EX-13 3 b45680mcexv13.txt EX-13 PORTIONS OF ANNUAL REPORT . . . 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 -----------------------------------------------------------------------
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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
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