and therefore are not presented
here.
STATEMENTS OF CASH FLOWS
---------------------------------------------------------------------------------------------------------------
(IN THOUSANDS) YEARS ENDED DECEMBER 31, 2002 2001 2000
---------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 9,814 $ 10,759 $ 11,111
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in undistributed earnings of subsidiaries 1,130 (2,025) (2,380)
Increase in current income tax asset, net (164) (17) (116)
Increase in deferred income tax asset, net (6) (5) (4)
(Decrease) increase in other liabilities 1,098 (282) (25)
Decrease in amount due from subsidiaries -- 84 20
(Decrease) increase in amount due to subsidiaries (246) 288 --
---------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 11,626 8,802 8,606
---------------------------------------------------------------------------------------------------------------
Cash flow from financing activities:
Payments to acquire treasury stock (7,285) (2,045) (5,814)
Purchase of company stock for deferred compensation plan 55 56 366
Issuance of common stock under stock option plan 1,726 803 415
Tax benefit resulting from stock options exercised 148 33 91
Dividends paid on common stock (4,139) (3,935) (3,829)
Tax benefit resulting from dividends paid on unallocated
shares held by the ESOP 4 7 10
---------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (9,491) (5,081) (8,761)
---------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 2,135 3,721 (155)
Cash and cash equivalents at beginning of year 4,274 553 708
---------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 6,409 $ 4,274 $ 553
---------------------------------------------------------------------------------------------------------------
During the years ended December 31, 2002, 2001 and 2000, the Company made
cash payments for income taxes of $40 thousand, $24 thousand and $44
thousand, respectively, and no payments for interest.
In addition, the Company made cash payments to the state of Delaware
for franchise taxes in the amount of $38 thousand, $37 thousand and $31
thousand during the years ended December 31, 2002, 2001 and 2000,
respectively.
51
18. TEN-YEAR STATISTICAL SUMMARY (UNAUDITED)
--------------------------------------------------------------------------------------------------------
(IN THOUSANDS EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31, 2002 2001 2000 1999 1998
--------------------------------------------------------------------------------------------------------
Net income $ 9,814 $ 10,759 $ 11,111 $ 11,311 $ 10,914
Diluted earnings per share 2.04 2.24 2.25 2.17 1.98
Cash dividends paid per share 0.88 0.84 0.79 0.74 0.68
Book value per share, at year end 25.45 24.34 22.83 20.43 21.05
Return on average assets 0.99% 1.13% 1.20% 1.20% 1.17%
Return on average realized equity (1) 8.92% 10.25% 10.95% 11.35% 11.08%
--------------------------------------------------------------------------------------------------------
--------------------------------------------------------------------------------------------------------
(IN THOUSANDS EXCEPT PER SHARE DATA)
YEARS ENDED DECEMBER 31, 1997 1996 1995 1994 1993
--------------------------------------------------------------------------------------------------------
Net income $ 10,167 $ 9,427 $ 8,759 $ 8,185 $ 6,695
Diluted earnings per share 1.85 1.72 1.56 1.42 1.11
Cash dividends paid per share 0.59 0.46 0.36 1/2 0.30 0.22 2/3
Book value per share, at year end 19.38 17.17 16.56 13.39 13.64
Return on average assets 1.12% 1.08% 1.04% 0.96% 0.79%
Return on average realized equity (1) 11.11% 11.01% 10.81% 10.62% 8.98%
--------------------------------------------------------------------------------------------------------
(1) Excludes average net unrealized gains or losses on securities
available for sale.
19. QUARTERLY DATA (UNAUDITED)
-----------------------------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31, 2002 2001
-----------------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS EXCEPT 4th 3rd 2nd 1st 4th 3rd 2nd 1st
PER SHARE DATA) Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
-----------------------------------------------------------------------------------------------------------------------------
Interest and dividend income $ 11,385 $ 11,728 $ 11,950 $ 12,040 $ 12,602 $ 13,517 $ 14,105 $ 14,893
Interest expense 5,062 5,602 5,943 6,094 6,939 8,064 8,476 8,912
-----------------------------------------------------------------------------------------------------------------------------
Net interest income 6,323 6,126 6,007 5,946 5,663 5,453 5,629 5,981
Provision for loan losses -- -- -- -- 4 12 12 12
-----------------------------------------------------------------------------------------------------------------------------
Net interest income after
provision for loan losses 6,323 6,126 6,007 5,946 5,659 5,441 5,617 5,969
Gains (losses) on securities, net (83) (50) 918 933 1,150 1,216 1,140 857
Other non-interest income 317 247 318 323 451 273 412 314
Non-interest expense 3,085 2,930 2,987 3,035 3,031 2,832 2,991 2,867
-----------------------------------------------------------------------------------------------------------------------------
Income before income taxes 3,472 3,393 4,256 4,167 4,229 4,098 4,178 4,273
Income tax expense 1,220 1,183 1,554 1,517 1,535 1,466 1,490 1,58
-----------------------------------------------------------------------------------------------------------------------------
Net Income $ 2,252 $ 2,210 $ 2,702 $ 2,650 $ 2,694 $ 2,632 $ 2,688 $ 2,745
-----------------------------------------------------------------------------------------------------------------------------
Earnings per share (in dollars):(1)
Basic $ 0.48 $ 0.47 $ 0.57 $ 0.56 $ 0.57 $ 0.56 $ 0.57 $ 0.59
Diluted 0.47 0.46 0.56 0.55 0.56 0.55 0.56 0.57
-----------------------------------------------------------------------------------------------------------------------------
Weighted average common
shares outstanding:(1)
Basic 4,665 4,670 4,724 4,734 4,692 4,679 4,674 4,699
Diluted 4,775 4,795 4,860 4,862 4,812 4,822 4,795 4,810
-----------------------------------------------------------------------------------------------------------------------------
(1) Computation of earnings per share is further described in Note 1.
52
MASSBANK CORP. AND SUBSIDIARIES STOCKHOLDER DATA
YEARS ENDED DECEMBER 31, 2002 AND 2001
MASSBANK Corp.'s common stock is currently traded on the NASDAQ Stock
Market under the symbol "MASB". At December 31, 2002 there were 4,608,066
shares outstanding and 698 shareholders of record. Shareholders of record
do not reflect the number of persons or entities who hold their stock in
nominee or "street" name.
The following table includes the quarterly ranges of high and low
sales prices for the common stock, as reported by NASDAQ, and dividends
declared per share for the periods indicated. The per share amounts for
2002 and 2001 have been restated to reflect the Company's three-for-two
stock split of April 19, 2002.
-----------------------------------------------------------------------
Price per Share Cash
------------------------ Dividends
High Low Declared
-----------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2002
-----------------------------------------------------------------------
Fourth Quarter $ 31.40 $ 27.37 $ 0.22
Third Quarter 34.93 27.70 0.22
Second Quarter 35.38 28.90 0.22
First Quarter 31.50 23.73 0.22
-----------------------------------------------------------------------
-----------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2001
-----------------------------------------------------------------------
Fourth Quarter $ 24.50 $ 22.57 $ 0.21
Third Quarter 27.33 24.17 0.21
Second Quarter 26.03 21.60 0.21
First Quarter 22.33 19.25 0.21
-----------------------------------------------------------------------
53
MASSBANK BRANCH OFFICES d/b/a
MASSBANK of Reading* MASSBANK of Melrose
123 Haven Street 476 Main Street
Reading, MA 01867 Melrose, MA 02176
(781) 942-8188 (781) 662-0100
(978) 446-9200
27 Melrose Street
Towers Plaza
MASSBANK of Chelmsford Melrose, MA 02176
(781) 662-0165
291 Chelmsford Street
Chelmsford, MA 01824
(978) 256-3751 MASSBANK of Stoneham
17 North Road 240 Main Street
Chelmsford, MA 01824 Stoneham, MA 02180
(978) 256-3733 (781) 662-0177
MASSBANK of Dracut MASSBANK of Tewksbury
45 Broadway Road 1800 Main Street
Dracut, MA 01826 Tewksbury, MA 01876
(978) 441-0040 (978) 851-0300
MASSBANK of Everett MASSBANK of Westford
738 Broadway 203 Littleton Road
Everett, MA 02149 Westford, MA 01886
(617) 387-5115 (978) 692-3467
MASSBANK of Lowell MASSBANK of Wilmington
50 Central Street 370 Main Street
Lowell, MA 01852 Wilmington, MA 01887
(978) 446-9200 (978) 658-4000
755 Lakeview Avenue 219 Lowell Street
Lowell, MA 01850 Lucci's Plaza
(978) 446-9216 Wilmington, MA 01887
(978) 658-5775
MASSBANK of Medford
4110 Mystic Valley Parkway
Wellington Circle Plaza
Medford, MA 02155
(781) 395-4899
* Main Office
54
CORPORATE INFORMATION
MASSBANK Corp. Trademark Transfer Agent
123 Haven Street
Reading, MA 01867 MASSBANK and its logo are American Stock Transfer &
(781) 662-0100 registered trademarks of the Trust Company
(978) 446-9200 Company 59 Maiden Lane
FAX (781) 942-1022 New York, NY 10038
(800) 937-5449
Form 10-K (877) 777-0800
Savings and Mortgage www.amstock.com
24-Hour-Rate Lines Shareholders may obtain without
(781) 662-0154 charge a copy of the Company's
(978) 446-9285 2002 Form 10-K. Written requests Independent Auditors
should be addressed to:
Shareholder Services KPMG LLP
Notice of Shareholders' Meeting MASSBANK Corp. 99 High Street
159 Haven Street Boston, MA 02110
The Annual Meeting of the Reading, MA 01867
Shareholders of MASSBANK Corp.
will be held at 10:00 AM. on Legal Counsel
Tuesday, April 22, 2003 at the Dividend Reinvestment and Stock
Sheraton Ferncroft Resort Purchase Plan Goodwin Procter LLP
50 Ferncroft Road Exchange Place
Danvers, MA 01923 Shareholders may obtain a Boston, MA 02109
brochure containing a detailed
description of the plan by
writing to:
Shareholder Services
MASSBANK Corp.
159 Haven Street
Reading, MA 01867
55
OFFICERS AND DIRECTORS
MASSBANK CORP.
OFFICERS BOARD OF DIRECTORS
Gerard H. Brandi * Mathias B. Bedell * Robert S. Cummings
Chairman, President and Retired, Bedell Brothers Insurance Senior Counsel,
Chief Executive Officer Agency, Inc. Nixon Peabody LLP
Reginald E. Cormier Gerard H. Brandi Leonard Lapidus
Senior Vice President, Treasurer and Chairman, President and Banking and Bank Regulation
Chief Financial Officer Chief Executive Officer, Consultant
MASSBANK Corp.
Robert S. Cummings * Stephen E. Marshall
Secretary Allan S. Bufferd Retired, C. H. Cleaves Insurance
Treasurer, Agency, Inc.
Donna H. West Massachusetts Institute of Technology
Assistant Secretary Nancy L. Pettinelli
+ Peter W. Carr Executive Director,
Retired, Guilford Transportation Visiting Nurse Association
Industries
+* Herbert G. Schurian
+ Alexander S. Costello Certified Public Accountant
Teacher, Brooks School
* Dr. Donald B. Stackhouse
Retired, Dental Health Concepts
* Member, Executive Committee
+ Member, Audit Committee
OFFICERS AND DIRECTORS
MASSBANK
OFFICERS
Gerard H. Brandi Marilyn H. Abbott Scott H. Hilfiker Joseph D. Regan
Chairman, President and Assistant Treasurer Portfolio Manager Comptroller
Chief Executive Officer
Carol A. Axelrod Brian W. Hurley Charles E. Samour
Donald R. Washburn Loan Officer Assistant Vice President Security Officer
Senior Vice President, Lending
Andrea S. Bradford Kimberly A. Judge Alice B. Sweeney
Donna H. West Assistant Vice President Assistant Treasurer Assistant Comptroller
Senior Vice President,
Community Banking Ernest G. Campbell, Jr. Anne M. Lee Margaret E. White
Collections Officer Director of Human Resources Assistant Treasurer
Reginald E. Cormier
Senior Vice President, Treasurer Marianne J. Carpenter Kenneth A. Masson Patricia o. Witts
and Chief Financial Officer Assistant Treasurer Assistant Vice President, Assistant Treasurer
Marketing
David F. Carroll Lisa A. DiCicco Michael J. Woods
Vice President, Operations Trust Operations Officer Laura M. O'Connor Assistant Vice President
Assistant Treasurer
Richard J. Flannigan Claudeia F. Downing
Vice President and Assistant Treasurer Erik C. Olson BOARD OF DIRECTORS
Senior Trust Officer Auditor and AND
Karen L. Flammia Compliance Officer EXECUTIVE COMMITTEE
Thomas J. Queeney Assistant Vice President
Vice President and Joseph P. Orefice Mathias B. Bedell
Senior Trust Officer Scott M. Forbes Information Technology Officer Gerard H. Brandi, Chairman
Loan Officer Robert S. Cummings, Clerk
Karen L. O'Rourke Stephen E. Marshall
Rachael E. Garneau Assistant Treasurer Herbert G. Schurian
Assistant Treasurer Dr. Donald B. Stackhouse
Donna H. West
Kathleen M. Hardy
Assistant Treasurer
56