Item 1. Business
Business of MASSBANK Corp.
General
MASSBANK Corp. (sometimes referred to as the Company) is a general business corporation incorporated under the laws of the State of Delaware on August 11, 1986. MASSBANK Corp. was organized for the purpose of becoming the holding company for MASSBANK (the “Bank”). The Company is a one-bank holding company registered with the Board of Governors of the Federal Reserve System (Federal Reserve Board) under the Bank Holding Company Act of 1956, as amended. As of and since December 2, 1986, the effective date of the reorganization whereby MASSBANK Corp. became the holding company for the Bank, the Bank has been a wholly owned subsidiary of MASSBANK Corp. The only office of MASSBANK Corp., and its principal place of business, is located at the main office of the Bank at 123 Haven Street, Reading, Massachusetts 01867.
MASSBANK Corp. currently has no material assets other than its investment in the Bank. The Company’s primary business, therefore, is managing its investment in the stock of the Bank. MASSBANK Corp. is classified by the Commonwealth of Massachusetts as a securities corporation for tax purposes which restricts its business to buying, selling, dealing in, or holding securities on its own behalf. In the future, MASSBANK Corp. may become an operating company or acquire banks or companies engaged in bank-related activities. In addition, MASSBANK Corp. may elect to become a financial holding company and to engage in activities permissible to financial holding companies. See “Supervision and Regulation of the Company and its Subsidiaries.”
The principal sources of revenues for MASSBANK Corp. are dividends from the Bank and, to a lesser extent, interest income received from its interest- bearing bank deposits. These revenues are used primarily for the payment of dividends to stockholders and for the repurchase of stock pursuant to the Company’s stock repurchase program. MASSBANK Corp.’s assets at December 31, 2004 are represented by its investment in the Bank of $105.3 million, interest- bearing bank deposits of $4.2 million and other assets of $0.5 million. See Note 17 to the Consolidated Financial Statements for Parent Company only financial information. At December 31, 2004, MASSBANK Corp. on a consolidated basis had total assets of $976.2 million, deposits of $849.5 million, and stockholders’ equity of $110.0 million which represents 11.27% of total assets. Book value per share at December 31, 2004 stood at $25.11, compared to $25.17 at year-end 2003.
The Company does not own or lease any real estate or personal property. Instead it intends to utilize during the immediate future the premises, equipment and furniture of the Bank without the direct payment of rental fees to the Bank.
Competition
The primary business of MASSBANK Corp. currently is the ongoing business of the Bank. Therefore, the competitive conditions faced by MASSBANK Corp. currently are the same as those faced by the Bank. See “Business of MASSBANK - Competition.” In addition, many banks and financial institutions have formed holding companies. It is likely that these holding companies will attempt to acquire commercial banks, thrift institutions or companies engaged in bank-related activities. MASSBANK Corp. would face competition in undertaking any such acquisitions and in operating any such entity subsequent to its acquisition.
Employees
MASSBANK Corp. does not employ any persons other than its management which also serves as management of, and is paid by, the Bank. See “Item 10 - Directors and Executive Officers of the Registrant.” MASSBANK Corp. utilizes the support staff of the Bank from time to time and paid the Bank $12,000 in 2004 for the support.
Dividends
MASSBANK Corp. paid total cash dividends of $1.00 per share in 2004 compared to $0.92 per share in 2003. The Company’s dividend payout ratios (cash dividends paid divided by net income) for 2004 and 2003 were 60% and 52%, respectively.
Business of MASSBANK
General
MASSBANK is a Massachusetts-chartered savings bank founded in 1872 as the Melrose Savings Bank. In 1983, the Reading Savings Bank was merged with and into the Melrose Savings Bank and the name of the resulting institution was changed to MASSBANK for Savings. In 1986, the Bank converted from mutual to stock form of ownership. In 1996, the name of the bank was changed from “MASSBANK for Savings” to “MASSBANK”.
The Bank is primarily engaged in the business of attracting deposits from the general public through its fifteen full service banking offices in Reading, Chelmsford, Dracut, Everett, Lowell, Medford, Melrose, Stoneham, Tewksbury, Westford and Wilmington, and originating residential and commercial real estate mortgages, construction loans, commercial loans, and a variety of consumer loans. The Bank invests a significant portion of its funds in U.S. Treasury and Government agency securities (including callable agency securities), mortgage-backed securities, federal funds sold, and other authorized investments. The Bank also invests a portion of its funds in equity securities traded on a national securities exchange or quoted on the NASDAQ System. The Bank’s earnings depend largely upon net interest income, which is the difference between the interest and dividend income derived by the Bank from its loans and investments (interest-earning assets) and the interest paid by the Bank on its deposits (interest-bearing liabilities). Net interest income is significantly affected by general economic conditions, particularly changes in interest rates, competition, government legislation and policies affecting fiscal affairs, monetary policies of the Federal Reserve System, and the actions of the bank regulatory authorities. Earnings results are also affected by the Company’s provisions (credit) for loan losses; loan and investment activities, particularly residential mortgage loan and mortgage-backed securities prepayment activity; changes in non-interest income, such as fee-based revenues and securities gains or losses; non-interest expense; and income taxes.
The Bank’s deposits are insured to applicable limits by the Bank Insurance Fund (BIF) of the Federal Deposit Insurance Corporation (the FDIC) and excess deposit balances are insured by the Depositors Insurance Fund, Inc. (DIF), a private industry-sponsored deposit insurer.
The Bank recognizes that loan and investment opportunities change over time and that yields derived from such opportunities can vary significantly even when the risks associated with those opportunities are comparable. By developing a relatively liquid loan and investment portfolio, the Bank has attempted to position itself so as to be able to take advantage of these changing opportunities. Consequently, the Bank expects that the relative mix of its loan and investment portfolios will change over time in response to changing market conditions.
Market Area
The Bank is headquartered in Reading, Massachusetts, which is located approximately 15 miles north of Boston. The Bank’s market area includes a significant portion of eastern Massachusetts and is served by a network of 15 branch offices located on a broad arc stretching from Medford and Everett in the south, Dracut in the north, and Westford in the west.
The Bank’s general market area consists of the municipalities in which it operates banking offices and all of the contiguous cities and towns.
The Bank currently operates banking offices in the municipalities of Chelmsford, Dracut, Everett, Lowell, Medford, Melrose, Reading, Stoneham, Tewksbury, Westford and Wilmington.
Lending Activities
The Bank’s net loan portfolio totaled $234.9 million at December 31, 2004.
The following table sets forth information concerning the Bank’s loan portfolio by type of loan at the dates shown:
(1) The allowance for loan losses for 2002 and 2001 has been restated to reflect the reclassification of the allowance for loan losses on off-balance sheet credit exposures (shown separately on the balance sheet) and to facilitate comparison with the current fiscal year.
The following table shows the maturity distribution and interest rate sensitivity of the Bank’s loan portfolio at December 31, 2004:
(1) Loan amounts are accumulated as if the entire balance came due on the last contractual payment date. Accordingly, the amounts do not reflect proceeds from contractual loan amortization or anticipated prepayments.
The following table shows the amounts, included in the table above, which are due after one year and which have fixed or adjustable interest rates:
Mortgage Lending. The Bank believes that the repayment periods of long-term first mortgage loans, the general resistance of the public in our market area to variable rate mortgage instruments and the highly competitive nature of the mortgage industry require a prudent approach to mortgage lending. Consequently, as part of its policy of generally attempting to match the maturities of its assets and its liabilities, the Bank has attempted to keep its mortgage loan portfolio to a level at which the Bank believes there
is an acceptable risk-to-reward ratio in light of opportunities in the market-place and its long-term objectives. In 2004, however, the Bank’s mortgage loan portfolio decreased $15.7 million or 6.5%. At December 31, 2004 the mortgage loan portfolio totaled $226.2 million compared to $241.9 million at December 31, 2003. The decrease in loans is principally due to loan principal payments, paydowns and payoffs combined with a decline in loan origination activity. Loan originations totaled $60.3 million in 2004, down 27.0% from $82.6 million in 2003. In today’s economic climate, there is a tremendous amount of competition for mortgages in the Bank’s area. Consequently, increasing the size of the loan portfolio will take time. In the meantime, short-term mortgage-backed securities may be used as substitutes for loans as certain of their financial characteristics are very similar to short-term mortgage loans. If interest rates increase in 2005 and the shape of the yield curve is positive, the Bank will likely add mortgage-backed securities to its portfolio.
Mortgage Lending (continued)
Loan originations come from a number of sources, including referrals from real estate brokers, walk-in customers, purchasers of property owned by existing customers and refinancings for existing customers. In addition to actively soliciting loan applications, the Bank conducts an advertising and promotion program, directed both toward the general public and real estate professionals who might refer potential borrowers.
Substantially all of the real estate loans originated by the Bank during 2004 were secured by real estate located in the Bank’s primary lending area, reflecting the Bank’s commitment to serve the credit needs of the local communities in which it operates banking offices.
The Bank makes both conventional fixed and adjustable-rate loans on one- to-four family residential properties for a term of ten to thirty years. The Bank currently retains all of the mortgages it originates for its own portfolio. These are primarily 10, 12, 15 or 20 year fixed rate and adjustable rate mortgages (ARMs). The few long-term (30 year) fixed rate mortgage loans that the Bank originates from time to time are also added to the loan portfolio. Adjustable rate mortgage loans have rates that are re-set at either 1, 3, 5, 7 or 10 year intervals and are indexed to various financial indices.
In addition to its traditional mortgage products, the Bank offers several other loan programs which have been well received by customers. It offers ARM programs featuring an initial fixed rate for 5 or 7 years and a 1 year adjustable rate thereafter. A special first time home buyers program has also been instituted featuring a discounted ARM. This program is designed for first- time home buyers meeting certain income and property location criteria.
At December 31, 2004, 1-4 family residential mortgage loans totaled $224.5 million, or 95.0% of the total loan portfolio, compared to $240.2 million, or 94.9% of the total loan portfolio, at December 31, 2003. Residential mortgage and construction loan originations decreased to $53.7 million in 2004, from $74.9 million in 2003. Much of this volume was due to mortgage refinancing. Origination volumes are sensitive to interest rates and are affected by the interest rate environment. The low interest rate environment in 2004 created
demand for mortgage refinancings, but also a high level of loan paydowns and payoffs for the Bank. Although the Bank originated $53.1 million in residential mortgage loans in 2004, it saw its residential mortgage loan portfolio decline as a result of the prepayment activity.
The Bank also originates construction loans and mortgage loans secured by commercial or investment property. The commercial and multifamily real estate mortgages and construction loans totaled approximately $1.7 million, or 0.7% of the total loan portfolio at December 31, 2004. In 2004 construction loan originations amounted to $0.6 million. There were no commercial real estate mortgage loan originations in 2004 or 2003.
Mortgage Lending (continued)
The total amount of first mortgage loans held by the Bank at December 31, 2004 was $226.2 million as indicated in the maturity distribution table appearing on page nine. Of this amount, $23.1 million was subject to interest rate adjustments. The remaining $203.1 million represents fixed rate mortgage loans, which constitute 86.0% of the Company’s total loans.
Fees received for originating loans and related direct incremental loan origination costs are offset and the resulting net amount is deferred and amortized over the life of the related loans.
The Bank also receives fees relating to existing loans, primarily late charges and prepayment penalties.
Other Loans. The Bank makes a variety of consumer loans and had a consumer loan portfolio of approximately $9.9 million at December 31, 2004 representing 4.2% of the Bank’s total loan portfolio. Of this amount, $1.6 million or 0.7% of the total loan portfolio are education loans guaranteed by the American Student Assistance Services Corporation.
The balance of the Bank’s consumer loan portfolio consists of home equity lines of credit and consumer loan contracts such as automobile loans, home improvement loans and other secured and unsecured financings. These loans totaled $8.3 million at December 31, 2004, representing 3.5% of the Bank’s total loan portfolio.
At December 31, 2004, the Bank also had $0.1 million in outstanding loans to commercial enterprises not secured by real estate.
Loan Approval. The Bank’s loan approval process for all loans generally includes a review of an applicant’s financial statements, credit history, banking history and verification of income. For mortgage loans, the Bank generally obtains an independent appraisal of the subject property. The Bank has a formal lending policy approved by the Board of Directors of the Bank which delegates levels of loan approval authority to Bank personnel. All loans in excess of established limits require approval of the Bank’s Board of Directors.
The Bank issues commitments to prospective borrowers to make loans subject to certain conditions for generally up to 60 days. The interest rate applicable to the committed loans is usually the rate in effect at the time a rate lock fee is paid. At December 31, 2004, the Bank had issued commitments on residential first mortgage loans totaling $3,811,000, and had commitments to advance funds on construction loans and unused credit lines, including unused portions of home equity lines of credit, of $89,000 and $33,909,000, respectively. In addition, the Bank had commitments to provide $3,926,000, which represents its participating share of the funding for an affordable housing project in Lowell, Massachusetts, $45,000 in commitments to advance funds for business development in downtown Lowell and unused commercial loan credit lines of $55,000.
Loan Delinquencies. It is the Bank’s policy to manage its loan portfolio so as to recognize problem loans at an early stage and thereby minimize loan losses. Loans are considered delinquent when any payment of principal or interest is one month or more past due. The Bank generally commences collection procedures, however, when accounts are 15 days past due. It is the Bank’s practice to generally discontinue accrual of interest on all loans for which payments are 90 days or more past due. Loans with delinquent payments 90 or more days past due, as shown in the table on the following page, totaled $74,000 at December 31, 2004, down from $230,000 at year-end 2003.
Real Estate Acquired through Foreclosure.
Real estate acquired through foreclosure is comprised of foreclosed properties where the Bank has actually received title and loans determined to be substantially repossessed. Real estate loans that are substantially repossessed include only those loans for which the Bank has taken possession of the collateral but has not completed legal foreclosure proceedings. Loan losses arising from the acquisition of such properties are charged against the allowance for loan losses. Real estate acquired through foreclosure is recorded at the lower of the carrying value of the loan or the fair value of the property constructively or actually received, less estimated costs to sell the property following foreclosure. Operating expenses and any subsequent provisions to reduce the carrying value to fair value are charged to current period earnings. Gains or losses upon disposition are reflected in earnings as realized. At year-end 2004, MASSBANK had no real estate acquired through foreclosure.
Non-Performing Assets
The following table shows the composition of non-performing assets at the dates shown:
The reduction in interest income associated with nonaccrual loans is as follows:
Allowance for Loan Losses and Allowance for Loan Losses on Off-Balance Sheet Credit Exposures
The Company maintains an allowance for probable losses that are inherent in the Company’s loan portfolio. The allowance for loan losses is increased (decreased) by provisions (credits) charged to operations based on the estimated loan loss exposure inherent in the portfolio. Management uses a methodology to systematically measure the amount of estimated loan loss exposure inherent in the portfolio for purposes of establishing a sufficient allowance for loan losses. The methodology includes three elements: an analysis of individual loans deemed to be impaired, general loss allocations for various loan types based on loss experience factors and an unallocated allowance which is maintained based on management’s assessment of many factors including the risk characteristics of the portfolio, concentrations of credit, current and anticipated economic conditions that may effect 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. In 2004, the Bank recorded a negative provision for loan losses of $242 thousand due to the quality of loans in the portfolio and a decrease in the size of the Bank’s loan portfolio. This compares to a negative provision for loan loses of $502 thousand in 2003
The Company also maintains an allowance for probable losses on its outstanding loan commitments. The allowance for loan losses on off-balance sheet credit exposures (shown separately on the balance sheet) is maintained based on expected drawdowns of committed loans and their loss experience factors and management’s assessment of various other factors including current and anticipated economic conditions that may effect the borrowers’ ability to pay, and trends in loan delinquencies and charge-offs.
The allowance for loan losses on off-balance sheet credit exposures totaled $588 thousand and $626 thousand, respectively, at December 31, 2004 and 2003. In 2004, the Company recorded a negative provision for off-balance sheet credit exposures of $39 thousand compared to a provision of $16 thousand in 2003. The credit or provision is included in other non-interest expense.
The following table sets forth the activity in the allowance for loan losses during the years indicated:
Investment Activities
The Bank believes that investment opportunities in United States Government, corporate and other securities are at times more attractive than the opportunities present in the loan market. As compared to loans, these investments of the Bank are generally shorter-term and hence more liquid, are subject to lower risk of loss, and present an opportunity for appreciation. In addition, these investments often permit the Bank to better match the maturities of its assets and its liabilities.
The Bank’s investment portfolio is managed by its officers in accordance with an investment policy approved by the Bank’s Board of Directors. The objectives of that policy are to provide a level of liquidity, earnings and diversification consistent with the exercise of prudent investment judgment. The policy authorizes the senior management of the Bank to make and execute investment decisions and requires that those persons report all investment transactions to the Bank’s Board of Directors at each of its regular meetings. In addition, management is required to report all gains or losses on all securities transactions at each meeting of the Bank’s Board of Directors. Purchases and sales of securities by the Bank are generally required to be made on a competitive basis and all investments must be permitted by applicable law.
The Bank invests in a wide variety of securities and obligations, including: Federal funds sold (which are sold only to institutions included on the Bank’s internally-prepared approved list of adequately capitalized institutions); commercial paper and bankers’ acceptances; United States Treasury and Government agency obligations (including callable agency securities); United States agency guaranteed and other mortgage-backed securities; investment grade corporate debt securities (generally limited to those rated A or better by Standard & Poor’s); mutual funds; and equity securities traded on a national securities exchange or quoted on the NASDAQ System.
Under the 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, 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, 2004, stockholders’ equity included accumulated other comprehensive income of approximately $1.8 million, representing the net unrealized gains on securities available for sale, less applicable income taxes.
Securities that are bought and held principally for the purpose of sale in the near term are classified as trading securities. Trading generally reflects active and frequent buying and selling, and trading securities are generally used with the objective of generating profits on short-term differences in price caused by market volatility. Investments classified as trading securities are stated at market value with unrealized gains and losses included in earnings.
Investment Activities (continued)
Income on debt securities available for sale 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.
Most of the Company’s mortgage-backed securities are currently classified as available for sale. At times of low loan demand, short-term mortgage-backed securities may be used as substitutes for loans as certain of their financial characteristics are very similar to short-term mortgage loans.
At December 31, 2004, the Company’s investments, which consist of securities available for sale (including mortgage-backed securities), securities held to maturity, trading securities, short-term investments (including federal funds sold) and interest-bearing deposits in banks totaled $704.6 million, representing 72.2% of the Company’s total assets.
The following table sets forth the composition of the Company’s investment portfolio as of the dates indicated:
Investment Portfolio
The following table presents the amortized cost of debt securities available for sale at December 31, 2004 maturing within stated periods with the weighted average interest yield from securities falling within the range of maturities:
Debt Securities Available for Sale
(1)
Mortgage-backed securities are shown based on contractual maturities. Actual maturities will differ from contractual maturities due to scheduled amortization and prepayments.
(2)
The amortized cost of callable securities included in securities available for sale totaled $160.0 million as of December 31, 2004.
At December 31, 2004, the Company did not have an investment in any issuer (other than securities of the U.S. Government and Government Agencies) in excess of 10% of stockholders equity.
Deposits and Other Sources of Funds
General. Deposits have been the Bank’s primary source of funds for making investments and loans. In addition to deposits, the Bank’s other major sources of funds are derived from amortization and prepayment of loans and mortgage-backed securities, from sales, calls or maturities of investment securities, and from operations. Deposit flows can vary significantly and are influenced by prevailing interest rates, money market conditions, economic conditions and competition. The Bank can respond to changing market conditions and competition through the pricing of its deposit accounts. Management can attempt to control the level of its deposits to a significant degree through its pricing policies. Another important factor in attracting deposits is convenience. In addition to the Bank’s fifteen conveniently located banking offices, customers can access accounts through the Bank’s Automated Teller Machine (ATM) network. The Bank is a member of the Transaxion (TX), NYCE and CIRRUS System, Inc. (CIRRUS) networks which allow access to ATMs in over 100,000 locations worldwide. Additionally, MASSBANK has joined with over 400 other financial institutions to form the SUM Program. This program allows MASSBANK customers to access over 2,500 SUM ATM’s throughout the Northeast and Midwest without having to pay an access or surcharge fee.
Deposits. A substantial amount of the Bank’s deposits are derived from customers who live or work within the Bank’s market area. The Bank does not solicit deposits through any outside agents. The Bank’s deposits at December 31, 2004 consist of regular, silver and smart savings accounts, holiday club savings accounts, NOW and Super NOW accounts, regular and business checking accounts, money market deposit accounts, IRA and Keogh accounts, and term deposit accounts.
Deposits decreased by $33.0 million or 3.7% to $849.5 million at December 31, 2004, from $882.5 million at year-end 2003. Management believes that increased competition for deposits and more attractive returns from alternative investments, such as stocks and mutual funds, were the principal reasons for deposit outflows. These competing investment vehicles have recently produced higher returns than bank deposits.
Borrowed Funds. From time to time the Bank has obtained funds through repurchase agreements with its customers and federal funds purchased. The Bank also has the ability, although it has never exercised it, to borrow from the Federal Reserve Bank and The Depositors Insurance Fund, Inc. The Bank did not have any borrowed funds in 2004 or 2003.
DEPOSITS
The following table shows the composition of the deposits as of the dates indicated:
In the following table the average amount of deposits and average rate is shown for each of the years as indicated.
Investment Management and Trust Services
The Bank’s Trust and Investment Services Division offers a variety of investment, trust and estate planning services and also serves as trustee, executor, and executor’s agent for bank customers.
As of December 31, 2004 the Trust Division had approximately $25.0 million (market value) of assets in custody and under management.
Competition
The Bank faces substantial competition both in originating loans and in attracting deposits. Competition in originating loans comes primarily from other thrift institutions, commercial banks, credit unions and mortgage banking companies. The Bank competes for loans principally on the basis of interest rates and loan fees, the types of loans originated and the quality of services provided to borrowers.
In attracting deposits, the Bank’s primary competitors are other thrift institutions, commercial banks, mutual funds and credit unions located in its market area. The Bank’s attraction and retention of deposits depends on its ability to provide investment opportunities that satisfy the requirements of customers with respect to rate of return, liquidity, risk and other factors. The Bank attracts a significant amount of deposits through its branch offices primarily from the communities in which those branch offices are located. The Bank competes for these deposits by offering competitive rates, convenient branch and ATM locations and convenient business hours.
The Bank also faces strong competition from banks and other financial services providers in the bank’s market area for both loans and deposits.
Supervision and Regulation of the Company and its Subsidiary
The business in which the Company and its subsidiary are engaged is subject to extensive supervision, regulation and examination by various bank regulatory authorities and other governmental agencies. State and federal banking laws have as their principal objective either the maintenance of the safety and soundness of financial institutions and the federal deposit insurance system or the protection of consumers or classes of consumers, and depositors in particular, rather than the specific protection of stockholders of a bank or its parent company.
Set forth below is a brief description of certain laws and regulations that relate to the regulation of the Company. To the extent the following material describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statute or regulation.
Regulation of the Company. As a registered bank holding company, we are subject to regulation under the Bank Holding Company Act of 1956, as amended, (BHCA) and to inspection, examination and supervision by the Board of Governors of the Federal Reserve System, (FRB). The Company is also subject to laws of the Commonwealth of Massachusetts and the jurisdiction of the Massachusetts Board of Bank Incorporation (BBI) and the Massachusetts Commissioner of Banks (Commissioner). The Company is incorporated in the State of Delaware and is therefore also subject to Delaware corporation law.
The FRB has the authority to issue orders to bank holding companies to cease and desist from unsound banking practices and violations of conditions imposed by, or violations of agreements with, the FRB. The FRB is also empowered to assess civil money penalties against companies or individuals who violate the BHCA or orders or regulations thereunder, to order termination of non-banking activities of non-banking subsidiaries of bank holding companies, and to order termination of ownership and control of a non-banking subsidiary by a bank holding company. Under the BHCA, the Company may not generally engage in activities or acquire more than 5% of any class of voting securities of any company engaged in activities other than banking or activities that are closely related to banking. However, if the Company elects to be treated as a financial holding company, the Company may engage in activities that are financial in nature or incidental or complimentary to such financial activities, as determined by the FRB and the Secretary of the Department of the Treasury. The Company has not elected financial holding company status. Under certain circumstances, the Company may be required to give notice to or seek approval of the FRB before engaging in activities other than banking.
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. (Riegle-Neal), Riegle-Neal permits adequately capitalized and adequately managed bank holding companies, as determined by the FRB, to acquire banks in any state subject to certain concentration limits and other conditions. Riegle-Neal also generally authorizes the interstate merger of banks. In addition, among other things, Riegle-Neal permits banks to establish new branches on an interstate basis provided that the law of the host state specifically authorizes such action. However, as a bank holding company, we are required to obtain prior FRB approval before acquiring more than 5% of a class of voting securities, or substantially all of the assets of a bank holding company, bank or savings association.
Control Acquisitions. The Change in Bank Control Act prohibits a person or group of persons from acquiring “control” of a bank holding company, such as the Company, unless the FRB has been notified and has not objected to the transaction. Under a rebuttable presumption established by the FRB, the acquisition of 10% or more of a class of voting securities of a bank holding company with a class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended, would, under the circumstances set forth in the presumption, constitute acquisition of control of the bank holding company.
Supervision and Regulation of the Company and its Subsidiary (continued)
In addition, a company is required to obtain the approval of the FRB under the BHCA before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of outstanding voting securities of a bank holding company, or otherwise obtaining control or a “controlling influence” over that bank holding company. Massachusetts law also imposes certain limitations on the ability of persons and entities to acquire control of banking institutions and their parent companies.
Bank Holding Company Dividends. The FRB has authority to prohibit bank holding companies from paying dividends if such payment is deemed to be an unsafe or unsound practice. The FRB has indicated generally that it may be an unsafe or unsound practice for bank holding companies to pay dividends unless the bank holding company’s net income over the preceding year is sufficient to fund the dividends and the expected rate of earnings retention is consistent with the organization’s capital needs, asset quality and overall financial condition. In addition, Delaware corporate law includes limitations on a corporation’s payment of dividends if such dividends exceed the corporation’s surplus or current net profits. The Company depends upon dividends received from its subsidiary bank to fund its activities, including the payment of dividends. As described below, the Federal Deposit Insurance Corporation (FDIC) may regulate the amount of dividends payable by the subsidiary bank. The inability of the bank to pay the dividend may have an adverse effect on the Company.
Regulation of the Bank. The Company’s subsidiary bank (Bank) is subject to regulation, supervision and examination by the Massachusetts Division of Banks (Division) and the FDIC.
Insurance of Accounts and FDIC Regulation. The Bank pays deposit insurance premiums to the FDIC based on an assessment rate established by the FDIC for Bank Insurance Fund-member institutions. The FDIC has established a risk-based premium system under which the FDIC classifies institutions based on their capital ratios and on other relevant factors and generally assesses higher rates on those institutions that tend to pose greater risks to the federal deposit insurance funds. The Federal Deposit Insurance Act (FDIA) does not require the FDIC to charge all banks deposit insurance premiums when the ratio of deposit insurance reserves to insured deposits is maintained above specified levels. However, as a result of general economic conditions and recent bank failures, it is possible that the ratio of deposit insurance reserves to insured deposits could fall below the minimum ratio that FDIA requires, which would result in the FDIC setting deposit insurance assessment rates sufficient to increase deposit insurance reserves to the required ratio. We cannot predict whether the FDIC will be required to increase deposit insurance assessments above their current levels.
Bank Holding Company Support of Subsidiary Banks. Under FRB policy, a bank holding company is expected to act as a source of financial and managerial strength to each of its subsidiary banks and to commit resources to their support. This support may be required at times when the bank holding company may not have the resources to provide it. Similarly, under the cross-guarantee provisions of FDIA, the FDIC can hold any FDIC-insured depository institution liable for any loss suffered or anticipated by the FDIC in connection with (1) the “default” of a commonly controlled FDIC-insured depository institution; or (2) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution “in danger of default.” Our subsidiary bank is an FDIC- insured depository institution.
Supervision and Regulation of the Company and its Subsidiary (continued)
Regulatory Capital Requirements. The FRB and the FDIC have issued substantially similar risk-based and leverage capital guidelines applicable to United States banking organizations. In addition, these regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels, whether because of its financial condition or actual or anticipated growth.
The FRB risk-based guidelines define a three-tier capital framework. Tier 1 capital includes common shareholders’ equity and qualifying preferred stock, less goodwill and other adjustments. Tier 2 capital consists of preferred stock not qualifying as Tier 1 capital, mandatory convertible debt, limited amounts of subordinated debt, other qualifying term debt and the allowance for credit losses up to 1.25 percent of risk-weighted assets. Tier 3 capital includes subordinated debt that is unsecured, fully paid, has an original maturity of at least two years, is not redeemable before maturity without prior approval by the FRB and includes a lock-in clause precluding payment of either interest or principal if the payment would cause the issuing bank’s risk-based capital ratio to fall or remain below the required minimum. The sum of Tier 1 and Tier 2 capital less investments in unconsolidated subsidiaries represents qualifying total capital. Risk-based capital ratios are calculated by dividing Tier 1 and total capital by risk-weighted assets. Assets and off-balance sheet exposures are assigned to one of four categories of risk-weights, based primarily on relative credit risk. The minimum Tier 1 capital ratio is four percent and the minimum total capital ratio is eight percent. The Company’s tier 1 capital (to risk-weighted assets) calculation equals 39.16%.
The leverage ratio is determined by dividing Tier 1 capital by adjusted average total assets. Although the stated minimum ratio is 100 to 200 basis points above three percent, banking organizations are required to maintain a ratio of at least five percent to be classified as well capitalized. The Company’s leverage ratio is 11.15%.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), among other things, identifies five capital categories for insured depository institutions (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized) and requires the federal bank regulatory agencies to implement systems for “prompt corrective action” for insured depository institutions that do not meet minimum capital requirements within such categories. FDICIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the category in which an institution is classified. Failure to meet the capital guidelines could also subject a banking institution to capital raising requirements. An “undercapitalized” bank must develop a capital restoration plan and its parent holding company must guarantee that bank’s compliance with the plan. The liability of the parent holding company under any such guarantee is limited to the lesser of five percent of the bank’s assets at the time it became “undercapitalized” or the amount needed to comply with the plan. Furthermore, in the event of the bankruptcy of the parent holding company, such guarantee would take priority over the parent’s general unsecured creditors. In addition, FDICIA requires the various regulatory agencies to prescribe certain non-capital standards for safety and soundness relating generally to operations and management, asset quality and executive compensation and permits regulatory action against a financial institution that does not meet such standards.
Supervision and Regulation of the Company and its Subsidiary (continued)
The various regulatory agencies have adopted substantially similar regulations that define the five capital categories identified by FDICIA, using the total risk-based capital, Tier 1 risk-based capital and leverage capital ratios as the relevant capital measures. Such regulations establish various degrees of corrective action to be taken when an institution is considered under-capitalized. Under the regulations, a “well capitalized” institution must have a Tier 1 risk-based capital ratio of at least six percent, a total risk-based capital ratio of a least ten percent and a leverage ratio of at least five percent and not be subject to a capital directive order. Regulators also must take into consideration (a) concentrations of credit risk; (b) interest rate risk (when the interest rate sensitivity of an institution’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position); and (c) risks from non-traditional activities, as well as an institution’s ability to manage those risks, when determining the adequacy of an institution’s capital. This evaluation will be made as a part of the institution’s regular safety and soundness examination. In addition, the Company, and any Bank with significant trading activity, must incorporate a measure for market risk in their regulatory capital calculations.
Limitations on Bank Dividends. The FDIC has the authority to use its enforcement powers to prohibit a bank from paying dividends if, in its opinion, the payment of dividends would constitute an unsafe or unsound practice. Federal law also prohibits the payment of dividends by a bank that will result in the bank failing to meet its applicable capital requirements on a pro forma basis.
Customer Information Security. The FDIC and other bank regulatory agencies have adopted final guidelines for establishing standards for safeguarding nonpublic personal information about customers that implement provisions of the Gramm-Leach Bliley Act (1999) (GLBA), which establishes a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the BHCA framework. Specifically, the Information Security Guidelines established by the GLBA require each financial institution, under the supervision and ongoing oversight of its Board of Directors or an appropriate committee thereof, to develop, implement and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, to protect against anticipated threats or hazards to the security or integrity of such information; and to protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer.
Privacy. The GLBA requires financial institutions to implement policies and procedures regarding the disclosure of nonpublic personal information about consumers to nonaffiliated third parties. In general, the statute requires financial institutions to explain to consumers their policies and procedures regarding the disclosure of such nonpublic personal information, and, unless otherwise required or permitted by law, financial institutions are prohibited from disclosing such information except as provided in their policies and procedures.
Supervision and Regulation of the Company and its Subsidiary (continued)
USA Patriot Act. The USA Patriot Act of 2001, designed to deny terrorists and others the ability to obtain anonymous access to the U.S. financial system, has significant implications for depository institutions, broker-dealers and other businesses involved in the transfer of money. The USA Patriot Act, together with the implementing regulations of various federal regulatory agencies, have caused financial institutions, including banks, to adopt and implement additional, or amend existing, policies and procedures with respect to, among other things, anti-money laundering compliance, suspicious activity and currency transaction reporting, customer identity verification and customer risk analysis. The statute and its underlying regulations also permit information sharing for counter-terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions, and require the FRB (and other federal banking agencies) to evaluate the effectiveness of an applicant in combating money laundering activities when considering applications filed under Section 3 of the BHCA or under the Bank Merger Act. Management believes that the Company is in compliance with all the requirements prescribed by the USA Patriot Act and all applicable final implementing regulations.
The Community Reinvestment Act. The Community Reinvestment Act (CRA) requires lenders to identify the communities served by the institution’s offices and other deposit taking facilities and to make loans and investments and provide services that meet the credit needs of these communities. Regulatory agencies examine each of the banks and rate such institutions’ compliance with CRA as “Outstanding”, “Satisfactory”, “Needs to Improve”, or “Substantial Noncompliance”. Failure of an institution to receive at least a “Satisfactory” rating could inhibit such institution or its holding company from undertaking certain activities, including engaging in activities newly permitted as a financial holding company under the GLBA and acquisitions of other financial institutions. The FRB must take into account the record of performance of banks in meeting the credit needs of the entire community served, including low-and moderate-income neighborhoods. The Bank has achieved a rating of Satisfactory on their last examination. The Commonwealth of Massachusetts also has enacted substantially similar community reinvestment requirements.
Employees
MASSBANK Corp. utilizes the support staff of the Bank from time to time for which a $12,000 fee was paid to the Bank in 2004. No separate compensation is being paid to the executive officers of MASSBANK Corp., all of whom are executive officers of the Bank and receive compensation as such. As of December 31, 2004, the Bank had 111 full-time employees (including 32 officers) and 49 part-time employees (including 1 officer). None of the Bank’s employees is represented by a collective bargaining group, and management believes that its employee relations are good. The Bank provides its employees with formal training in product knowledge, sales techniques, mortgage origination, fair lending, privacy and various other bank related functions and topics. In addition, each supervisor at the Bank receives management training before assuming his or her supervisory duties and periodically thereafter. The Bank maintains a comprehensive employee benefits program for qualified employees that includes a qualified pension plan, an Employee Stock Ownership Plan (ESOP), health and dental insurance, life and long-term disability insurance and tuition assistance.
Subsidiaries
The Bank has three wholly owned subsidiaries: Readibank Investment Corporation, Melbank Investment Corporation, and Readibank Properties, Inc.
Readibank Investment Corporation and Melbank Investment Corporation were established for the purpose of managing portions of the Bank’s investment portfolio. They are classified by the Commonwealth of Massachusetts as securities corporations for tax purposes which restricts their business to buying, selling, dealing in, or holding securities on their own behalf. As securities corporations they are currently taxed at a lower rate than the Bank. Legislative proposals have recently been discussed which may impact this favorable tax treatment.
Assets of Readibank Investment Corporation and Melbank Investment Corporation totaled $162.9 million and $164.5 million, respectively, at December 31, 2004.
Readibank Properties, Inc. was incorporated primarily for the purpose of real estate development projects. These projects were completed many years ago and this subsidiary is currently inactive. Its assets totaled $618 thousand at December 31, 2004, consisting primarily of an inter-company receivable from the Bank.
Executive Officers of the Registrant
The executive officers of the Company and the Bank and the age of each officer as of December 31, 2004 are as follows:
Gerard H. Brandi. Mr. Brandi has served in various capacities with MASSBANK since he joined the Bank in 1975 as Vice President of the Lending Division. He served as Senior Vice President from 1978 to 1981, Executive Vice President and Senior Lending Officer from 1981 to 1983, and Executive Vice President and Treasurer from 1983 to 1986. Mr. Brandi was named President of the Company and the Bank in 1986, Chief Executive Officer in 1992 and Chairman in 1993.
David F. Carroll. Mr. Carroll retired on December 31, 2004. He had been employed by the Bank since 1983 and had been Vice President of Operations since 1984. He served as Vice President of the Lending Division for a year before becoming Vice President of Operations.
Reginald E. Cormier. Mr. Cormier joined the Bank as Treasurer in September, 1987 and served in this capacity until his promotion to Vice President, Treasurer and Chief Financial Officer in January, 1995. In December 1999, he was promoted to Senior Vice President, Treasurer and Chief Financial Officer.
Thomas J. Queeney. Mr. Queeney joined the Bank in 1986 as a Management Trainee in Loan Origination. He became an Assistant Manager in 1987 and was promoted to Assistant Treasurer in 1988. He then served as a Marketing and Investor Relations Representative until his promotion to Loan Servicing Manager in 1990. In 1992, he was promoted to Loan Officer and Commercial Lending Manager. He was promoted to Assistant Vice President, Lending in 1997, where he served until his promotion to AVP/Trust Administrator in July of 1998. In January of 1999, he was promoted to Vice President and Senior Trust Officer.
William F. Rivers. Mr. Rivers joined the Bank as Vice President of Operations and Mr. David Carroll’s successor in 2004. Prior to joining the Bank Mr. Rivers worked for Medford Bank for over 28 years. His most recent position there was Senior Vice President, Operations & Administration.
Executive Officers of the Registrant (continued)
Donald R. Washburn. Mr. Washburn joined the Bank in 1973 as a Loan Officer. He became an Assistant Vice President in January, 1977 and a Vice President in the Lending Division in June, 1980. Mr. Washburn served as Vice President of the Operations Division from February, 1983 to January, 1984, as Vice President of the Community Banking Division from January, 1984 to January, 1986 and as Vice President of the Lending Division from January, 1986 until his promotion to Senior Vice President of the Lending Division in June, 1994.
Donna H. West. Mrs. West has been employed by the Bank since 1979 and has served as Vice President of the Community Banking Division since October, 1987. Starting at the Bank as an Assistant Branch Manager in 1979, Mrs. West became a Branch Manager in 1981, an Assistant Treasurer and Branch Manager in 1982, an Assistant Treasurer and Regional Branch Administrator in 1984 and an Assistant Vice President and Regional Branch Administrator in 1986. She served in this capacity until her October, 1987 promotion to Vice President of the Community Banking Division. In June, 1994, Mrs. West was promoted to Senior Vice President of the Community Banking Division.
Item 2.
Item 2. Properties
The main office of MASSBANK Corp. and MASSBANK is located at 123 Haven Street, Reading, Massachusetts. Additionally, the Bank has fourteen branches and three operations facilities. The Bank owns its main office, three operations facilities and nine of its branches. All of the remaining branches and other facilities are leased under various leases. At December 31, 2004, management believes that the Bank’s existing facilities are adequate for the conduct of its business.
The following table sets forth certain information relating to the Bank’s existing facilities.
Item 3.
Item 3. Legal Proceedings
From time to time, MASSBANK Corp. and/or the Bank are involved as a plaintiff or defendant in various legal actions incident to their business. As of December 31, 2004, none of these actions individually or in the aggregate is believed by management to be material to the financial condition of MASSBANK Corp. or the Bank.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None during the fourth quarter of 2004.
PART II
Item 5.
Item 5. Market for Registrant’s Common Stock and Related Stockholder Matters
The information contained under the caption “MASSBANK Corp. and Subsidiaries Stockholder Data” in the Registrant’s 2004 Annual Report to Stockholders is incorporated herein by reference.
Issuer Purchases of Equity Securities
The following table sets forth purchases made by the Company of its shares of common stock under the stock repurchase program during the year ended December 31, 2004:
Item 5. (Continued)
In addition, the following number of shares were purchased by the Company’s Directors’ Deferred Compensation Plan and Trust during the year Ended December 31, 2004:
Item 6.
Item 6. Selected Financial Data
The information contained under the caption “MASSBANK Corp. and Subsidiaries - Selected Consolidated Financial Data” in the Registrant’s 2004 Annual Report to Stockholders is incorporated herein by reference.
This selected consolidated financial data should be read in conjunction with the consolidated statements and related notes thereto appearing in the Registrant’s 2004 Annual Report to Stockholders which are incorporated herein by reference.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The information contained under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Registrant’s 2004 Annual Report to Stockholders is incorporated herein by reference.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The information contained under the captions “Asset and Liability Management”, “Interest Rate Risk” and “Other Market Risks” included in Management’s Discussion and Analysis of Financial Condition and Results of Operations section of the Registrant’s 2004 Annual Report to Stockholders is incorporated herein by reference.
Item 8.
Item 8. Financial Statements and Supplementary Data
The Registrant’s consolidated financial statements and notes thereto, together with the reports of KPMG LLP, contained in the Registrant’s 2004 Annual Report to Stockholders are incorporated herein by reference. The unaudited quarterly financial data set forth on page 60 of such Annual Report is incorporated herein by reference.
Item 9.
Item 9. Changes in and Disagreements with Independent Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
As required by Rule 13a-15 under the Securities Exchange Act of 1934 (Exchange Act), the Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based upon their evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that material information relating to the Company required to be disclosed by us in reports we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. In designing and evaluating the disclosure controls and procedures, the Company’s management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives, and management necessarily was required to apply its judgment in designing and evaluating the controls and procedures. The Company currently is in the process of further reviewing and documenting its disclosure controls and procedures, and its internal control over financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.
Changes in Internal Control Over Financial Reporting.
There were no changes in our internal control over financial reporting during the fourth quarter of fiscal year 2004 that have materially affected, or that are reasonably likely to materially affect, our internal controls over financial reporting.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
The information appearing under the caption “Election of Directors” and “Compliance with Section 16(A) of the Exchange Act” in the Registrant’s definitive proxy statement relating to its 2005 Annual Meeting of Stockholders is incorporated herein by reference. Information required by this item concerning the Executive Officers of the Registrant is contained in Part I of this Form 10-K.
Item 11.
Item 11. Executive Compensation
The information appearing under the caption “Executive Compensation” in the Registrant’s definitive proxy statement relating to its 2005 Annual Meeting of Stockholders is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information appearing under the captions “Election of Directors”, “Principal Stockholders” and “Equity Compensation Plan Information” in the Registrant’s definitive proxy statement relating to its 2005 Annual Meeting of Stockholders is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions
The information contained in Note 5 of the Consolidated Financial Statements under the caption “Loans” in the Registrant’s 2004 Annual Report to Stockholders is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information required by this item appears in the definitive proxy statement filed pursuant to Regulation 14A for the 2005 Annual Meeting of our stockholders and is incorporated by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
The following financial statements and financial statement schedules are contained herein or are incorporated herein by reference:
(a)1. Financial Statements
* Incorporated, by reference to pages 29 through 60 of the Registrant’s 2004 Annual Report to Stockholders attached to this filing as Exhibit 13.
2. Financial Statement Schedules
All schedules are omitted as the required information is either not applicable or is included in the consolidated financial statements or related notes.
3. Exhibits
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
MASSBANK CORP.
/s/ Gerard H. Brandi
Gerard H. Brandi
Chairman, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
/s/ Gerard H. Brandi
Chairman, President,
Gerard H. Brandi
Chief Executive Officer and
Director
March 14, 2005
/s/ Reginald E. Cormier
Senior Vice President, Treasurer
Reginald E. Cormier
and Chief Financial Officer
(Principal Financial and
Accounting Officer)
March 14, 2005
/s/ Mathias B. Bedell
Director
March 14, 2005
Mathias B. Bedell
/s/ Allan S. Bufferd
Director
March 14, 2005
Allan S. Bufferd
/s/ Kathleen M. Camilli
Director
March 14, 2005
Kathleen M. Camilli
/s/ Peter W. Carr
Director
March 14, 2005
Peter W. Carr
/s/ Alexander S. Costello
Director
March 14, 2005
Alexander S. Costello
/s/Robert S. Cummings
Director
March 14, 2005
Robert S. Cummings
/s/Stephen E. Marshall
Director
March 14, 2005
Stephen E. Marshall
/s/Nancy L. Pettinelli
Director
March 14, 2005
Nancy L. Pettinelli
/s/Herbert G. Schurian
Director
March 14, 2005
Herbert G. Schurian
/s/Donald B. Stackhouse
Director
March 14, 2005
Donald B. Stackhouse