<PAGE>   1
                              FINANCIAL HIGHLIGHTS
--------------------------------------------------------------------------------


MASSBANK CORP. AND SUBSIDIARIES
SELECTED CONSOLIDATED FINANCIAL DATA
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS) YEARS ENDED DECEMBER 31,                      1998         1997         1996         1995         1994
---------------------------------------------------------------------------------------------------------------------
<S>                                                      <C>          <C>          <C>          <C>          <C>     
BALANCE SHEET DATA:
        Total assets                                     $946,625     $925,403     $888,237     $854,542     $843,647
        Mortgage loans                                    283,654      248,798      224,139      220,603      220,269
        Other loans                                        21,335       23,505       25,522       28,582       30,547
        Allowance for loan losses                           2,450        2,334        2,237        2,529        2,566
        Investments(1)                                    624,082      635,694      622,645      586,768      568,635
        Real estate acquired through foreclosure               86           --          503          255          129
        Deposits                                          824,031      809,850      788,350      753,657      759,676
        Stockholders' equity                              110,489      103,779       92,250       90,817       74,504
---------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS) YEARS ENDED DECEMBER 31,                      1998         1997         1996         1995         1994
---------------------------------------------------------------------------------------------------------------------
OPERATING DATA:
        Interest and dividend income                     $ 59,834     $ 60,733     $ 58,109     $ 56,611     $ 51,451
        Interest expense                                   34,320       34,681       33,062       30,896       26,152
---------------------------------------------------------------------------------------------------------------------
        Net interest income                                25,514       26,052       25,047       25,715       25,299
        Provision for loan losses                             193          260          160          170          705
        Gains (losses) on securities, net                   2,893        1,939          868           92         (533)
        Other non-interest income                           1,697        1,859        1,797        1,856        3,070
        Non-interest expense                               12,515       13,425       12,124       13,178       14,213
---------------------------------------------------------------------------------------------------------------------
        Income before income taxes                         17,396       16,165       15,428       14,315       12,918
        Income tax expense                                  6,482        5,998        6,001        5,556        4,733
---------------------------------------------------------------------------------------------------------------------
        Net income                                       $ 10,914     $ 10,167     $  9,427     $  8,759     $  8,185
=====================================================================================================================
</TABLE>

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31,                                     1998         1997         1996         1995         1994
---------------------------------------------------------------------------------------------------------------------
<S>                                                          <C>          <C>          <C>          <C>          <C>  
OTHER DATA:
        Yield on average interest-earning assets             6.56%        6.81%        6.84%        6.90%        6.22%
        Cost of average interest-bearing liabilities         4.23         4.30         4.27         4.11         3.41
        Interest rate spread                                 2.33         2.51         2.57         2.79         2.81
        Net interest margin                                  2.81         2.93         2.96         3.15         3.07
        Non-interest expense to average assets(5)            1.35         1.39         1.40         1.57         1.67
        Efficiency ratio(2)(5)(6)                            41.4         43.0         43.5         47.4         50.8
        Return on assets (net income/average assets)         1.17         1.12         1.08         1.04         0.96
        Return on equity (net income/average
                stockholders' equity)                       10.05        10.51        10.65        10.65        10.62
        Return on average realized equity(3)                11.08        11.11        11.01        10.81        10.62
        Percent non-performing loans to total loans          0.33         0.65         0.64         0.97         0.84
        Percent non-performing assets to total assets        0.12         0.19         0.24         0.31         0.26
        Stockholders' equity to assets, at year-end         11.67        11.21        10.39        10.63         8.83
        Book value per share, at year-end(4)             $  31.58     $  29.06     $  25.75     $  24.84     $  20.09
        Earnings per share:(4)
          Basic                                              3.09         2.88         2.65         2.43         2.19
          Diluted                                            2.97         2.77         2.58         2.34         2.13
        Cash dividends declared per share(4)                 1.02        0.885         0.69       0.5475         0.45
        Dividend payout ratio                                  33%          31%          26%          23%          21%
=====================================================================================================================
</TABLE>

(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) All share information presented has been adjusted to reflect the 4-for-3 and
    3-for-2 split of the Company's common stock effective September 15, 1997 and
    September 9, 1994, respectively.
(5) Excludes non-recurring non-interest expense of $778 thousand in 1997.
(6) Excludes $620 thousand in market appreciation on securities contributed to
    the Massbank Charitable Foundation in 1997.


<PAGE>   2

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 
1998 presentation. The discussion contains certain forward-looking statements 
regarding the future performance of the Company. All forward-looking 
information is inherently uncertain and actual results may differ 
substantially from the assumptions, estimates, or expectations reflected or 
contained in the forward-looking information.

     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; non-interest expense; and income taxes.

FINANCIAL CONDITION

Total assets at December 31, 1998 were $946.6 million, up $21.2 million or 
2.3% from $925.4 million a year ago. The growth in total assets was driven by 
$32.7 million growth in the loan portfolio, offset by a decline of $11.6 
million in the investment portfolio. Other assets increased by $0.1 million 
in 1998. 

     The Bank's total loan portfolio at December 31, 1998 amounted to $305.0
million compared with $272.3 million at December 31, 1997, an increase of $32.7
million or 12.0%. MASSBANK benefited from the favorable mortgage interest rate
environment in 1998. Loan originations reached record levels in 1998 due to an
increased volume of home mortgage refinancing. Loan originations totaled $105.2
million in 1998, up 79.5% or $46.6 million, compared with $58.6 million in 1997.

     The increase in the total loan portfolio was achieved despite a continued
high level of principal amortization and payoffs in the Bank's loan portfolio,
making it more difficult to grow the portfolio. This is due in part to the
shorter term mortgages the Bank originates and the prevailing low interest rates
which encourage borrowers to prepay higher rate mortgages.

     Total investments consisting of investment securities and other short-term
investments, including term federal funds sold and interest-bearing deposits,
decreased from $635.7 million at December 31, 1997 to $624.1 million at December
31, 1998. The decrease is mainly attributable to a decrease in mortgage-backed
securities and U.S. Treasury and government agency securities, offset by an
increase in trading and equity securities, and term federal funds sold. The
primary component of the Bank's investment securities portfolio, mortgage-backed
securities, accounted for 43.7% of total investments at December 31, 1998, down
from 52.0% at year-end 1997. Mortgage-backed securities which totaled $330.7
million at year-end 1997 decreased to $272.6 million at year-end 1998 due
primarily to the significant pre-payments received during 1998.

     This decrease in total investments was offset in part by a change in net
unrealized gains on securities available for sale from $15.5 million at December
31, 1997 to $19.8 million at December 31, 1998, a net increase in market value
of $4.3 million. The increase in market value of the Bank's investment
securities available for sale portfolio is directly related to the upward
movement in both bond and stock prices in 1998.

     The change in the market value of the Bank's securities available for sale
also had the effect of increasing stockholders' equity by $2.6 million since
year-end 1997. The net unrealized gains on securities available for sale, net of
tax effect reported as part of stockholders' equity totaled $11.7 million at
year-end 1998, up from $9.1 million at December 31, 1997. Total stockholder s'
equity was $110.5 million at December 31, 1998, up $6.7 million from $103.8
million at December 31, 1997. Also contributing to the increase in stockholders'
equity was the Company's record net income of $10.9 million in 1998 and the
issuance of common stock under the Company's stock option plan. These were
partially offset by the payment of $3.6 million in dividends to stockholders and
the cost of additional shares of treasury stock repurchased during the year in
the amount of $4.7 million. The Company's book value per share at December 31,
1998 was $31.58, up $2.52 or 8.7% from the prior year.

     Deposit accounts of all types have traditionally been the primary source of
funds for the Bank's lending and investment activities. The Bank's deposit flows
are influenced by prevailing interest rates, competition and other market
conditions. The Bank's management attempts to manage its deposits through
selective pricing and marketing. Total deposits increased $14.1 million during
1998 to $824.0 million at December 31, 1998 from $809.9 million at year-end
1997.


                                       9
<PAGE>   3

ASSET QUALITY

Asset quality continued to improve during 1998. Nonaccrual loans, generally 
those loans which are 90 days or more delinquent, amounted to only $1.0 
million at December 31, 1998, compared to $1.8 million at December 31, 1997. 
The bank's provision for loan losses, which amounted to $260 thousand in 
1997, decreased by $67 thousand to $193 thousand in 1998, partially as a 
result of lower net loan charge-offs. Loan charge-offs, net of recoveries, 
amounted to $77 thousand in 1998, down from $268 thousand in 1997 and $452 
thousand in 1996.

     The Bank continued to add to its allowance for loan losses in 1998 in
response to increased residential lending. The bank's allowance for loan losses
at December 31, 1998 totaled approximately $2.5 million, representing 244.0% of
nonaccrual loans and 0.80% 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. Real estate acquired through foreclosure totaled $86
thousand at year-end 1998.

RESULTS OF OPERATIONS

COMPARISON OF THE YEARS 1998 AND 1997

MASSBANK Corp. recorded net income for the year ended December 31, 1998 of 
$10.9 million or $3.09 in basic earnings per share compared to $10.2 million 
or $2.88 in basic earnings per share for the year ended December 31, 1997. 
This was the sixth consecutive year of record net income for the Company. 
Diluted earnings per share for 1998 increased to $2.97 from $2.77 in the 
prior year.

     In 1998, MASSBANK's return on average assets rose to 1.17% from 1.12% in
the prior year. Return on average realized equity was 11.08% in 1998, down
slightly from 11.11% in 1997. The Company's favorable earnings performance in
1998 is mainly attributable to higher securities gains and lower non-interest
expenses and provision for loan losses, partially offset by a decrease in net
interest income and non-interest income (exclusive of securities gains).

NET INTEREST INCOME

The Company's net interest income on a fully taxable equivalent ("FTE") basis 
was $25.7 million in 1998, a decrease of $0.5 million from the prior year. 
The decrease is the result of a lower net interest margin, due mainly to the 
flattening of the yield curve which was seen in 1998, partially offset by the 
positive effect of earning asset growth. The Company's net interest margin 
was 2.81% in 1998, down from its prior year net interest margin of 2.93%. The 
Company's average earning assets increased $18.3 million or 2.0% to $912.9 
million in 1998, from $894.6 million in 1997. 

     The tables on pages 19 and 20 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 effected 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.

INTEREST AND DIVIDEND INCOME

Interest and dividend income on a fully taxable equivalent basis was $60.0 
million for the year ended December 31, 1998, compared to $60.9 million for 
the year ended December 31, 1997. The average total earning assets of the 
Company increased to $912.9 million in 1998, up $18.3 million from $894.6 
million in 1997. As reflected in the table on page 19, the Company saw a 
decline in yield in all categories of earning assets this past year. This 
resulted in an overall  decline in yield on total average earning assets of 
25 basis points in 1998. The yield on average earning assets for the year 
ended December 31, 1998 was 6.56% compared to 6.81% in the prior year.

     As exhibited in the rate volume analysis table on page 20, the total effect
of lower market interest rates on interest income in 1998 was a $1.9 million
decline from 1997. Conversely, the total effect of higher average earning assets
on interest income in 1998 was a $1.0 million increase over 1997, resulting in a
net decrease in total interest and dividend income of $899 thousand from 1997.

INTEREST EXPENSE

Total interest expense decreased 1.0% to $34.3 million for the year ended 
December 31, 1998 from $34.7 million for the year ended December 31, 1997. 
This decrease is due to a decrease in the Company's average cost of funds 
from 4.30% in 1997 to 4.23% in 1998, partially offset by the higher interest 
expense resulting from an increase in the Company's average total deposits, 
from $807.3 million in 1997 to $811.6 million in 1998.

     The principal reason for the Company's lower cost of funds was lower market
interest rates in 1998.

                                       10
<PAGE>   4

INTEREST EXPENSE (CONTINUED)

     As exhibited in the rate/volume analysis table on page 20, the effect on
total interest expense from changes in interest-bearing deposit rates from a
year ago was a $522 thousand decrease from 1997. Conversely, the total effect of
higher average deposits on interest expense in 1998 was a $161 thousand increase
over 1997, resulting in a net decrease in total interest expense of $361
thousand from 1997.

PROVISION FOR LOAN LOSSES

The provision for loan losses in 1998 was $193 thousand compared to $260
thousand in 1997. In determining the amount to provide for loan losses, the key
factor is the adequacy of the allowance for loan losses. In making its decision,
management considers a number of factors, including the risk characteristics of
the loan portfolio, underlying collateral, current and anticipated economic
conditions, and trends in loan delinquencies and charge-offs. At December 31,
1998, the allowance for loan losses was approximately $2.5 million representing
244.0% of non-performing loans. The Bank's non-performing loans totaled $1.0
million at December 31, 1998 compared to $1.8 million a year earlier. Net
charge-offs totaled $77 thousand in 1998 compared to $268 thousand in 1997.
Management believes that the allowance for loan losses is adequate to cover the
risks inherent in the loan portfolio under current conditions.

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 to $4.6 million for the year ended December
31, 1998, from $3.8 million for the year ended December 31, 1997. This
improvement is due to an increase in securities gains in 1998.

     Net gains on securities totaled $2.9 million in 1998 compared to $1.9
million in the prior year. The bank's equity securities portfolio continued to
contribute significant returns in 1998 through a combination of gains on the
sale of securities in the amount of $2.6 million and unrealized gains. The
pretax unrealized gains in the bank's equity securities portfolio amounted to
$10.5 million at year-end 1998, up from $8.2 million at December 31, 1997. All
other non-interest income combined decreased $162 thousand to $1.7 million from
$1.9 million in the prior year.

NON-INTEREST EXPENSE

One measure often used in the banking industry to assess the level of 
non-interest expense is the efficiency ratio. The efficiency ratio measures 
how much it cost to generate one dollar of revenue. MASSBANK's efficiency 
ratio continued its steady improvement of the past several years, reaching 
41.4% in 1998.

     MASSBANK's non-interest expenses (i.e., operating expenses) decreased by
$910 thousand to $12.5 million in 1998, from $13.4 million a year ago. This
decrease is due largely to non-recurring expenses incurred in 1997, summarized
below, and to a decrease in compensation expenses which are tied to the
Company's stock performance.

     Salaries and employee benefits decreased by $317 thousand or 4.1%, to $7.4
million in 1998, from $7.7 million in 1997. The decrease reflects a reduction of
$311 thousand in Deferred Compensation Plan expenses which are tied to the
Company's stock performance. The price of MASSBANK Corp. stock decreased by
$8.50 or 17.8% in 1998, from $47.62 at December 31, 1997 to $39.12 at December
31, 1998. Conversely, in 1997 the Company saw the price of it's common stock
increase by $19.03 or 66.6%. This significantly increased Deferred Compensation
Plan expenses in 1997. Normal salary increases and higher employee benefit
costs, in 1998, were partly offset by staff reductions and more loan origination
related salary expenses (which are amortized over the life of the loan) being
deferred due to increased residential lending activity in 1998.

     Occupancy and equipment expense decreased by $37 thousand to $2.1 million
in 1998. This decrease reflects a reduction in utilities expenses and a drop in
real estate tax expenses due to real estate tax abatements received in 1998.

     Data processing expenses increased by $72 thousand to $510 thousand in
1998, from $438 thousand in the previous year. 1997 expenses, however, reflect a
reduction $150 thousand due to a one-time credit the bank negotiated as part of
its initial contract with a new service bureau. This temporary reduction in data
processing expense was used in part to defray nonrecurring expenses the bank
incurred in converting to the new service bureau.

     Professional services expenses increased by $54 thousand to $461 thousand
in 1998, from $407 thousand in 1997. This increase was due mostly to higher
legal fees.

     In 1998, the Company did not incur any merger and acquisition related
expenses. As a result, 1998 expenses when compared to the prior year, show a
decrease of $156 thousand due to the nonrecurring merger and acquisition related
expenses incurred in 1997 in connection with the bank's acquisition of the
Glendale Co-operative Bank ("Glendale").

     Advertising and marketing expenses declined slightly in 1998 to $171
thousand, from $187 thousand in the prior year.

     The amortization of intangibles expense increased by $51 thousand to $302
thousand in 1998, from $251 thousand in 1997. The increase reflects the
additional amortization of goodwill recorded in 1998 in connection with the
Glendale acquisition. In 1997, the goodwill was only amortized for a partial
year since the acquisition was completed in July of that year.

                                       11
<PAGE>   5

NON-INTEREST EXPENSE (CONTINUED)

     Deposit insurance expense totaled $116 thousand in 1998, unchanged from the
prior year.

     The bank's contributions expense decreased by $650 thousand to $14 thousand
in 1998, from $664 thousand in the prior year. This decrease is due to a
significant contribution made in the prior year. The bank, in 1997, contributed
appreciated securities valued at $622 thousand to establish and endow a tax
exempt private foundation. The establishment of the MASSBANK Charitable
Foundation benefits the bank by reducing its contributions expense in 1998 and
future years, since many of the contributions previously made by the bank are
now made by the Foundation.

     Other expenses increased by $89 thousand to $1.5 million in 1998, from $1.4
million in 1997 due to increases in several other non-interest expense
categories.

INCOME TAX EXPENSE

The Company recorded a tax expense of $6.5 million in 1998 compared to $6.0 
million in 1997. The increase in income tax expense is due primarily to 
higher pretax earnings and a slight increase in the Company's effective 
income tax rate. The effective income tax rate for the year ended December 
31, 1998 was 37.3%, up from 37.1% in the prior year. The increase in the 
Company's effective income tax rate in 1998 was due to a non-recurring tax 
benefit in the amount of $260 thousand the Company recorded in 1997 as a 
result of having donated appreciated securities to establish and endow a tax 
exempt private foundation. This reduced the effective income tax rate for 
1997. In 1998, there were two factors which reduced the effective income tax 
rate for the year. The Company, in 1998, received a state tax refund, net of 
federal tax, of approximately $44 thousand due to the settlement of a state 
tax issue from prior years. It also changed its year-end for tax filing 
purposes from October 31 to December 31. This change, because of the bank tax 
reform legislation signed into law in 1995 which lowered the bank tax rate 
from 12.54% to 10.50% over five years,  accelerated the scheduled reduction 
in the Bank's state excise tax rate by one full year from 11.32% to 10.91%. 
For years beginning after 1998, the rate is 10.50%. For further information 
on income taxes, see Note 12 of Notes to Consolidated Financial Statements.

RESULTS OF OPERATIONS

Comparison of the Years 1997 and 1996

MASSBANK Corp. recorded record net income for the year ended December 31, 
1997 of $10.2 million or $2.88 in basic earnings per share compared to $9.4 
million or $2.65 in basic earnings per share for the year ended December 31, 
1996. On a diluted basis, the Company earned $2.77 per share in 1997, up 7.4% 
or $0.19 per share from the $2.58 in diluted earnings per share reported in 
1996.

     In 1997, MASSBANK achieved record breaking results in net income, earnings
per share and return on average realized equity, and increased its return on
average assets. Return on average realized equity and return on average assets
improved to 11.11% and 1.12% in 1997 from 11.01% and 1.08% in 1996,
respectively. The Company's favorable financial performance in 1997 can be
attributed to an improvement in net interest income and higher securities gains,
partially offset by an increase in non-interest expenses and provision for loan
losses. Also, in 1997, the Bank received a non-recurring tax benefit of
approximately $260 thousand from a donation of appreciated securities made to
endow the Massbank Charitable Foundation, a tax exempt private foundation
established for the purpose of making grants in future years to benefit the
Bank's local communities.

NET INTEREST INCOME

The Company's net interest income on a fully taxable equivalent ("FTE") basis 
was $26.2 million in 1997, an increase of $1.0 million over the prior year. 
This year's improvement in net interest income reflects the positive effect 
of earning asset growth exceeding the negative effect of a slightly lower net 
interest margin. The Company's average earning assets increased $42.3 million 
or 5% to $894.6 million in 1997, up from $852.3 million in 1996. The 
Company's net interest margin was 2.93% in 1997, slightly below its 1996 net 
interest margin of 2.96%.

     The tables on pages 19 and 20 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.

INTEREST AND DIVIDEND INCOME 

Interest and dividend income on a fully taxable equivalent basis was $60.9 
million for the year ended December 31, 1997, compared to $58.3 million for 
the year ended December 31, 1996. The average total earning assets of the 
Company increased to $894.6 million in 1997, up $42.3 million from $852.3 
million in 1996. As reflected in the table on page 19, the combination of 
yield declines in loans and investment securities, partially offset by yield 
increases in federal funds sold and short-term investments, resulted in an 
overall decline in yield on total average earning assets of 3 basis points. 
The weighted average yield on earning assets for the year ended December 31, 
1997 was 6.81% compared to 6.84% in the prior year.



                                       12
<PAGE>   6

INTEREST AND DIVIDEND INCOME (CONTINUED)

     As exhibited in the rate/volume analysis table on page 20, the total effect
of lower market interest rates on interest income in 1997 was a $270 thousand
decline from 1996. Conversely, the total effect of higher average earning assets
on interest income in 1997 was a $2.9 million increase over 1996, resulting in a
net increase in total interest and dividend income of $2.6 million over 1996.

INTEREST EXPENSE

Total interest expense increased 4.9% to $34.7 million for the year ended 
December 31, 1997 from $33.1 million for the year ended December 31, 1996. 
This increase is due to an increase in the Company's average deposits, from 
$774.4 million in 1996 to $807.3 million in 1997, coupled with an increase in 
the Company's average cost of funds from 4.27% in 1996 to 4.30% in 1997. The 
increase in the Company's average total deposits in 1997 is attributable to 
the deposits acquired in connection with the Glendale purchase and internal 
growth.

     As reflected in the table on page 19, the migration from lower cost savings
deposits to higher cost CDs, combined with the growth in CDs in 1997,
contributed significantly to the Company's increased cost of funds in 1997.

     As exhibited in the rate/volume analysis table on page 20, the effect on
total interest expense from changes in interest bearing deposit rates from a
year ago was a $219 thousand decrease from 1996. Conversely, the total effect of
higher average deposits on interest expense in 1997 was a $1.8 million increase
over 1996, resulting in a net increase in total interest expense of $1.6 million
over 1996.

PROVISION FOR LOAN LOSSES

The provision for loan losses in 1997 was $260 thousand compared to $160
thousand in 1996. In determining the amount to provide for loan losses, the key
factor is the adequacy of the allowance for loan losses. In making its decision,
management considers a number of factors, including the risk characteristics of
the portfolio, underlying collateral, current and anticipated economic
conditions, and trends in loan delinquencies and charge-offs. At December 31,
1997, the allowance for loan losses was $2.3 million representing 131.8% of
non-performing loans. The Bank's non-performing loans totaled $1.8 million at
December 31, 1997 compared to $1.6 million a year earlier. Net charge-offs
totaled $268 thousand in 1997 compared to $452 thousand in 1996. Management
believes that the allowance for loan losses is adequate to cover the risks
inherent in the loan portfolio under current conditions.

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 to $3.8 million for the year ended December
31, 1997, from $2.7 million for the year ended December 31, 1996. This
improvement is due to an increase in securities gains in 1997.

     Net gains on securities totaled $1.9 million in 1997 compared to $868
thousand in 1996. Included in the $1.9 million in securities gains is $620
thousand in market appreciation on securities contributed to the Massbank
Charitable Foundation. All other non-interest income combined increased $62
thousand to $1.9 million from $1.8 million in the prior year.

NON-INTEREST EXPENSE

Non-interest expenses (i.e., operating expenses) increased by $1.3 million in 
1997, from $12.1 million a year ago. This increase is due largely to an 
increase in those expenses which are tied to the Company's stock performance 
and non-recurring expenses incurred in 1997 which are summarized below:

     Salaries and employee benefits increased by $528 thousand or 7.3%, to $7.7
million in 1997, from $7.2 million in 1996. The increase reflects a $247
thousand increase in Employee Stock Ownership Plan ("ESOP") and Deferred
Compensation Plan expenses which are tied to MASSBANK Corp.'s stock performance.
The price of MASSBANK Corp. stock increased by $19.03 or 66.6% in 1997, from
$28.59 at December 31, 1996 to $47.62 at December 31, 1997. In addition,
salaries increased by $289 thousand due primarily to normal salary increases
granted to employees. These increases were partially offset by a decrease in the
costs of employee retirement benefits of $86 thousand. The expense for all other
employee benefits combined increased $78 thousand over 1996.

     Occupancy and equipment expense increased by $119 thousand to $2.1 million
in 1997. This is due largely to an increase in depreciation expense resulting
from building and leasehold improvements and the computer equipment that the
bank purchased in conjunction with its computer conversion in July, 1997. The
Bank made this change to its computer systems to enhance its technological
capabilities in order to better service its customers and continue to provide
increased efficiencies throughout the bank.

     Data processing expenses were reduced by $170 thousand to $438 thousand in
1997, from $608 the previous year. This decrease reflects $150 thousand in total
credits the bank negotiated as part of its initial contract with a new data
center which it converted to in July, 1997. The temporary reduction in data
processing expense was used to defray nonrecurring expenses which the bank
incurred in converting to the new data center.


                                       13
<PAGE>   7

NON-INTEREST EXPENSE (CONTINUED)

     Professional services expenses increased by $67 thousand to $407 thousand
in 1997, from $340 thousand in 1996. This increase was due mostly to an increase
of $40 thousand in legal fees.

     The non-recurring merger and acquisition related expenses incurred in
connection with the acquisition of the Glendale Co-operative Bank totaled $156
thousand in 1997.

     Advertising and marketing expenses were reduced by $33 thousand to $187
thousand in 1997, from $220 thousand in 1996.

     The amortization of intangibles expense was $251 thousand in 1997, up from
$230 thousand in 1996. This increase is due to the Glendale acquisition.

     Deposit insurance expense in 1997 increased $103 thousand over 1996 due to
increases in the FDIC deposit insurance and Depositors Insurance Fund ("DIF")
assessments. The DIF insures customer deposits in excess of the FDIC insurance
limits. The increased assessments are attributable to higher deposit volume and
the FDIC's Financing Corporation (FICO) debt service assessment which became
applicable to all insured institutions as of January 1, 1997, in accordance with
the Deposit Insurance Act of 1996.

     The bank's contributions expense increased to $664 thousand in 1997, from
$60 thousand in the prior year. In the second quarter 1997, the bank established
and endowed a tax exempt private foundation the "MASSBANK Charitable
Foundation" for the purpose of making grants in future years to benefit the
bank's local communities. The bank contributed appreciated equity securities
valued at $622 thousand. This expense will benefit the bank by reducing its
contributions expense in future years, since many of the contributions
previously made by the bank will now be made by the Foundation.

     Other expenses were reduced by $94 thousand to $1.4 million in 1997, from
$1.5 million in 1996. This decrease is essentially due to a reduction in real
estate acquired through foreclosure expenses.

INCOME TAX EXPENSE

The Company recorded a tax expense of $6.0 million in 1997 and 1996. The 
effective income tax rate for the year ended December 31, 1997 was 37.1%, a 
decrease from 38.9% in 1996. In 1997, the Bank received a non-recurring tax 
benefit of approximately $260 thousand as a result of having donated 
appreciated securities to establish and endow the MASSBANK Charitable 
Foundation. For further information on income taxes, see Note 12 of Notes to 
Consolidated Financial Statements.

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 amortization and prepayments, sales or maturities of investment securities
and income on earning assets. In addition to loan payments and maturing
investment securities, which are relatively predictable sources of funds, the
Bank maintains a high percentage of its assets invested in overnight federal
funds sold, which can be immediately converted into cash, and United States
Treasury and Government agency securities, which can be sold or pledged to raise
funds. At December 31, 1998, the Bank had $123.2 million or 13.0% of total
assets and $124.0 million or 13.1% of total assets invested, respectively, in
overnight federal funds sold 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 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 Bank and the Company currently exceed the minimum
regulatory requirements. At December 31, 1998, the Bank had a leverage Tier I
capital to average assets ratio of 10.34%, a Tier I capital to risk-weighted
assets ratio of 31.59% and a total capital to risk-weighted assets ratio of
34.00%. The Company, on a consolidated basis, had ratios of leverage Tier I
capital to average assets of 10.61%, Tier I capital to risk-weighted assets of
32.40% and total capital to risk-weighted assets of 34.81% at December 31, 1998.


                                       14
<PAGE>   8

YEAR 2000 ISSUE

As we near the 21st century, MASSBANK is taking important steps to tackle the 
computer glitch dubbed the Year 2000 Problem, Y2K, or Millennium Bug. The 
problem originated from software designers' attempt to save memory by 
recording years in a two digit format  "98" instead of "1998" for example  
which didn't take into account that the year 2000, or "00" could also be 
interpreted, by any system that has time sensitive software, as the year 1900 
rather than the year 2000. This could result in a system failure or in 
miscalculations.

     In May 1997, the Company organized a Year 2000 project team to address the
Y2K critical issues in order to resolve its Year 2000 computer problems. The
project team provides direct oversight of the Year 2000 initiative. The
Company's Board of Directors receives project updates on a quarterly basis and
the Bank's Board of Directors receives a monthly project update.

     The project team has completed its assessment of the Company's technology
and non-information technology systems, such as vault doors, elevators, and
security systems, to identify the systems that could be affected by the Year
2000 issue and has developed a plan to address this issue. The project plan,
which incorporates the Federal Financial Institutions Examination Council
("FFIEC") recommended guidelines, encompasses a service bureau for systems that
are outsourced, in-house systems, vendors, customers and suppliers (including
correspondent banks). In addition to addressing the Company's technology issues,
the project plan includes a customer awareness program designed to keep the
bank's customers informed about the Year 2000 issue and the Company's state of
readiness.

     The Company has incurred and will continue to incur expenses in connection
with the testing and upgrading of its computer systems to prepare for the Year
2000. Year 2000 project expenditures approximated $53 thousand in 1998.
Approximately $33 thousand of the expenditures were expensed as incurred, while
the cost of new hardware and software of approximately $20 thousand was
capitalized and will be amortized over the software and hardware's useful life.
The capitalized expenditures represent the cost of a new general ledger system
and the replacement of some personal computers that were not Year 2000 ready.
Expenses for the remainder of the Year 2000 project are not expected to exceed
$300 thousand. This includes an estimated $150 thousand to upgrade the Bank's
check processing equipment. Since the majority of these expenditures will be to
replace or upgrade existing hardware and software, the majority of these
expenditures will be capitalized and amortized in accordance with the Company's
standard accounting practices.

     The Company relies on a third party service bureau for its primary business
processes (e.g., loans and deposits applications). It continues to work closely
with the service bureau to monitor the progress of their Year 2000 efforts. The
service bureau's Y2K remediation efforts are also being monitored by the federal
banking regulators. The service bureau expects to have substantially completed
the remediation and testing of all its applications by the end of the first
quarter of 1999. The Company's testing with the service bureau that began April
1998 is expected to be substantially completed by the end of the second quarter
of 1999. However, the Company expects to continue testing into the third quarter
of 1999.

     The Company has made significant progress in testing, upgrading, and/or
replacing its information systems to assure Y2K compliance. The testing of all
of the Company's computer hardware and mission critical internal information
systems has been substantially completed, with the exception of its trust and
items processing department systems. These systems are being replaced with
hardware and software that is Year 2000 ready. The delivery of these systems is
expected by May 1999 and the Company expects testing to be substantially
completed by the end of the second quarter of 1999.

     Most of the Company's other date sensitive systems operate on software
supported by outside vendors. The Company continues to monitor the progress of
their Year 2000 efforts and is seeking to receive written verification from
these vendors as to their Year 2000 readiness.

     Testing of the Company's non-mission critical internal information systems
and interfaces is expected to be substantially completed by June 30, 1999.
Examination of the Company's non-information technology systems indicated that
no significant replacements are required for Year 2000 readiness.

     While the Company continues to receive written verification from its
service bureau and vendors as to their Year 2000 compliance, and continues to
test their systems, there is no guarantee that these systems will not fail in
the Year 2000. Also, there can be no assurance that the systems of other
companies, banks, government agencies, etc. that interface with the Company will
be timely remediated. If they are not successful, the Year 2000 problem could
have a material effect on the Company's operations. The Company, therefore, has
drafted contingency and business resumption plans for its primary lines of
business. These plans are being enhanced to address potential Year 2000
scenarios. This process will be completed by the end of the second quarter of
1999.

     The expenditures of the project and the dates on which the Bank plans to
complete Year 2000 testing and contingency and business resumption plans, are
based on management's best estimates, which were derived utilizing numerous
assumptions of future events including the continued availablility of certain
resources, third party modification plans and other factors.

     Management presently does not believe that the Year 2000 issue will result
in significant operational problems for the Company. In addition, the Company's
efforts to address the Year 2000 issue are being monitored by its federal
banking regulators. Failure to be Year 2000 compliant on a timely basis could
subject the Company to formal supervisory or enforcement actions.


                                       15
<PAGE>   9

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 Asset/Liability Committee
("ALCO"). The ALCO which is comprised of members of the Company's Board of
Directors, members of senior management and the bank's comptroller, generally
meets quarterly to review the economic environment and the volume, mix and
maturity of the Company's assets and liabilities.

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 ALCO. 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 and mortgage-backed 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.

     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, profits 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 profits will fall as more liabilities react to
market rates than assets.

     In contrast, however, the Company's one-year GAP position in recent years
has been negative and its net interest income 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 raise rates or to 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 income has moved in the same direction as market interest rates in the
past and are likely to in the near future despite having a negative cumulative
one-year GAP position.


                                       16
<PAGE>   10

INTEREST RATE RISK (CONTINUED)

     The Company's policy is to limit its one-year GAP position to 15 percent of
total assets. 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.

     The following table summarizes the Company's GAP position at December 31,
1998. As of this date, the Company's one-year cumulative GAP position was
negative $21.6 million, or approximately 2.28% of total assets. 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.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------------------
                                                                    INTEREST SENSITIVITY PERIODS
                                               3 MONTHS        3 TO 6       6 MONTHS       1 TO 5         OVER           
(IN THOUSANDS)                                  OR LESS        MONTHS      TO 1 YEAR        YEARS       5 YEARS         TOTAL
------------------------------------------------------------------------------------------------------------------------------
<S>                                            <C>            <C>           <C>           <C>          <C>            <C>     
INTEREST-EARNING ASSETS:
Loans                                          $ 32,525      $ 14,469      $ 30,637      $165,685     $ 61,673      $304,989
Short-term investments:
    Federal funds sold                          123,207            --            --            --           --       123,207
    Investment in money market funds             24,569            --            --            --           --        24,569
Term federal funds sold                          25,000            --            --            --           --        25,000
Interest-bearing deposits in banks                  544           749            --           740           --         2,033
Securities held to maturity                          42            82            --           230           --           354
Securities available for sale                    60,306        27,401        48,818       212,210       69,391       418,126
Trading securities                               30,793            --            --            --           --        30,793
----------------------------------------------------------------------------------------------------------------------------
    Total interest-earning assets              $296,986      $ 42,701      $ 79,455      $378,865     $131,064      $929,071
----------------------------------------------------------------------------------------------------------------------------
INTEREST-BEARING LIABILITIES:
Deposits                                       $277,176      $ 83,556      $ 79,989      $ 99,968     $260,931      $801,620
----------------------------------------------------------------------------------------------------------------------------
    Total interest-bearing liabilities         $277,176      $ 83,556      $ 79,989      $ 99,968     $260,931      $801,620
----------------------------------------------------------------------------------------------------------------------------
GAP for period                                 $ 19,810      $(40,855)     $   (534)     $278,897     $129,867)     $127,451
Cumulative GAP                                 $ 19,810      $(21,045)     $(21,579)     $257,318     $127,451
Cumulative GAP as a percent of total assets        2.09%        (2.22%)       (2.28%)       27.18%       13.46%
----------------------------------------------------------------------------------------------------------------------------
Cumulative GAP - December 31, 1997             $(52,503)     $(85,716)     $(99,394)     $186,310     $115,560
==============================================================================================================================
</TABLE>


                                       17
<PAGE>   11

INTEREST RATE RISK (CONTINUED)

The following table shows the Company's financial instruments that are 
sensitive to changes in interest rates, categorized by expected maturity, and 
the instruments' fair values as of December 31, 1998.

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
                                                           EXPECTED MATURITY DATE
                                                            AT DECEMBER 31, 1998
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                                          FAIR VALUE
(IN THOUSANDS)                                      1998       1999      2000      2001      2002   THEREAFTER   TOTAL   AT 12/31/98
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                              <C>        <C>        <C>       <C>       <C>       <C>        <C>        <C>     
INTEREST SENSITIVE ASSETS:
Fixed rate securities                            $111,888   $ 81,582   $56,145   $48,685   $26,028   $ 69,391   $393,719   $393,719
    Average interest rate(1)                         6.40%      6.56%     6.54%     6.58%     6.77%      6.61%      6.54%         
Variable rate securities                           52,373        979        --        --        --      2,202     55,554     55,554
    Average interest rate(1)                         4.18%      4.61%       --        --        --       6.49%      4.28%         
Fixed rate loans                                   50,443     39,631    32,807    28,677    30,437     59,948    241,943    248,997
    Average interest rate                            6.99%      6.99%     7.01%     7.04%     6.99%      6.93%      6.98%         
Variable rate loans                                13,313     10,501     7,562     5,720     4,353     21,597     63,046     63,841
    Average interest rate                            7.64%      7.61%     7.62%     7.67%     7.74%      8.13%      7.81%         
Other fixed rate assets                            26,293        639       101        --        --         --     27,033     27,033
    Average interest rate                            5.54%      6.11%     5.50%       --        --         --       5.55%         
Other variable rate assets                        147,776         --        --        --        --         --    147,776    147,776
    Average interest rate                            4.96%        --        --        --        --         --       4.96%         
------------------------------------------------------------------------------------------------------------------------------------
        Total interest sensitive assets          $402,086   $133,332   $96,615   $83,082   $60,818   $153,138   $929,071   $936,920
------------------------------------------------------------------------------------------------------------------------------------
INTEREST SENSITIVE LIABILITIES:
Savings and money market
        deposit accounts                         $  5,504   $  3,901   $ 3,804   $ 3,714   $ 3,631   $327,495   $348,049   $348,049
    Average interest rate                            3.23%      3.20%     3.21%     3.21%     3.22%      3.44%      3.43%         
Fixed rate certificates of deposit                251,132     56,103     9,428     1,134       538        156    318,491    320,007
    Average interest rate                            5.22%      5.26%     5.25%     5.40%     5.19%      4.92%      5.23%         
Variable rate certificates of deposit              33,730     28,772    19,415       116        --         --     82,033     82,033
    Average interest rate                            5.79%      5.90%     6.02%     6.02%       --         --       5.88%         
NOW accounts                                           --         --        --        --        --     52,324     52,324     52,324
    Average interest rate                              --         --        --        --        --       1.16%      1.16%         
Escrow deposits of borrowers                        1,438         --        --        --        --         --      1,438      1,438
    Average interest rate                            0.25%        --        --        --        --         --       0.25%         
Deposit acquisition premium,
    net of amortization                              (226)      (230)     (230)      (29)       --         --       (715)        -- 
------------------------------------------------------------------------------------------------------------------------------------
        Total interest sensitive liabilities     $291,578   $ 88,546   $32,417   $ 4,935   $ 4,169   $379,975   $801,620   $803,851
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Securities rates presented are on a tax equivalent basis.

The Company uses certain assumptions to estimate fair values and expected
maturities. For interest-sensitive assets, expected maturities are based upon
contractual maturity, and projected repayments and prepayments of principal. 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 $21.6 million at December 31, 1998. The net
unrealized gains on these securities totaled $10.5 million at year-end 1998.
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.


                                       18
<PAGE>   12

AVERAGE BALANCE SHEETS

<TABLE>
<CAPTION>
==================================================================================================================================
(IN THOUSANDS) YEARS ENDED DECEMBER 31,               1998                          1997                          1996
----------------------------------------------------------------------------------------------------------------------------------
                                                     INTEREST   AVERAGE            INTEREST  AVERAGE             INTEREST  AVERAGE
                                        AVERAGE       INCOME/    YIELD/  AVERAGE    INCOME/   YIELD/  AVERAGE     INCOME/   YIELD/
                                       BALANCE(4)     EXPENSE   RATE(4) BALANCE(4)  EXPENSE  RATE(4) BALANCE(4)  EXPENSE   RATE(4)
----------------------------------------------------------------------------------------------------------------------------------
<S>                                    <C>          <C>          <C>     <C>        <C>       <C>     <C>         <C>       <C>  
ASSETS:

Earning assets:
    Federal funds sold                 $ 137,123    $   7,316    5.34%   $106,890   $ 5,840   5.46%   $ 95,253    $ 5,084   5.34%
    Short-term investments(2)             26,792        1,440    5.37      26,369     1,459   5.53      23,656      1,259   5.32
    Investment securities                145,863        8,473    5.81     166,949    10,554   6.32     194,229     12,586   6.48
    Mortgage-backed securities           299,368       20,496    6.85     321,521    22,368   6.96     277,409     19,353   6.98
    Trading securities                    16,460          819    4.98      12,741       735   5.77       9,719        563   5.79
    Mortgage loans(1)                    264,898       19,413    7.33     235,587    17,704   7.51     225,005     16,933   7.53
    Other loans(1)                        22,375        2,021    9.03      24,584     2,224   9.05      26,993      2,481   9.19
----------------------------------------------------------------------------------------------------------------------------------
       Total earning assets              912,879       59,978    6.56%    894,641    60,884   6.81%    852,264     58,259   6.84%
==================================================================================================================================
Allowance for                                                                                                     
    loan losses                           (2,375)                          (2,245)                      (2,414)
----------------------------------------------------------------------------------------------------------------------------------
    Total earning assets                                                                                          
    less allowance for                                                                                            
    loan losses                          910,504                          892,396                      849,850
Other assets                              19,512                           18,956                       19,194
----------------------------------------------------------------------------------------------------------------------------------
    Total assets                       $ 930,016                         $911,352                     $869,044
==================================================================================================================================
LIABILITIES:                                                                                                      

Deposits:                                                                                                         
    Demand and NOW                     $  70,159          554    0.79%   $ 65,895       536   0.81%   $ 63,969        574   0.90%
    Savings                              349,637       11,959    3.42     355,395    12,240   3.44     358,056     12,268   3.43
    Time certificates of deposit         391,816       21,807    5.57     386,062    21,905   5.67     352,385     20,220   5.74
----------------------------------------------------------------------------------------------------------------------------------
       Total deposits                    811,612       34,320    4.23     807,352    34,681   4.30     774,410     33,062   4.27
----------------------------------------------------------------------------------------------------------------------------------
Other liabilities                          9,776                            7,296                        6,106
----------------------------------------------------------------------------------------------------------------------------------
    Total liabilities                    821,388                          814,648                      780,516
==================================================================================================================================
STOCKHOLDERS' EQUITY:                    108,628                           96,704                       88,528

    Total liabilities and                                                                                         
       stockholders' equity            $ 930,016                         $911,352                     $869,044
==================================================================================================================================
Net interest income (tax-                                                                                         
    equivalent basis)                     25,658                           26,203                       25,197
Less adjustment of tax-                                                                                           
   exempt interest income                   (144)                            (151)                        (150)
----------------------------------------------------------------------------------------------------------------------------------
Net interest income                    $  25,514                         $ 26,052                     $ 25,047
----------------------------------------------------------------------------------------------------------------------------------
Interest rate spread                                     2.33%                         2.51%                                2.57%
----------------------------------------------------------------------------------------------------------------------------------
Net interest margin(3)                                   2.81%                         2.93%                                2.96%
==================================================================================================================================
</TABLE>

(1) Loans on nonaccrual status are included in the average balance.
(2) Short-term investments consist of interest-bearing deposits in banks and
    investments in money market funds.
(3) Net interest income (tax equivalent basis) before provision for loan losses
    divided by average interest-earning assets.
(4) Includes the effects of SFAS No. 115.



                                       19
<PAGE>   13

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.

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------
                                                 1998 COMPARED TO 1997             1997 COMPARED TO 1996
(IN THOUSANDS)                                    INCREASE (DECREASE)               INCREASE (DECREASE)
YEARS ENDED DECEMBER 31,                                 DUE TO                            DUE TO
--------------------------------------------------------------------------------------------------------------
                                            VOLUME        RATE       TOTAL      VOLUME      RATE       TOTAL
--------------------------------------------------------------------------------------------------------------
<S>                                         <C>         <C>         <C>         <C>         <C>       <C>    
INTEREST AND DIVIDEND INCOME:
    Federal funds sold                      $ 1,616     $  (140)    $ 1,476     $   634     $ 122     $   756
    Short-term investments                       23         (42)        (19)        148        52         200
    Investment securities                    (1,248)       (826)     (2,074)     (1,708)     (325)     (2,033)
    Trading securities                          194        (110)         84         174        (2)        172
    Mortgage-backed securities               (1,521)       (351)     (1,872)      3,069       (54)      3,015
    Mortgage loans                            2,157        (448)      1,709         795       (24)        771
    Other loans                                (200)         (3)       (203)       (218)      (39)       (257)
--------------------------------------------------------------------------------------------------------------
      Total interest and dividend income      1,021      (1,920)       (899)      2,894      (270)      2,624
--------------------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
  Deposits:
    Demand and NOW                               34         (16)         18          17       (55)        (38)
    Savings                                    (197)        (84)       (281)        (92)       64         (28)
    Time certificates of deposit                324        (422)        (98)      1,913      (228)      1,685
--------------------------------------------------------------------------------------------------------------
      Total interest expense                    161        (522)       (361)      1,838      (219)      1,619
--------------------------------------------------------------------------------------------------------------
Net interest income                         $   860     $(1,398)    $  (538)    $ 1,056     $ (51)    $ 1,005
==============================================================================================================
</TABLE>

IMPACT OF INFLATION AND CHANGING PRICES

MASSBANK Corp.'s financial statements presented herein have been prepared in 
accordance with generally accepted accounting principles which require the 
measurement of financial position and operating results in terms of 
historical dollars, without considering changes in the relative purchasing 
power of money over time, due to the fact that substantially all of the 
assets and liabilities of a financial institution are monetary in nature. As 
a result, interest rates have a more significant impact on a financial 
institution's performance than the effects of general levels of inflation. 
Interest rates do not necessarily move in the same direction or in the same 
magnitude as the prices of goods and services.

RECENT ACCOUNTING PRONOUNCEMENTS

ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities." This
Statement establishes accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
It requires that an entity recognize all derivatives as either assets or
liabilities in its balance sheet and measure those instruments at fair market
value. Under this Statement, an entity that elects to apply hedge accounting is
required to establish at the inception of the hedge the method it will use for
assessing the effectiveness of the hedging derivative and the measurement
approach for determining the ineffective aspect of the hedge. This Statement is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
This Statement is not expected to have a material effect on the Company's
consolidated financial statements.


                                       20
<PAGE>   14

INDEPENDENT AUDITORS' REPORT

[KPMG PEAT MARWICK LLP LOGO OMITTED]

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, 1998 and 1997, 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, 1998.
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 generally accepted auditing
standards. 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 at December 31, 1998 and 1997, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1998, in conformity with generally accepted accounting
principles. 


                                                       /s/ KPMG Peat Marwick LLP

Boston, Massachusetts 
January 11, 1999


                                       21
<PAGE>   15

MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------
(IN THOUSANDS EXCEPT SHARE DATA) AT DECEMBER 31,                                  1998         1997
-----------------------------------------------------------------------------------------------------
<S>                                                                             <C>          <C>     
ASSETS:
Cash and due from banks                                                         $  7,038     $  6,808
Short-term investments (Note 2)                                                  147,776      109,755
-----------------------------------------------------------------------------------------------------
    Total cash and cash equivalents                                              154,814      116,563
-----------------------------------------------------------------------------------------------------
Term federal funds sold                                                           25,000       20,000
Interest-bearing deposits in banks                                                 2,033        2,083
Securities held to maturity, at amortized cost
    (market value of $354 in 1998 and $372 in 1997) (Note 3)                         354          372
Securities available for sale, at market value
    (amortized cost of $398,343 in 1998 and $466,749 in 1997) (Note 3)           418,126      482,224
Trading securities, at market value (Note 4)                                      30,793       21,260
Loans (Notes 5, 7 and 11):
    Mortgage loans                                                               283,654      248,798
    Other loans                                                                   21,335       23,505
-----------------------------------------------------------------------------------------------------
       Total loans                                                               304,989      272,303
    Less: allowance for loan losses (Note 6)                                      (2,450)      (2,334)
-----------------------------------------------------------------------------------------------------
       Net loans                                                                 302,539      269,969
-----------------------------------------------------------------------------------------------------
Premises and equipment (Note 9)                                                    4,320        4,369
Real estate acquired through foreclosure (Note 7)                                     86           --
Accrued interest receivable                                                        5,058        5,395
Goodwill                                                                           1,387        1,487
Other assets                                                                       2,115        1,681
-----------------------------------------------------------------------------------------------------
    Total assets                                                                $946,625     $925,403
=====================================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY:
Deposits (Notes 10 and 11):
    Demand and NOW                                                              $ 76,173     $ 66,859
    Savings                                                                      348,049      352,875
    Time certificates of deposit                                                 400,524      391,034
    Deposit acquisition premium, net of amortization                                (715)        (918)
-----------------------------------------------------------------------------------------------------
       Total deposits                                                            824,031      809,850
Escrow deposits of borrowers                                                       1,438        1,502
Employee stock ownership plan liability (Note 15)                                    625          781
Accrued and deferred income taxes payable (Note 12)                                7,484        6,167
Other liabilities                                                                  2,558        3,324
-----------------------------------------------------------------------------------------------------
    Total liabilities                                                            836,136      821,624
-----------------------------------------------------------------------------------------------------
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, 7,384,332 and 7,336,800 shares issued, respectively               7,384        7,337
    Additional paid-in capital                                                    60,003       58,737
    Retained earnings                                                             78,308       70,984
-----------------------------------------------------------------------------------------------------
                                                                                 145,695      137,058
    Treasury stock at cost, 3,885,222 and 3,766,022 shares, respectively         (46,272)     (41,569)
    Accumulated other comprehensive income (Note 1)                               11,691        9,071
    Common stock acquired by ESOP (Note 15)                                         (625)        (781)
-----------------------------------------------------------------------------------------------------
       Total stockholders' equity                                                110,489      103,779
-----------------------------------------------------------------------------------------------------
       Total liabilities and stockholders' equity                               $946,625     $925,403
=====================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements. 


                                       22
<PAGE>   16

MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------
(IN THOUSANDS EXCEPT SHARE DATA) YEARS ENDED DECEMBER 31,          1998          1997          1996
------------------------------------------------------------------------------------------------------
<S>                                                             <C>           <C>           <C>       
INTEREST AND DIVIDEND INCOME:
    Mortgage loans                                              $   19,413    $   17,704    $   16,933
    Other loans                                                      2,021         2,224         2,481
    Securities available for sale:
      Mortgage-backed securities                                    20,496        22,368        19,353
      Other securities                                               8,310        10,385        12,425
    Trading securities                                                 819           735           563
    Federal funds sold                                               7,316         5,840         5,084
    Other investments                                                1,459         1,477         1,270
------------------------------------------------------------------------------------------------------
       Total interest and dividend income                            9,834        60,733        58,109
------------------------------------------------------------------------------------------------------
INTEREST EXPENSE:
    Deposits:
     NOW                                                               554           536           574
     Savings                                                        11,959        12,240        12,268
     Time certificates of deposit                                   21,807        21,905        20,220
------------------------------------------------------------------------------------------------------
       Total interest expense                                       34,320        34,681        33,062
------------------------------------------------------------------------------------------------------
       Net interest income                                          25,514        26,052        25,047
PROVISION FOR LOAN LOSSES (NOTE 6)                                     193           260           160
------------------------------------------------------------------------------------------------------
       Net interest income after provision for loan losses          25,321        25,792        24,887
------------------------------------------------------------------------------------------------------
NON-INTEREST INCOME:
    Deposit account service fees                                       811           924           932
    Gains on securities, net                                         2,893         1,939           868
    Other                                                              886           935           865
------------------------------------------------------------------------------------------------------
       Total non-interest income                                     4,590         3,798         2,665
------------------------------------------------------------------------------------------------------
NON-INTEREST EXPENSE:
    Salaries and employee benefits                                   7,426         7,743         7,215
    Occupancy and equipment                                          2,059         2,096         1,977
    Data processing                                                    510           438           608
    Professional services                                              461           407           340
    Merger and acquisition related expense                              --           156            --
    Advertising and marketing                                          171           187           220
    Amortization of intangibles                                        302           251           230
    Deposit insurance                                                  116           116            13
    Contributions                                                       14           664            60
    Other                                                            1,456         1,367         1,461
------------------------------------------------------------------------------------------------------
       Total non-interest expense                                   12,515        13,425        12,124
------------------------------------------------------------------------------------------------------
       Income before income taxes                                   17,396        16,165        15,428
INCOME TAX EXPENSE (NOTE 12)                                         6,482         5,998         6,001
------------------------------------------------------------------------------------------------------
       Net income                                               $   10,914    $   10,167    $    9,427
======================================================================================================
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING:
    Basic                                                        3,528,817     3,524,657     3,556,660
    Diluted                                                      3,676,642     3,663,310     3,658,505
EARNINGS PER SHARE (IN DOLLARS):
    Basic                                                       $     3.09    $     2.88    $     2.65
    Diluted                                                           2.97          2.77          2.58
======================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements. 


                                       23
<PAGE>   17

MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------
(IN THOUSANDS) YEARS ENDED DECEMBER 31,                                      1998         1997           1996
---------------------------------------------------------------------------------------------------------------
<S>                                                                       <C>           <C>           <C>      
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income                                                              $  10,914     $ 10,167      $   9,427
  Adjustments to reconcile net income to net cash (used in) provided
    by operating activities:
    Depreciation and amortization                                               928          853            735
    Loan interest capitalized                                                   (88)          --             -- 
    Amortization of ESOP shares committed to be released                        243          184             63
    Charitable contribution of appreciated securities                            --          622              5
    Decrease in accrued interest receivable                                     337          464          1,633
    (Decrease) increase in other liabilities                                   (734)          56           (388)
    (Decrease) increase in current income taxes payable                        (517)         435            (75)
    Accretion of discounts on securities, net of
      amortization of premiums                                               (1,152)      (1,178)        (1,052)
    Net trading securities activity                                          (8,671)     (16,480)         2,065
    Gains on securities available for sale                                   (2,798)      (1,831)          (950)
    (Gains) losses on trading securities                                        (95)        (108)            82
    Increase in deferred mortgage loan origination fees, net of
      amortization                                                              231          168            114
    Deferred income tax (benefit) expense                                       146         (372)           238
    Decrease (increase) in other assets                                          85          553            (74)
    Loans originated for sale                                                  (129)        (770)          (215)
    Loans sold                                                                  129          770            378
    Provision for loan losses                                                   193          260            160
    Provisions for losses and writedowns on real estate acquired
      through foreclosure                                                        --          (21)            32
    Gains on sales of real estate acquired through foreclosure                   (5)         (34)           (26)
    Gains on sales of premises and equipment                                     --           (1)            (2)
    (Decrease) increase in escrow deposits of borrowers                         (64)         231            279
---------------------------------------------------------------------------------------------------------------
      Net cash (used in) provided by operating activities                    (1,047)      (6,032)        12,429
---------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
    Cash and cash equivalents for acquisitions                                   --       (2,874)            -- 
    Purchases of term federal funds                                         (35,000)     (30,000)
    Proceeds from maturities of term federal funds                           30,000       20,000          5,000
    Increase in interest-bearing bank deposits                                 (766)      (1,649)          (810)
    Proceeds from maturities of interest-bearing bank deposits                  816        1,240             -- 
    Proceeds from sales of investment securities available for sale          26,580       42,741         49,940
    Proceeds from maturities of investment securities held to maturity
      and available for sale                                                 43,650       59,000         86,225
    Purchases of investment securities available for sale                   (59,291)     (63,696)       (56,196)
    Purchases of investment securities held to maturity                          --         (230)            --
    Purchases of mortgage-backed securities                                 (10,043)     (63,661)      (135,854)
    Principal repayments of mortgage-backed securities                       70,203       42,246         36,858
    Principal repayments of securities held to maturity                          18           18             17
    Principal repayments of securities available for sale                         4           85             --
    Loans originated                                                       (105,103)     (57,787)       (51,152)
    Loan principal payments received                                         71,687       48,560         49,118
    Loans purchased                                                              --         (201)            --
    Purchases of premises and equipment                                        (508)        (491)          (310)
    Proceeds from sale of premises and equipment                                 --            9              2
    Proceeds from sale of real estate acquired through foreclosure              316          964            511
    Net advances on real estate acquired through foreclosure                    (20)         (30)            --
---------------------------------------------------------------------------------------------------------------
      Net cash provided by (used in) investing activities                    32,543       (5,756)       (26,651)
---------------------------------------------------------------------------------------------------------------
                                                                                                    (Continued)
</TABLE>


                                       24
<PAGE>   18

MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS) YEARS ENDED DECEMBER 31,                                            1998          1997          1996
---------------------------------------------------------------------------------------------------------------------
<S>                                                                                <C>           <C>           <C>   
CASH FLOWS FROM FINANCING ACTIVITIES:
    Net increase (decrease) in deposits                                            13,978        (8,523)       34,463
    Payments to acquire treasury stock                                             (4,703)       (1,665)       (3,534)
    Issuance of common stock under stock option plan                                  741           466           738
    Tax benefit resulting from stock options exercised                                329           260           266
    Cash dividends paid on common stock                                            (3,605)       (3,124)       (2,459)
    Tax benefit resulting from dividends paid on unallocated shares
      held by the ESOP                                                                 15            15            15
---------------------------------------------------------------------------------------------------------------------
      Net cash provided by (used in) financing activities                           6,755       (12,571)       29,489
---------------------------------------------------------------------------------------------------------------------
      Net increase (decrease) in cash and cash equivalents                         38,251       (24,359)       15,267
Cash and cash equivalents at beginning of year                                    116,563       140,922       125,655
---------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year                                        $ 154,814     $ 116,563     $ 140,922
---------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL CASH FLOW DISCLOSURES:
CASH TRANSACTIONS:
    Cash paid during the year for interest                                      $  34,319     $  34,671     $  33,026
    Cash paid during the year for taxes                                             6,185         5,237         5,557
NON-CASH TRANSACTIONS:
    SFAS 115:
      Increase (decrease) in stockholders' equity                                   2,620         5,070        (3,239)
      Increase (decrease) in deferred tax liabilities                               1,688         3,510        (2,329)
      Securities reclassified from available for sale to trading                    1,111            --            -- 
    Transfers from loans to real estate acquired through foreclosure                  377           376           765
    Transfers from loans to other assets                                               56            --            -- 
    Transfers from premises and equipment to other assets                               9            --            -- 
    Purchases of securities incomplete (not settled) at beginning of
    year which settled during the year                                                 32            --            -- 
    Purchase of securities incomplete (not settled) as of year-end                    129            32            -- 
    Sales of securities incomplete (not settled) as of year-end                       583            --            30
    Cost of donated securities                                                         --             2            --
---------------------------------------------------------------------------------------------------------------------

In connection with the acquisition of Glendale Co-operative Bank in July, 1997, assets acquired and liabilities 
assumed were as follows:
    Assets acquired                                                                    --     $  31,561            -- 
    Goodwill                                                                           --         1,530            -- 
    Liabilities assumed                                                                --        30,217            -- 
---------------------------------------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements. 


                                       25
<PAGE>   19

MASSBANK CORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS EXCEPT SHARE DATA) YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
-----------------------------------------------------------------------------------------------------------------------------------
                                                                                                 ACCUMULATED   COMMON
                                                             ADDITIONAL                             OTHER       STOCK
                                                     COMMON    PAID-IN    RETAINED    TREASURY  COMPREHENSIVE  ACQUIRED
                                                      STOCK    CAPITAL    EARNINGS      STOCK       INCOME      BY ESOP     TOTAL
-----------------------------------------------------------------------------------------------------------------------------------
<S>                                                  <C>       <C>        <C>         <C>          <C>         <C>        <C>      
Balance at December 31, 1995                         $5,425    $56,842    $ 58,773    $(36,370)    $  7,240    $(1,093)   $  90,817
    Net Income                                           --         --       9,427          --           --         --        9,427
    Other comprehensive income, net of tax:
      Unrealized gains on securities, net of
      reclassification adjustment                        --         --          --          --       (3,239)        --       (3,239)
                                                                                                                            -------
    Comprehensive income                                 --         --          --          --           --         --        6,188
    Cash dividends declared
      ($0.69 per share)                                  --         --      (2,459)         --           --         --       (2,459)
    Tax benefit resulting from dividends paid
      on unallocated shares held by the ESOP             --         --          15          --           --         --           15
    Net decrease in liability to ESOP                    --         --          --          --           --        156          156
    Amortization of ESOP shares
      committed to be released                           --         63          --          --           --         --           63
    Purchase of treasury stock                           --         --          --      (3,534)          --         --       (3,534)
    Exercise of stock options and
      related tax benefits                               51        953          --          --           --         --        1,004
-----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996                          5,476     57,858      65,756     (39,904)       4,001       (937)      92,250
    Net Income                                           --         --      10,167          --           --         --       10,167
    Other comprehensive income, net of tax:
      Unrealized gains on securities, net of
      reclassification adjustment (Note 1)               --         --          --          --        5,070         --        5,070
                                                                                                                            -------
    Comprehensive income                                 --         --          --          --           --         --       15,237
    Cash dividends declared
      ($0.885 per share)                                 --         --      (3,124)         --           --         --       (3,124)
    Tax benefit resulting from dividends paid
      on unallocated shares held by the ESOP             --         --          15          --           --         --           15
    Net decrease in liability to ESOP                    --         --          --          --           --        156          156
    Amortization of ESOP shares
      committed to be released                           --        184          --          --           --         --          184
    Purchase of treasury stock                           --         --          --      (1,665)          --         --       (1,665)
    Exercise of stock options and
      related tax benefits                               31        695          --          --           --         --          726
    Transfer resulting from four-for-three
      stock split                                     1,830         --      (1,830)         --           --         --           -- 
-----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1997                          7,337     58,737      70,984     (41,569)       9,071       (781)     103,779
    Net Income                                           --         --      10,914          --           --         --       10,914
    Other comprehensive income, net of tax:
      Unrealized gains on securities, net of
      reclassification adjustment (Note 1)               --         --          --          --        2,620         --        2,620
                                                                                                                            -------
    Comprehensive income                                 --         --          --          --           --         --       13,534
    Cash dividends declared
      ($1.02 per share)                                  --         --      (3,605)         --           --         --       (3,605)
    Tax benefit resulting from dividends paid
      on unallocated shares held by the ESOP             --         --          15          --           --         --           15
    Net decrease in liability to ESOP                    --         --          --          --           --        156          156
    Amortization of ESOP shares
      committed to be released                           --        243          --          --           --         --          243
    Purchase of treasury stock                           --         --          --      (4,703)          --         --       (4,703)
    Exercise of stock options and
      related tax benefits                               47      1,023          --          --           --         --        1,070
-----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1998                         $7,384    $60,003    $ 78,308    $(46,272)    $ 11,691    $  (625)   $ 110,489
===================================================================================================================================
</TABLE>
See accompanying notes to consolidated financial statements. 


                                       26
<PAGE>   20

MASSBANK CORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

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
    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 Depositors 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 accounts of MASSBANK'S subsidiary, Readibank Equipment
    Corporation, which was sold in October, 1997 are also included through the
    sale date.

         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 generally accepted accounting principles 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.

         Certain amounts in the prior years' consolidated financial statements
    were reclassified to permit comparison with the current fiscal year. The
    Company's reported per share amounts and average common and common
    equivalent shares outstanding for 1997 and prior years have been restated to
    reflect the Company's four-for-three stock split of September 15, 1997.

    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 interest rates, changes in
    prepayment risk, the need to increase regulatory capital and other similar
    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, 1998, stockholders' equity included
    approximately $11.7 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 and losses on sales of securities available for sale which
    are also reported in non-interest income under the caption "gains on
    securities." When a security suffers a loss in value which is considered
    other than temporary, such loss is recognized by a charge to earnings.

    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.


                                       27
<PAGE>   21

1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

    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 management's assessment of many
    factors including the risk characteristics of the portfolio, underlying
    collateral, current and anticipated economic conditions that may affect the
    borrower's 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 substantially from the assumptions
    used in making the evaluation. In addition, various regulatory agencies, as
    an integral part of their examination process, periodically review the
    Bank's allowance for 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.

    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 and losses upon disposition are reflected
    in earnings as realized.

    GOODWILL

    The excess of purchase price over the fair value of net assets of acquired
    companies is classified and reported as goodwill. Goodwill is being
    amortized using the straight-line method, over 15 years.

    DEPOSIT ACQUISITION PREMIUM

    The deposit acquisition premium arising from acquisitions is reported net of
    accumulated amortization. Such premium is being amortized on a straight-line
    basis over 10 years.

    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.

    STOCK-BASED COMPENSATION

    On January 1, 1996, the Company adopted Statement of Financial Accounting
    Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation." The
    Statement establishes financial accounting and reporting standards for
    stock-based compensation plans. SFAS No. 123 encourages, but does not
    require, a fair value based method of accounting for stock-based
    compensation plans. The Statement allows an entity to continue to measure
    compensation cost for those plans using the intrinsic value based method
    prescribed by Accounting Principles Board ("APB") Opinion No. 25. For those
    entities electing to use the intrinsic value based method, SFAS No. 123
    requires pro forma disclosures of net income and earnings per share computed
    as if the fair value based method had been applied. The Company continues to
    account for stock-based compensation costs under APB Opinion No. 25.


                                       28
<PAGE>   22

1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

    EARNINGS PER COMMON SHARE

    In February 1997, the Financial Accounting Standards Board ("FASB") issued
    SFAS No. 128, "Earnings Per Share." This Statement supersedes APB Opinion
    No. 15 regarding the presentation of earnings per share ("EPS") on the face
    of the income statement. SFAS No. 128 replaces the presentation of Primary
    EPS with a Basic EPS calculation that excludes the dilutive effect of common
    stock equivalents. The Statement requires a dual presentation of Basic and
    Diluted EPS, which is computed similarly to Fully Diluted EPS pursuant to
    APB Opinion No. 15 for all entities with complex capital structures.

         For earnings per share 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.

         All share information set forth herein has been adjusted to reflect the
    4-for-3 split of the Company's common stock effective September 15, 1997.

    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 nonmember of the Federal Reserve System, 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 $2.7 million and $3.6 million at
    December 31, 1998 and 1997, 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.

    REPORTING COMPREHENSIVE INCOME

    The Company has adopted SFAS No. 130, "Reporting Comprehensive Income." This
    Statement establishes standards for the reporting and displaying of
    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" is used in the Statement to describe
    the total of all components of comprehensive income including net income.

         Comparative financial statements provided for earlier periods have been
    reclassified to reflect application of the provisions of the Statement. The
    adoption of this Statement did not have a material impact on the Company's
    financial presentation.

              The Company's other comprehensive income and related tax effect 
for the year ended December 31, 1998 and the year ended December 31, 1997 is 
as follows:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS) YEARS ENDED DECEMBER 31,                         1998                               1997
----------------------------------------------------------------------------------------------------------------------
                                                                 TAX        NET-                     TAX        NET-
                                                BEFORE-TAX    (EXPENSE)    OF-TAX    BEFORE-TAX   (EXPENSE)    OF-TAX
                                                  AMOUNT     OR BENEFIT    AMOUNT      AMOUNT    OR BENEFIT    AMOUNT
----------------------------------------------------------------------------------------------------------------------
<S>                                               <C>         <C>         <C>         <C>          <C>         <C>    
Unrealized gains on securities: 
  Unrealized holding gains arising during period  $ 7,106     $(2,864)    $ 4,242     $ 10,411     $(4,290)    $ 6,121
  Less: reclassification adjustment for
    gains realized in net income                   (2,798)      1,176      (1,622)      (1,831)        780      (1,051)
----------------------------------------------------------------------------------------------------------------------
  Net unrealized gains                              4,308      (1,688)      2,620        8,580      (3,510)      5,070
----------------------------------------------------------------------------------------------------------------------
  Other comprehensive income                      $ 4,308     $(1,688)    $ 2,620     $  8,580     $(3,510)    $ 5.070
======================================================================================================================
</TABLE>


                                       29
<PAGE>   23


1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

    EMPLOYERS' DISCLOSURES ABOUT PENSIONS AND OTHER POSTRETIREMENT BENEFITS

    Effective January 1, 1998, the Company adopted SFAS No. 132, "Employers'
    Disclosures about Pensions and Other Postretirement Benefits, an amendment
    of SFAS Nos. 87, 88 and 106." SFAS No. 132 standardizes the disclosure
    requirements for pensions and other postretirement benefits to the extent
    practicable, requires additional information on changes in the benefit
    obligations and fair values of plan assets that will facilitate financial
    analysis, and eliminates certain disclosures required by SFAS Nos. 87, 88
    and 106. The adoption of this pronouncement also requires restatement of
    disclosures for earlier periods. The adoption of this pronouncement did not
    have a material impact on the Company's financial presentation.

2.  SHORT-TERM INVESTMENTS

    Short-term investments consist of the following:

<TABLE>
<CAPTION>
------------------------------------------------------------
(In thousands) At December 31,            1998        1997
------------------------------------------------------------
<S>                                     <C>         <C>     
Federal funds sold (overnight)          $123,207    $ 85,241
Money market funds                        24,569      24,514
------------------------------------------------------------
        Total short-term investments    $147,776    $109,755
============================================================
</TABLE>

    The investments above are stated at cost which approximates market value.

3.  INVESTMENT SECURITIES

    The amortized cost and market value of investment securities follows:

<TABLE>
<CAPTION>
    ----------------------------------------------------------------------------------------------
                                                                    GROSS       GROSS
                                                     AMORTIZED   UNREALIZED   UNREALIZED   MARKET
    (IN THOUSANDS) AT DECEMBER 31, 1998                 COST        GAINS       LOSSES      VALUE
    ----------------------------------------------------------------------------------------------
    <S>                                               <C>         <C>        <C>          <C>     
    Securities held to maturity:
      Other bonds and obligations                     $    354    $    --    $     --     $    354
    ----------------------------------------------------------------------------------------------
        Total securities held to maturity                  354         --          --          354
    ----------------------------------------------------------------------------------------------
    Securities available for sale:
      Debt securities:
        U.S. Treasury obligations                      112,627      2,354          --      114,981
        U.S. Government agency obligations               8,966         26          --        8,992
    ----------------------------------------------------------------------------------------------
          Total                                        121,593      2,380          --      123,973
    ----------------------------------------------------------------------------------------------
        Mortgage-backed securities:
          Government National Mortgage Association      48,347      1,517          --       49,864
          Federal Home Loan Mortgage Corporation       205,949      5,116          (6)     211,059
          Federal National Mortgage Association          4,984        181          --        5,165
          Collateralized mortgage obligations            6,193         60          (3)       6,250
          Other                                            223         12          --          235
    ----------------------------------------------------------------------------------------------
          Total mortgage-backed securities             265,696      6,886          (9)     272,573
    ----------------------------------------------------------------------------------------------
          Total debt securities                        387,289      9,266          (9)     396,546
    ----------------------------------------------------------------------------------------------
      Equity securities                                 11,054     10,579         (53)      21,580
    ----------------------------------------------------------------------------------------------
          Total securities available for sale          398,343    $19,845    $    (62)    $418,126
    ----------------------------------------------------------------------------------------------
      Net unrealized gains on securities:
        available for sale                              19,783
    ----------------------------------------------------------------------------------------------
          Total securities available for sale, net     418,126
    ----------------------------------------------------------------------------------------------
          Total investment securities, net            $418,480
    ==============================================================================================
</TABLE>


                                       30
<PAGE>   24

3.  INVESTMENT SECURITIES (CONTINUED)

    The amortized cost and market value of investment securities follows:

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------
                                                                                     GROSS       GROSS                   
                                                                       AMORTIZED   UNREALIZED  UNREALIZED   MARKET
(IN THOUSANDS) AT DECEMBER 31, 1997                                       COST       GAINS       LOSSES      VALUE
-------------------------------------------------------------------------------------------------------------------
<S>                                                                     <C>         <C>          <C>       <C>     
Securities held to maturity:
  Other bonds and obligations                                           $    372    $    --      $  --     $    372
-------------------------------------------------------------------------------------------------------------------
         Total securities held to maturity                                   372         --         --          372
-------------------------------------------------------------------------------------------------------------------
Securities available for sale:
  Debt securities:
      U.S. Treasury obligations                                          121,399      1,622         --      123,021
      U.S. Government agency obligations                                   9,800         24        (11)       9,813
-------------------------------------------------------------------------------------------------------------------
         Total                                                           131,199      1,646        (11)     132,834
-------------------------------------------------------------------------------------------------------------------
      Mortgage-backed securities:
         Government National Mortgage Association                         60,493      1,247        (31)      61,709
         Federal Home Loan Mortgage Corporation                          248,744      4,257       (180)     252,821
         Federal National Mortgage Association                                      7,733  258      --        7,991
         Collateralized mortgage obligations                               7,836         62         --        7,898
         Other                                                               298         14         --          312
-------------------------------------------------------------------------------------------------------------------
         Total mortgage-backed securities                                325,104      5,838       (211)     330,731
-------------------------------------------------------------------------------------------------------------------
         Total debt securities                                           456,303      7,484       (222)     463,565
-------------------------------------------------------------------------------------------------------------------
  Investments in mutual funds                                              1,110          4         --        1,114
-------------------------------------------------------------------------------------------------------------------
  Equity securities                                                        9,336      8,227        (18)      17,545
-------------------------------------------------------------------------------------------------------------------
         Total securities available for sale                             466,749    $15,715      $(240)    $482,224
-------------------------------------------------------------------------------------------------------------------
  Net unrealized gains on securities
      available for sale                                                  15,475
-------------------------------------------------------------------------------------------------------------------
         Total securities available for sale, net                        482,224
-------------------------------------------------------------------------------------------------------------------
         Total investment securities, net                               $482,596
===================================================================================================================
</TABLE>


    During the years ended December 31, 1998, 1997 and 1996, the Company
    realized gains and losses on sales of securities available for sale as
    follows:


<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------
(IN THOUSANDS) AT DECEMBER 31,                 1998               1997                1996
-------------------------------------------------------------------------------------------------
                                             REALIZED           Realized            Realized
                                         GAINS     LOSSES    Gains     Losses    Gains     Losses
-------------------------------------------------------------------------------------------------
<S>                                      <C>         <C>     <C>       <C>       <C>       <C>   
U.S. Treasury obligations                $  180      $--     $   38    $ (35)    $  118    $(103)
Mortgage-backed securities                   --       --         --     (301)        --     (166)
Marketable equity securities              3,577     (959)     2,201      (96)     1,146      (45)
Other equity securities                      --       --         25       --         --       -- 
-------------------------------------------------------------------------------------------------
        Total realized gains (losses)    $3,757    $(959)    $2,264    $(432)    $1,264    $(314)
=================================================================================================
</TABLE>

    Proceeds from sales of debt securities available for sale during 1998, 1997
    and 1996 were $13.1 million, $34.1 million and $40.8 million, respectively.
    Proceeds from sales of equity securities available for sale during 1998,
    1997 and 1996, were $13.7 million, $8.6 million and $9.1 million,
    respectively. 

         There were no sales of investment securities held-to-maturity during
    1998, 1997 and 1996.


                                       31
<PAGE>   25

3.  INVESTMENT SECURITIES (CONTINUED)

    The amortized cost and market value of debt securities held to maturity and
    debt securities available for sale by contractual maturity are as follows:

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------
(IN THOUSANDS) AT DECEMBER 31,                                  1998                   1997
---------------------------------------------------------------------------------------------------
                                                       AMORTIZED    MARKET    AMORTIZED     MARKET
                                                         COST        VALUE       COST        VALUE
---------------------------------------------------------------------------------------------------
<S>                                                    <C>         <C>         <C>         <C>     
Investment securities held to maturity:
  Other bonds and obligations:
      Maturing after 1 year but within 5 years         $    230    $    230    $    230    $    230
      Maturing after 5 years but within 10 years             82          82          97          97
      Maturing after 10 years but within 15 years            42          42          45          45
---------------------------------------------------------------------------------------------------
          Total debt securities held to maturity            354         354         372         372
===================================================================================================
Investment securities available for sale:
  U.S. Treasury obligations:
      Maturing within 1 year                             50,876      51,260      35,869      36,001
      Maturing after 1 year but within 5 years           58,790      60,557      85,530      87,020
      Maturing after 5 years but within 10 years          2,961       3,164          --          --
---------------------------------------------------------------------------------------------------
          Total                                         112,627     114,981     121,399     123,021
---------------------------------------------------------------------------------------------------
  U.S. Government agency obligations:
      Maturing within 1 year                              2,000       2,006       2,000       2,006
      Maturing after 1 year but within 5 years            6,771       6,788       6,600       6,614
      Maturing after 5 years but within 10 years             --          --       1,000         994
      Maturing after 15 years                               195         198         200         199
---------------------------------------------------------------------------------------------------
          Total                                           8,966       8,992       9,800       9,813
---------------------------------------------------------------------------------------------------
  Mortgage-backed securities:
      Maturing within 1 year                                371         367         312         311
      Maturing after 1 year but within 5 years            6,014       6,155       8,826       8,984
      Maturing after 5 years but within 10 years         35,087      36,073      30,677      31,617
      Maturing after 10 years but within 15 years       219,579     225,298     279,147     283,631
      Maturing after 15 years                             4,645       4,680       6,142       6,188
---------------------------------------------------------------------------------------------------
          Total                                         265,696     272,573     325,104     330,731
---------------------------------------------------------------------------------------------------
          Total debt securities available for sale      387,289     396,546     456,303     463,565
===================================================================================================
  Net unrealized gains on debt securities
      available for sale                                  9,257          --       7,262          --
---------------------------------------------------------------------------------------------------
          Total debt securities available for sale,
           net carrying value                          $396,546    $396,546    $463,565    $463,565
===================================================================================================
</TABLE>

    Mortgage-backed securities are shown at their contractual maturity but are
    expected to have shorter average lives due to normal principal amortization
    and prepayments.


                                       32
<PAGE>   26
4.   TRADING SECURITIES

The amortized cost and market values of trading securities are as follows:
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) AT DECEMBER 31,               1998                           1997
----------------------------------------------------------------------------------------- 
                                  AMORTIZED       MARKET         AMORTIZED         MARKET
                                       COST        VALUE              COST          VALUE
----------------------------------------------------------------------------------------- 
<S>                                 <C>          <C>                <C>           <C>    

U.S. Treasury obligations           $29,690      $29,707            $18,548       $18,542
Investments in mutual funds           1,112        1,086              2,757         2,718
----------------------------------------------------------------------------------------- 
   Total trading securities         $30,802      $30,793            $21,305       $21,260
=========================================================================================
</TABLE>

During the years ended December 31, 1998, 1997 and 1996, the Company realized
gains and losses on sales of trading securities as follows:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) YEARS ENDED DECEMBER 31,     1998               1997           1996    
----------------------------------------------------------------------------------------- 
                                          REALIZED          REALIZED         REALIZED       
                                       GAINS   LOSSES    GAINS   LOSSES    GAINS   LOSSES   
-----------------------------------------------------------------------------------------    
<S>                                     <C>     <C>       <C>     <C>      <C>     <C>      

U.S. Treasury obligations               $ 48    $ --      $22     $ --     $--     $ --     
Investments in mutual funds               11     (35)      --      (33)     --      (44)    
Marketable equity securities              55     (20)      46       --      65       --     
-----------------------------------------------------------------------------------------    
   Total realized gains                                                                     
     (losses)                           $114    $(55)     $68     $(33)    $65     $(44)    
=========================================================================================    
</TABLE>
                                      
Proceeds from sales of trading securities during 1998, 1997 and 1996 were $50.2
million, $16.3 million and $3.1 million, respectively. Unrealized gains or
(losses) included in income in 1998, 1997 and 1996 were $36 thousand, $73
thousand and $(103) thousand, respectively.

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,
mortgage loans secured by commercial or investment property such as apartment
buildings and commercial or corporate facilities, and a variety of consumer
loans. The Bank also offers loans for the construction of residential homes,
multi-family properties and for land development. 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 construction 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.



                                                                              33

<PAGE>   27

5.   LOANS (continued)

The composition of the Bank's loan portfolio is summarized as follows:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------    
(In thousands) AT DECEMBER 31,                                         1998        1997
-----------------------------------------------------------------------------------------    
<S>                                                                  <C>         <C>     
Mortgage loans:
   Residential:
      Conventional:
          Fixed rate                                                 $237,979    $193,319
          Variable rate                                                42,702      50,163
      FHA and VA                                                        1,181       1,843
   Commercial                                                           2,257       3,861
   Construction                                                           730         492
-----------------------------------------------------------------------------------------
          Total mortgage loans                                        284,849     249,678
   Add: premium on loans                                                  259         343
   Less: deferred mortgage loan origination fees                       (1,454)     (1,223)
-----------------------------------------------------------------------------------------
          Mortgage loans, net                                         283,654     248,798
-----------------------------------------------------------------------------------------
Other loans:
   Consumer:
      Installment                                                       1,547       2,199
      Guaranteed education                                              7,967       8,934
      Other secured                                                     1,366       1,600
      Home equity lines of credit                                      10,159      10,470
      Unsecured                                                           235         266
-----------------------------------------------------------------------------------------
          Total consumer loans                                         21,274      23,469
   Commercial                                                              61          36
-----------------------------------------------------------------------------------------
          Total other loans                                            21,335      23,505
-----------------------------------------------------------------------------------------
          Total loans                                                $304,989    $272,303
=========================================================================================
</TABLE>

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, 1998 follows:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------
(In thousands)
-----------------------------------------------------------------------------------------
<S>                                                                                  <C>

Balance at December 31, 1997                                                         $340
Additions                                                                             342
Repayments                                                                           (120)
-----------------------------------------------------------------------------------------
Balance at December 31, 1998                                                         $562
=========================================================================================
</TABLE>



34

<PAGE>   28
6.   ALLOWANCE FOR LOAN LOSSES

An analysis of the activity in the allowance for loan losses is as follows:

<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------
(In thousands) YEARS ENDED DECEMBER 31,                1998           1997           1996
-----------------------------------------------------------------------------------------
<S>                                                  <C>            <C>            <C>    

Balance at beginning of year                         $2,334         $2,237         $2,529 
Glendale Co-operative Bank acquisition                   --            105             -- 
Provision for loan losses                               193            260            160 
Recoveries of loans previously charged-off               26             59             90 
-----------------------------------------------------------------------------------------
      Total                                           2,553          2,661          2,779 
-----------------------------------------------------------------------------------------
Less charge-offs:                                                                         
   Mortgage loans                                       (81)          (221)          (480)
   Other loans                                          (22)          (106)           (62)
----------------------------------------------------------------------------------------- 
Balance at end of year                               $2,450         $2,334         $2,237 
=========================================================================================
</TABLE>

The following table shows the allocation of the allowance for loan losses by
category of loans at December 31, 1998, 1997 and 1996.

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) AT DECEMBER 31,  1998                        1997                  1996
----------------------------------------------------------------------------------------- 
                                 PERCENTAGE              PERCENTAGE            PERCENTAGE
                                  OF LOANS                OF LOANS               OF LOANS
                     AMOUNT       TO TOTAL    AMOUNT      TO TOTAL     AMOUNT    TO TOTAL
----------------------------------------------------------------------------------------- 
<S>                  <C>             <C>      <C>             <C>      <C>           <C>
Mortgage loans:
   Residential       $1,786          92%      $1,544          90%      $1,915        88%
   Commercial             2           1           12           1            3         2
Consumer loans          153           7          160           9          119        10
Other loans              25          --           --          --           57        --
Unallocated             484          --          618          --          143        --   
----------------------------------------------------------------------------------------- 
      Total          $2,450         100%      $2,334         100%      $2,237       100%
=========================================================================================
</TABLE>

7.   NON-PERFORMING ASSETS

The following schedule summarizes non-performing assets at the dates shown:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) AT DECEMBER 31,                            1998         1997         1996
----------------------------------------------------------------------------------------- 
<S>                                                      <C>          <C>          <C>   

Total nonaccrual loans                                   $1,004       $1,771       $1,601
Total real estate acquired through foreclosure               86           --          503
----------------------------------------------------------------------------------------- 
     Total non-performing assets                         $1,090       $1,771       $2,104
=========================================================================================
Percent of non-performing loans to total loans             0.33%        0.65%        0.64%
Percent of non-performing assets to total assets           0.12%        0.19%        0.24%

</TABLE>

The reduction in interest income associated with nonaccrual loans is as follows:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) YEARS ENDED DECEMBER 31,                          1998      1997      1996
----------------------------------------------------------------------------------------- 
<S>                                                               <C>      <C>       <C> 
Interest income that would have been recorded
    under original terms                                          $84      $163      $149
Interest income actually recorded                                  61        97        78
----------------------------------------------------------------------------------------- 
Reduction in interest income                                      $23      $ 66      $ 71
=========================================================================================
</TABLE>

During 1998, 1997 and 1996 the Company had no impaired loans. 




                                                                              35
<PAGE>   29
8.   FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

The Bank is party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers and to
reduce its own exposure to fluctuations in interest rates. These financial
instruments include 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
Bank's 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.

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
                                                              CONTRACT OR NOTIONAL AMOUNT
(In thousands) AT DECEMBER 31,                                           1998      1997
----------------------------------------------------------------------------------------- 
<S>                                                                    <C>       <C>    
Financial instruments whose contract amounts represent 
  credit risk:
    Commitments to originate residential mortgage loans                 $ 7,941   $ 4,090
    Unadvanced portions of construction loans                               281       496
    Unused credit lines, including unused portions of
      equity lines of credit                                             29,163    19,445
=========================================================================================
</TABLE>

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.

9.   PREMISES AND EQUIPMENT

A summary of premises and equipment and their estimated useful lives used for
depreciation purposes is as follows:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
                                                                                ESTIMATED
                                                                              USEFUL LIFE
(IN THOUSANDS) AT DECEMBER 31,                                1998      1997    (IN YEARS) 
----------------------------------------------------------------------------------------- 
<S>                                                          <C>       <C>        <C>
Premises:
    Land                                                     $1,227    $1,227         --
    Buildings                                                 3,637     3,642      25-45
    Building and leasehold improvements                       1,937     1,635       1-20
Equipment                                                     3,606     3,405       1-30
----------------------------------------------------------------------------------------- 
                                                             10,407     9,909       
Less: accumulated depreciation and amortization               6,087     5,540
----------------------------------------------------------------------------------------- 
      Total premises and equipment, net                      $4,320    $4,369
=========================================================================================
</TABLE>

The Bank is obligated under a number of noncancelable operating leases for
various banking offices. These operating leases expire at various dates through
2006 with options for renewal. Rental expenses for the years ended December 31,
1998, 1997 and 1996 amounted to $518 thousand, $522 thousand and $508 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, 1998, are as follows:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) YEARS ENDING DECEMBER 31,                                         PAYMENTS
----------------------------------------------------------------------------------------- 
<C>                                                                                 <C>   
1999                                                                                $ 465 
2000                                                                                  252    
2001                                                                                  252    
2002                                                                                  165    
2003                                                                                  110    
Later years                                                                            98
----------------------------------------------------------------------------------------- 
    Total                                                                          $1,342
=========================================================================================
</TABLE>



36
<PAGE>   30
10.  DEPOSITS

Deposits are summarized as follows:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) AT DECEMBER 31,                               1998                1997
----------------------------------------------------------------------------------------- 
                                                        AMOUNT   RATE       AMOUNT   RATE
----------------------------------------------------------------------------------------- 
<S>                                                   <C>        <C>      <C>        <C>  
Demand and NOW:
    NOW accounts                                      $ 52,324   1.16%    $ 47,944   1.14%
    Demand accounts                                     23,849     --       18,915     -- 
----------------------------------------------------------------------------------------- 
        Total demand and NOW                            76,173   0.80       66,859   0.82 
----------------------------------------------------------------------------------------- 
Savings:                                                                                  
    Regular savings and special notice accounts        326,192   3.46      329,348   3.47 
    Money market accounts                               21,857   2.99       23,527   3.09 
----------------------------------------------------------------------------------------- 
        Total savings                                  348,049   3.43      352,875   3.44 
----------------------------------------------------------------------------------------- 
Time certificates:                                                                        
    Fixed rate certificates                            318,491   5.23      316,368   5.53 
    Variable rate certificates                          82,033   5.88       74,666   6.48 
----------------------------------------------------------------------------------------- 
        Total time certificates                        400,524   5.36      391,034   5.71 
----------------------------------------------------------------------------------------- 
Deposit acquisition premium, net of amortization          (715)    --         (918)    -- 
----------------------------------------------------------------------------------------- 
        Total deposits                                $824,031   4.13%    $809,850   4.32%
=========================================================================================
</TABLE>

The maturity distribution and related rate structure of the Bank's time
certificates at December 31, 1998 follows:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) AT DECEMBER 31,                                              1998
----------------------------------------------------------------------------------------- 
                                                                               AVERAGE
                                                                    AMOUNT  INTEREST RATE
----------------------------------------------------------------------------------------- 
<S>                                                                <C>          <C>  
Due within 3 months                                                $103,985     5.34%
Due within 3-6 months                                                87,696     5.10        
Due within 6-12 months                                               93,181     5.41        
Due within 1-2 years                                                 84,874     5.48        
Due within 2-3 years                                                 28,843     5.77        
Due within 3-5 years                                                  1,789     5.38        
Thereafter                                                              156     4.92 
----------------------------------------------------------------------------------------- 
    Total                                                          $400,524     5.36%
=========================================================================================
</TABLE>

At December 31, the Bank had individual time certificates of deposit of $100
thousand or more maturing as follows:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) AT DECEMBER 31,                                          1998       1997
----------------------------------------------------------------------------------------- 
<S>                                                                   <C>         <C>      
Due within 3 months                                                   $24,283     $22,757  
Due within 3-6 months                                                  13,338       9,298    
Due within 6-12 months                                                 15,511      17,969   
Due within 1-2 years                                                   16,997      12,293   
Due within 2-3 years                                                    6,759       8,602    
Due within 3-5 years                                                      100         114      
----------------------------------------------------------------------------------------- 
    Total                                                             $76,988     $71,033
=========================================================================================
</TABLE>


                                                                              37

<PAGE>   31
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 they mature in 90 days or less.

INTEREST-BEARING DEPOSITS IN BANKS AND TERM FEDERAL FUNDS SOLD

The carrying amounts of the interest-bearing deposits in banks and term federal
funds sold reported in the balance sheet at December 31, 1998 and 1997
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:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) AT DECEMBER 31,                      1998                   1997
----------------------------------------------------------------------------------------- 
                                            CARRYING   CALCULATED   CARRYING   CALCULATED
                                              AMOUNT   FAIR VALUE    AMOUNT    FAIR VALUE
----------------------------------------------------------------------------------------- 
<S>                                         <C>         <C>          <C>         <C>         
Securities held to maturity                 $    354    $    354     $    372    $    372    
Securities available for sale                418,126     418,126      482,224     482,224    
Trading securities                            30,793      30,793       21,260      21,260
----------------------------------------------------------------------------------------- 
    Total securities                        $449,273    $449,273     $503,856    $503,856    
=========================================================================================
</TABLE>
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 other.

     The fair values of residential, commercial, and certain consumer and other
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 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:
<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) AT DECEMBER 31,                 1998                         1997
----------------------------------------------------------------------------------------- 
                                      CARRYING     CALCULATED       CARRYING   CALCULATED
                                        AMOUNT     FAIR VALUE        AMOUNT    FAIR VALUE
----------------------------------------------------------------------------------------- 
<S>                                   <C>            <C>            <C>          <C>      
Real estate:
  Residential:
      Variable                        $ 42,617       $ 43,142       $ 50,068     $ 50,709 
      Fixed                            238,787        245,858        194,881      199,220 
  Commercial:                                                                             
      Variable                           2,243          2,267          3,833        3,867 
      Fixed                                  7              7             16           16 
  Consumer and other                    21,335         21,564         23,505       23,438 
----------------------------------------------------------------------------------------- 
      Total loans                      304,989        312,838        272,303      277,250 
Less: allowance for loan losses         (2,450)            --         (2,334)          -- 
----------------------------------------------------------------------------------------- 
      Net loans                       $302,539       $312,838       $269,969     $277,250 
=========================================================================================
</TABLE>

38
<PAGE>   32
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, 1998 and 1997. 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.

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) AT DECEMBER 31,  1998    1997
----------------------------------------------------------------------------------------- 
                                      CARRYING     CALCULATED       CARRYING   CALCULATED
                                        AMOUNT     FAIR VALUE        AMOUNT    FAIR VALUE
----------------------------------------------------------------------------------------- 
<S>                                   <C>           <C>             <C>         <C>      

Demand accounts                       $ 23,849      $ 23,849        $ 18,915    $ 18,915 
NOW accounts                            52,324        52,324          47,944      47,944 
Regular savings and special                                                              
  notice accounts                      326,192       326,192         329,348     329,348 
Money market accounts                   21,857        21,857          23,527      23,527 
Time certificates                      400,524       402,040         391,034     391,926 
Deposit acquisition premium, net                                                         
  of amortization                         (715)           --            (918)         --   
----------------------------------------------------------------------------------------- 
        Total deposits                 824,031       826,262         809,850     811,660 
Escrow deposits of borrowers             1,438         1,438           1,502       1,502 
----------------------------------------------------------------------------------------- 
        Total                         $825,469      $827,700        $811,352    $813,162 
========================================================================================
</TABLE>
                                                                     
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, 1998 and 1997 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 significant 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 based on existing on and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not considered
financial instruments. For example, the Bank has a trust department that
contributes net 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 many of the
estimates.


                                                                              39

<PAGE>   33
12.  INCOME TAXES

Income tax payable was allocated as follows:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) AT DECEMBER 31,                                         1998         1997
----------------------------------------------------------------------------------------- 
<S>                                                                   <C>          <C>      
Current income tax payable (receivable):
   Federal                                                            $1,010       $1,192   
   State                                                                (287)          48   
----------------------------------------------------------------------------------------- 
       Total current income tax payable                                  723        1,240   
----------------------------------------------------------------------------------------- 
Deferred income tax payable:                                                                
   Federal                                                             5,298        3,735   
   State                                                               1,463        1,192   
----------------------------------------------------------------------------------------- 
       Total deferred income tax payable                               6,761        4,927   
----------------------------------------------------------------------------------------- 
       Total income tax payable                                       $7,484       $6,167   
=========================================================================================

</TABLE>

Income tax expense (benefit) was allocated as follows:                

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) YEARS ENDED DECEMBER 31,                      1998       1997        1996
----------------------------------------------------------------------------------------- 
<S>                                                        <C>        <C>          <C>
Current income tax expense:
   Federal                                                 $5,565     $5,096       $4,641 
   State                                                      771      1,034        1,122  
----------------------------------------------------------------------------------------- 
       Total current tax expense                            6,336      6,130        5,763  
=========================================================================================
Deferred income tax expense (benefit):                                                     
   Federal                                                    110       (102)         194  
   State                                                       40        (26)          53  
   Change in valuation reserve                                 (4)        (4)          (9) 
----------------------------------------------------------------------------------------- 
       Total deferred tax expense (benefit)                   146       (132)         238  
----------------------------------------------------------------------------------------- 
       Total income tax expense                            $6,482     $5,998       $6,001  
=========================================================================================
</TABLE>

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:

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) YEARS ENDED DECEMBER 31,                         1998       1997     1996
----------------------------------------------------------------------------------------- 
<S>                                                            <C>       <C>       <C>   
Computed "expected" income tax expense at statutory rate       $6,089    $5,658    $5,400
Increase (reduction) in income taxes resulting from:
    State and local income taxes, net of federal benefit          527       656       764
    Dividends received deduction                                  (87)      (95)      (94)
    Other                                                         (43)     (217)      (60)
    Change in valuation reserve                                    (4)       (4)       (9)
----------------------------------------------------------------------------------------- 
Income tax expense                                             $6,482    $5,998    $6,001
----------------------------------------------------------------------------------------- 
Effective income tax rate                                       37.26%    37.10%    38.90%
=========================================================================================
</TABLE>




40

<PAGE>   34
12.  INCOME TAXES (continued)

At December 31, 1998 and 1997, the Bank had gross deferred tax assets and gross
deferred tax liabilities as follows: 

<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------- 
(In thousands) YEARS ENDED DECEMBER 31,                                  1998        1997
----------------------------------------------------------------------------------------- 
<S>                                                                    <C>         <C>     
Deferred tax assets:
  Loan losses                                                          $  431      $  257  
  Deferred loan fees, net                                                 100         195 
  Deferred compensation and pension cost                                  463         546 
  Depreciation                                                             33          83 
  Purchase accounting                                                     419         468 
  Other                                                                     6          26 
----------------------------------------------------------------------------------------- 
  Gross deferred tax asset                                              1,452       1,575 
----------------------------------------------------------------------------------------- 
Deferred tax liabilities:                                                                 
   Valuation of securities                                              8,092       6,404  
   Other unrealized securities gains                                      102          86 
   Other                                                                   19          12 
----------------------------------------------------------------------------------------- 
   Gross deferred tax liability                                         8,213       6,502 
----------------------------------------------------------------------------------------- 
Net deferred tax liability                                             $6,761      $4,927 
=========================================================================================
</TABLE>

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, 1998. The primary sources of
recovery of the gross federal deferred tax asset are federal income taxes paid
in 1998, 1997 and 1996 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:

<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------- 
Years Ended December 31,                           1998                      1997                       1996
---------------------------------------------------------------------------------------------------------------------- 
(In thousands except share data)            Basic      Diluted        Basic        Diluted        Basic        Diluted
---------------------------------------------------------------------------------------------------------------------- 
<S>                                     <C>          <C>          <C>           <C>           <C>           <C>       

Net income                              $   10,914   $   10,914   $   10,167    $   10,167    $    9,427    $    9,427
Average shares outstanding               3,571,298    3,571,298    3,575,962     3,575,962     3,616,769     3,616,769
Dilutive stock options                          --      147,825           --      138,653             --       101,845
Unallocated Employee Stock
   Ownership Plan ("ESOP") shares
      not committed to be released         (42,481)     (42,481)     (51,305)      (51,305)      (60,109)      (60,109)
---------------------------------------------------------------------------------------------------------------------- 
Weighted average shares outstanding      3,528,817    3,676,642    3,524,657     3,663,310     3,556,660     3,658,505
Earnings per share (in dollars)         $     3.09   $     2.97   $     2.88    $     2.77    $     2.65    $     2.58
======================================================================================================================
</TABLE>



                                                                              41
<PAGE>   35

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, 1998.

     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.


<TABLE>
<CAPTION>

(IN THOUSANDS)                                                         FOR CAPITAL           TO BE WELL
------------------------------------------------------------------------------------------------------------
AT DECEMBER 31, 1998                                  ACTUAL         ADEQUACY PURPOSES      CAPITALIZED(1)
------------------------------------------------------------------------------------------------------------
                                                 AMOUNT    RATIO     AMOUNT      RATIO      AMOUNT     RATIO
------------------------------------------------------------------------------------------------------------
<S>                                            <C>         <C>      <C>          <C>                       
TIER I CAPITAL (TO AVERAGE ASSETS):
Massbank Corp. (consolidated)                  $ 96,696    10.61%   $27,349      3.00          N/A       --
Massbank (the "Bank")                            94,305    10.34     27,349      3.00      $45,583     5.00%

TIER I CAPITAL (TO RISK-WEIGHTED ASSETS):
Massbank Corp. (consolidated)                    96,696    32.40     11,936      4.00          N/A       --
Massbank (the "Bank")                            94,305    31.59     11,939      4.00       17,909     6.00

TOTAL CAPITAL (TO RISK-WEIGHTED ASSETS):
Massbank Corp. (consolidated)                   103,883    34.81     23,872      8.00          N/A       --
Massbank (the "Bank")                           101,492    34.00     23,878      8.00       29,848    10.00
===========================================================================================================
</TABLE>

(1)  This column presents the minimum amounts and ratios that a financial
     institution must have to be categorized as adequately capitalized.

<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------
(IN THOUSANDS)                                                         FOR CAPITAL           TO BE WELL
AT DECEMBER 31, 1997                                  ACTUAL         ADEQUACY PURPOSES      CAPITALIZED(1)
------------------------------------------------------------------------------------------------------------
                                                 AMOUNT    RATIO     AMOUNT      RATIO      AMOUNT     RATIO
------------------------------------------------------------------------------------------------------------
<S>                                            <C>         <C>      <C>          <C>                       
TIER I CAPITAL (TO AVERAGE ASSETS):
Massbank Corp. (consolidated)                   $92,303    10.23%    $27,071      3.00%         N/A       --
Massbank (the "Bank")                            88,852     9.85      27,071      3.00      $45,118     5.00% 
                                                                                                              
TIER I CAPITAL (TO RISK-WEIGHTED ASSETS):                                                                     
Massbank Corp. (consolidated)                    92,303    34.14      10,814      4.00          N/A       --  
Massbank (the "Bank")                            88,852    32.87      10,814      4.00       16,221     6.00  
                                                                                                              
TOTAL CAPITAL (TO RISK-WEIGHTED ASSETS):                                                                      
Massbank Corp. (consolidated)                    94,637    35.01      21,628      8.00          N/A       --  
Massbank (the "Bank")                            91,186    33.73      21,628      8.00       27,035    10.00  
============================================================================================================
</TABLE>

(1)  This column presents the minimum amounts and ratios that a financial
     institution must have to be categorized as adequately capitalized.



42
<PAGE>   36

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, 1998 and 1997, the plan's latest valuation dates: 

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------
(In thousands) YEARS ENDED DECEMBER 31,                              1998        1997        1996
-------------------------------------------------------------------------------------------------
<S>                                                                <C>         <C>         <C>   

Actuarial present value of vested benefits                         $4,442      $4,028      $3,636
Total accumulated benefit obligation                                4,481       4,063       3,661
Change in benefit obligation
   Projected benefit obligation at beginning of year               $4,990      $4,287      $4,622
   Service cost                                                       443         367         309
   Interest cost                                                      362         321         308
   Actuarial loss (gain)                                              283         221        (742)
   Benefits paid                                                     (290)       (206)       (210)
-------------------------------------------------------------------------------------------------
   Projected benefit obligation at end of year                     $5,788      $4,990      $4,287
=================================================================================================
Change in plan assets
   Fair value of plan assets at beginning of year                  $5,810      $5,090      $4,181
   Actual return on plan assets                                       469         926         667
   Employer contribution                                              254          --         452
   Benefits paid                                                     (290)       (206)       (210)
-------------------------------------------------------------------------------------------------
   Fair value of plan assets at end of year                        $6,243      $5,810      $5,090
-------------------------------------------------------------------------------------------------
   Excess of plan assets over projected benefit obligation         $  455      $  820      $  803
=================================================================================================

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:

<CAPTION>
<S>                                                                <C>         <C>         <C>   

   Unrecognized net actuarial gain                                 $  487      $  886      $  670
   Transition asset                                                   190         211         232
   Accrued benefit cost                                              (222)       (277)        (99)
-------------------------------------------------------------------------------------------------
   Excess of plan assets over projected benefit obligation         $  455      $  820      $  803
=================================================================================================
Assumptions used in determining the actuarial
present value of the projected benefit obligation
were as follows:        
   Discount rate                                                     6.75%       7.25%       7.50% 
   Rate of compensation increase                                     4.50%       4.50%       4.50% 
Assumptions used to develop the                                                                   
net periodic benefit cost data were:                                                              
   Discount rate                                                     7.25%       7.50%       7.00% 
   Expected return on plan assets                                    8.00%       8.00%       8.00% 
   Rate of compensation increase                                     4.50%       4.50%       4.50% 
Components of net periodic benefit cost                                                           
   Service cost                                                    $  443      $  367      $  309  
   Interest cost                                                      362         322         308  
   Expected return on plan assets                                    (465)       (407)       (335) 
   Transition obligation                                              (21)        (21)        (21) 
   Recognized net actuarial (gain) loss                              (119)        (84)          7  
-------------------------------------------------------------------------------------------------
   Net periodic benefit cost                                       $  200      $  177      $  268  
=================================================================================================
</TABLE>


                                                                              43
<PAGE>   37

15.  EMPLOYEE BENEFITS (CONTINUED)

PROFIT SHARING AND INCENTIVE COMPENSATION BONUS PLANS

The Bank's Profit Sharing and 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 $399 thousand, $417 thousand
and $418 thousand were awarded under the plan in 1998, 1997 and 1996,
respectively.

EMPLOYEE STOCK OWNERSHIP PLAN

The Bank has an Employees' Stock Ownership Plan ("ESOP") 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. As of December 31,
1998 and 1997, such outstanding liabilities totaled $625 thousand and $781
thousand, respectively.

     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, 1998, the ESOP held
35,200 unallocated shares and 123,563 shares which have been allocated to
participants. The fair value of the unallocated shares at December 31, 1998 was
approximately $1.4 million.

     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 account.

     Total compensation and interest expense applicable to the ESOP amounted to
$462 thousand, $398 thousand and $314 thousand for the years ended December 31,
1998, 1997 and 1996, 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 $105
thousand, $132 thousand and $99 thousand in 1998, 1997 and 1996, respectively.

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 42/3 of the 690,000 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 360,000 shares.
Both incentive stock options and non-qualified stock options may be granted
under the plans. As of December 31, 1998, there were 141,010.7 non-qualified
stock options and 206,906.6 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.



44
<PAGE>   38
15.  EMPLOYEE BENEFITS (CONTINUED)

A summary of the status of the Company's fixed stock option plan as of December
31, 1998, 1997 and 1996, and changes during the years ended on those dates is
presented below:(1)
        
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31,                      1998                   1997                   1996    
--------------------------------------------------------------------------------------------------------
                                                  WEIGHTED                WEIGHTED              WEIGHTED
                                        SHARES    AVERAGE     SHARES      AVERAGE      SHARES    AVERAGE
                                         UNDER    EXERCISE     UNDER      EXERCISE     UNDER    EXERCISE 
FIXED OPTIONS                           OPTION     PRICE      OPTION       PRICE       OPTION     PRICE
--------------------------------------------------------------------------------------------------------
<S>                                     <C>        <C>      <C>           <C>          <C>        <C>   

Outstanding at beginning of year        360,200    $17.65   347,166.7     $  15.46     369,776    $13.60
Granted                                  35,250     44.25    48,333.3        30.09      46,000     23.40
Exercised                               (47,532)    15.59     (35,300)       13.19   (68,605.3)    10.74
Forfeited                                  (0.7)    30.09          --           --          (4)     8.63
--------------------------------------------------------------------------------------------------------
Outstanding at end of year            347,917.3    $20.62     360,200       $17.65   347,166.7    $15.46
--------------------------------------------------------------------------------------------------------
Options exercisable at year-end       347,917.3               360,200                347,166.7        --
--------------------------------------------------------------------------------------------------------
</TABLE>

The following table summarizes information about fixed stock options outstanding
and exercisable at December 31, 1998:
<TABLE>
<CAPTION>            
----------------------------------------------------------------------------------------
AT DECEMBER 31, 1998                    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
----------------------------------------------------------------------------------------
<C>      <C>             <C>          <C>              <C>           <C>         <C>    

$6.88 to $10.75          61,700       2.6 years        $ 8.66        61,700      $ 8.66 
16.00 to $17.34         159,884       4.8 years         16.62       159,884       16.62 
18.28 to $19.88         3,666.7       6.5 years         19.44       3,666.7       19.44 
23.25 to $44.25       122,666.6       8.0 years         31.89     122,666.6       31.89 
----------------------------------------------------------------------------------------
$6.88 to $44.25       347,917.3       5.5 years        $20.62     347,917.3      $20.62 
========================================================================================
</TABLE>
                                                                  
(1)  All share information presented has been adjusted to reflect the 4-for-3
     and 3-for-2 split of the Company's common stock effective September 15,
     1997 and September 9, 1994, respectively.

As discussed in Note 1, the Company adopted SFAS No. 123 on January 1, 1996, but
continues to account for its stock option plan using the intrinsic value based
method prescribed by APB Opinion No. 25. Accordingly, no compensation cost for
this plan has been recognized in the Consolidated Statements of Income for 1998.

     In determining the pro forma disclosures required by SFAS No. 123, the fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model. The following table presents pro forma net
income and earnings per share assuming the stock option plan was accounted for
using the fair value method prescribed by SFAS No. 123, the weighted average
assumptions used and the grant date fair value of options granted in 1998, 1997
and 1996:

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------
(In thousands except per share data) Years Ended December 31, 1998        1997        1996
-------------------------------------------------------------------------------------------
<S>                                                        <C>         <C>           <C>         

Net income                                   As reported   $  10,914   $  10,167     $9,427      
                                               Pro forma       0,743       9,916      9,230  
-------------------------------------------------------------------------------------------
Basic earnings per share                     As reported   $    3.09   $    2.88     $ 2.65  
                                               Pro forma        3.04        2.81       2.60  
-------------------------------------------------------------------------------------------
Diluted earnings per share                   As reported   $    2.97   $    2.77     $ 2.58  
                                               Pro forma        2.92        2.70       2.52  
-------------------------------------------------------------------------------------------
Weighted average fair value                                $    8.23   $    8.84     $ 8.04  
Expected life                                              7.3 years   7.4 years  7.2 years  
Risk-free interest rate                                         5.53%       6.47%      5.64% 
Expected volatility                                             23.0%       22.0%      23.0% 
Expected dividend yield                                          2.7%        2.3%       2.7% 
===========================================================================================
</TABLE>


                                                                              45
<PAGE>   39

16.  SHAREHOLDER RIGHTS AGREEMENT

In January, 1990, the Board of Directors adopted a Shareholders Rights Plan.
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 upon the occurrence of one of three
triggering events as specified in the Plan. In the event they become
exercisable, each holder of a Right would then be entitled to buy a unit
consisting of one one-hundredth of a share of the Company's preferred stock at
an exercise price of $70. The provisions of the Rights Plan, including the time
periods set forth therein, generally may be extended or amended by the Board of
Directors. The Rights will expire January 16, 2000, but they may be redeemed at
the option of the Board of Directors for $0.01 per Right until ten days after a
person becomes a 15% shareholder of Massbank Corp. or until certain other
triggering events have occurred.

17.  PARENT COMPANY FINANCIAL STATEMENTS

The following are the condensed financial statements for MASSBANK Corp. (the
"Parent Company") only:

 Balance Sheets
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------
(In thousands except share data) AT DECEMBER 31,                1998           1997
-------------------------------------------------------------------------------------
<S>                                                           <C>            <C>     
Assets:
  Cash                                                        $      1       $     13
  Interest-bearing deposits in banks                             2,324          3,390
  Investment in subsidiaries                                   108,724        101,109
  Due from subsidiaries                                             45             --
  Other assets                                                      53             77
-------------------------------------------------------------------------------------
        Total assets                                          $111,147       $104,589
=====================================================================================
Liabilities:
  Employee stock ownership plan liability (Note 15)           $    625       $    781
  Other liabilities                                                 33             29
-------------------------------------------------------------------------------------
        Total liabilities                                          658            810
=====================================================================================
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, 7,384,332 and
     7,336,800 shares issued, respectively                       7,384          7,337
  Additional paid-in capital                                    60,003         58,737
  Retained earnings                                             78,308         70,984
-------------------------------------------------------------------------------------
                                                               145,695        137,058
  Treasury stock at cost, 3,885,222 and
    3,766,022 shares, respectively                             (46,272)       (41,569)
  Accumulated other comprehensive income (Note 1)               11,691          9,071
  Common stock acquired by ESOP (Note 15)                         (625)          (781)
-------------------------------------------------------------------------------------
        Total stockholders' equity                             110,489        103,779
-------------------------------------------------------------------------------------
        Total liabilities and stockholders' equity            $111,147       $104,589
=====================================================================================
</TABLE>


46

<PAGE>   40

17.  PARENT COMPANY FINANCIAL STATEMENTS (CONTINUED)

STATEMENTS OF INCOME

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------
(In thousands) YEARS ENDED DECEMBER 31,                  1998         1997        1996
--------------------------------------------------------------------------------------
<S>                                                   <C>          <C>          <C>   
Income:
   Dividends received from subsidiaries               $ 6,400      $ 6,400      $5,750
   Interest and dividend income                            96           56          20
--------------------------------------------------------------------------------------
         Total interest and dividend income             6,496        6,456       5,770
Non-interest expense                                       99          118         103
--------------------------------------------------------------------------------------
   Income before income taxes                           6,397        6,338       5,667
Income tax benefit                                         28           40          14
--------------------------------------------------------------------------------------
   Income before equity in undistributed
         earnings of subsidiaries                       6,425        6,378       5,681
Equity in undistributed earnings of subsidiaries        4,489        3,789       3,746
--------------------------------------------------------------------------------------
   Net income                                         $10,914      $10,167      $9,427
======================================================================================
</TABLE>

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

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------
(In thousands) YEARS ENDED DECEMBER 31,                               1998          1997          1996
-------------------------------------------------------------------------------------------------------
<S>                                                                 <C>           <C>           <C>    
Cash flows from operating activities:
   Net income                                                       $10,914       $10,167       $ 9,427
   Adjustments to reconcile net income to net cash provided by
      operating activities:
         Equity in undistributed earnings of subsidiaries            (4,489)       (3,789)       (3,746)
         Decrease in other assets                                        --            --            25
         Increase (decrease) in accrued income taxes payable             25           (59)          (21)
         Deferred income tax benefit                                     (1)           (4)           (2)
         Increase in other liabilities                                    4            13             6
         Increase in amount due from subsidiaries                       (45)           --            --
         Decrease in amount due to subsidiaries                          --            (3)         (121)
-------------------------------------------------------------------------------------------------------
           Net cash provided by operating activities                  6,408         6,325         5,568
-------------------------------------------------------------------------------------------------------
Cash flow from financing activities:
   Payments to acquire treasury stock                                (4,703)       (1,665)       (3,534)
   Issuance of common stock under stock option plan                     741           467           738
   Tax benefit resulting from stock options exercised                    66          --              28
   Dividends paid on common stock                                    (3,605)       (3,124)       (2,459)
   Tax benefit resulting from dividends paid on unallocated
      shares held by the ESOP                                            15            15            15
-------------------------------------------------------------------------------------------------------
           Net cash used in financing activities                     (7,486)       (4,307)       (5,212)
-------------------------------------------------------------------------------------------------------
           Net change in cash and cash equivalents                   (1,078)        2,018           356
Cash and cash equivalents at beginning of year                        3,403         1,385         1,029
-------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year                            $ 2,325       $ 3,403       $ 1,385
=======================================================================================================
</TABLE>

During the years ended December 31, 1998, 1997 and 1996, the Company made cash
payments for income taxes of $24 thousand, $16 thousand and $23 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 $29 thousand, $42 thousand and $41 thousand
during the years ended December 31, 1998, 1997 and 1996, respectively.


                                                                              47

<PAGE>   41
18.  TEN-YEAR STATISTICAL SUMMARY (UNAUDITED)

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------------
(In thousands except per share data)
YEARS ENDED DECEMBER 31,                 1998     1997      1996    1995      1994    1993     1992      1991      1990    1989
--------------------------------------------------------------------------------------------------------------------------------
<S>                                   <C>       <C>       <C>     <C>        <C>     <C>     <C>       <C>        <C>     <C>   

Net income                            $10,914   $10,167   $9,427  $  8,759   $8,185  $6,695  $  4,677  $  2,250   $ 725   $2,668
Basic earnings per share(2)              3.09      2.88     2.65      2.43     2.19    1.71      1.22      0.59    0.16     0.50
Cash dividends declared per share(2)     1.02  0.88 1/2     0.69  0.54 3/4     0.45    0.34  0.26 1/2  0.22 1/4    0.22     0.21
Book value per share, at year end(2)    31.58     29.06    25.75     24.84    20.09   20.46     18.37     17.54   16.20    15.16
Return on average assets                 1.17%     1.12%    1.08%     1.04%    0.96%   0.79%     0.61%     0.60%   0.23%    0.86%   
Return on average realized equity(1)    11.08%    11.11%   11.01%    10.81%   10.62%   8.98%     6.79%     3.39%   1.03%    3.38%
================================================================================================================================
</TABLE>

(1)  Excludes average net unrealized gains or losses on securities available for
     sale.

(2)  All share information presented has been adjusted to reflect the 4-for-3
     and 3-for-2 split of the Company's common stock effective September 15,
     1997 and September 9, 1994, respectively.

19.  QUARTERLY DATA (UNAUDITED)


<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------
YEARS ENDED DECEMBER 31,                                 1998                                          1997
-----------------------------------------------------------------------------------------------------------------------------
(In thousands except                    4th        3rd         2nd        1st         4th        3rd         2nd        1st
per share data)                       Quarter    Quarter     Quarter    Quarter     Quarter    Quarter     Quarter    Quarter
-----------------------------------------------------------------------------------------------------------------------------
<S>                                   <C>        <C>         <C>        <C>         <C>        <C>         <C>        <C>    

Interest and dividend income          $14,721    $14,995     $15,025    $15,093     $15,496    $15,460     $15,017    $14,760
Interest expense                        8,534      8,703       8,562      8,521       8,840      8,937       8,555      8,349
-----------------------------------------------------------------------------------------------------------------------------
Net interest income                     6,187      6,292       6,463      6,572       6,656      6,523       6,462      6,411
Provision for loan losses                  88         15          45         45          95         45          52         68
-----------------------------------------------------------------------------------------------------------------------------
Net interest income after
        provision for loan losses       6,099      6,277       6,418      6,527       6,561      6,478       6,410      6,343
Non-interest income                     1,447        796       1,101      1,246         882        886       1,136        894
Non-interest expense                    3,269      2,871       3,119      3,256       3,115      3,191       3,924      3,195
Income before income taxes              4,277      4,202       4,400      4,517       4,328      4,173       3,622      4,042
Income tax expense                      1,598      1,507       1,694      1,683       1,672      1,584       1,173      1,569
-----------------------------------------------------------------------------------------------------------------------------
           Net income                 $ 2,679    $ 2,695     $ 2,706    $ 2,384     $ 2,656    $ 2,589     $ 2,449    $ 2,473
=============================================================================================================================
Earnings per share (in dollars):(1)
        Basic                         $  0.77    $  0.76     $  0.76    $  0.80     $  0.75    $  0.74     $  0.69    $  0.70
        Diluted                          0.74       0.73        0.73       0.77        0.72       0.70        0.67       0.68
-----------------------------------------------------------------------------------------------------------------------------
Weighted average common
        shares outstanding:(1)
        Basic                           3,487      3,548       3,546      3,535       3,521      3,520       3,529      3,530
        Diluted                         3,610      3,692       3,709      3,697       3,683      3,671       3,653      3,647
=============================================================================================================================
</TABLE>

(1)  Computation of earnings per share is further described in Note 1.




48
<PAGE>   42

MASSBANK CORP. AND SUBSIDIARIES STOCKHOLDER DATA

YEARS ENDED DECEMBER 31, 1998 AND 1997


MASSBANK Corp.'s common stock is currently traded on the Nasdaq Stock Market
under the symbol "MASB." At December 31, 1998 there were 3,499,110 shares
outstanding and 925 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.

<TABLE>
<CAPTION>
------------------------------------------------------------------------
                                      PRICE PER SHARE(1)         CASH
                                   ---------------------       DIVIDENDS
                                    HIGH            LOW        DECLARED
------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,                     1998
------------------------------------------------------------------------
<S>                                <C>            <C>           <C>  
Fourth Quarter                     40 1/2         29 1/2        $  0.27
Third Quarter                      50 3/4         38 3/4           0.25
Second Quarter                     54 1/4         47 1/2           0.25
First Quarter                      51 1/4         43 3/4           0.25
------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,                     1997
------------------------------------------------------------------------
Fourth Quarter                     48 1/4         41            $  0.24
Third Quarter                      47 1/2         35 5/8           0.24
Second Quarter                     35 13/16       29 29/32       0.2025
First Quarter                      31 7/8         28 1/8         0.2025
------------------------------------------------------------------------
</TABLE>

(1)  Stock prices have been adjusted to reflect the 4-for-3 split of the
     Company's common stock effective September 15, 1997.



                                                                              49

<PAGE>   43

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       
MASSBANK of Chelmsford                            Towers Plaza            
                                                  Melrose, MA 02176       
296 Chelmsford Street                             (781) 662-0165          
Eastgate Plaza                                                            
Chelmsford, MA 01824                              MASSBANK of Stoneham    
(978) 256-3751                                                            
                                                  240 Main Street         
17 North Road                                     Stoneham, MA 02180      
Chelmsford, MA 01824                              (781) 662-0177          
(978) 256-3733                                                            
                                                  MASSBANK of Tewksbury   
MASSBANK of Dracut                                                        
                                                  1800 Main Street        
45 Broadway Road                                  Tewksbury, MA 01876     
Dracut, MA 01826                                  (978) 851-0300          
(978) 441-0040                                                            
                                                  MASSBANK of Westford    
MASSBANK of Everett                                                       
                                                  203 Littleton Road      
738 Broadway                                      Westford, MA 01886      
Everett, MA 02149                                 (978) 692-3467          
(617) 387-5115                                                            
                                                  MASSBANK of Wilmington  
MASSBANK of Lowell                                                        
                                                  370 Main Street         
50 Central Street                                 Wilmington, MA 01887    
Lowell, MA 01852                                  (978) 658-4000          
(978) 446-9200                                                            
                                                  219 Lowell Street       
755 Lakeview Avenue                               Lucci's Plaza           
Lowell, MA 01850                                  Wilmington, MA 01887    
(978) 446-9216                                    (978) 658-5775          
                                                                          
MASSBANK of Medford                               

4110 Mystic Valley Parkway
Wellington Circle Plaza
Medford, MA 02155
(781) 395-4899



* Main Office





50

<PAGE>   44
CORPORATE INFORMATION

<TABLE>
<S>                                     <C>                                    <C>

MASSBANK CORP.                          Form 10-K                               Independent Auditors                         
                                                                                                                         
123 Haven Street                        Shareholders may obtain without         KPMG Peat Marwick LLP                    
Reading, MA 01867                       charge a copy of the Company's 1998     99 High Street                           
(781) 662-0100                          Form 10-K. Written requests             Boston, MA 02110                         
(978) 446-9200                          should be addressed to:                                                          
FAX (781) 942-1022                      Shareholder Services                    Legal Counsel                            
                                        Massbank Corp.                                                                   
Savings and Mortgage                    159 Haven Street                        Goodwin, Procter & Hoar                  
24-Hour-Rate Lines                      Reading, MA 01867                       Exchange Place                           
(781) 662-0154                                                                  Boston, MA 02109                         
(978) 446-9285                          Dividend Reinvestment and                                                        
                                        Stock Purchase Plan                     Reports on Effectiveness                 
Notice of Shareholders' Meeting                                                 of Internal Control Structure            
                                        Shareholders may obtain a brochure      Over Financial Reporting                 
The Annual Meeting of the               containing a detailed description                                                
Shareholders of Massbank Corp.          of the plan by writing to:              Shareholders may obtain without          
will be held at 10:00                   Shareholder Services                    charge a copy of Management's and        
A.M. on Tuesday,                        Massbank Corp.                          the Independent Auditors' 1998           
April 20, 1999 at the                   159 Haven Street                        Reports on the Effectiveness of          
Tara Ferncroft Conference Center        Reading, MA 01867                       the Company's Internal Control           
50 Ferncroft Road                                                               Structure Over Financial Reporting.      
Danvers, MA 01923                       Transfer Agent                          Written requests should be addressed to: 
                                                                                Shareholder Services                     
Trademark                               EquiServe                               Massbank Corp.                           
                                        Boston EquiServe Division               159 Haven Street                         
MASSBANK and its logo are               Shareholder Services                    Reading, MA 01867                        
registered trademarks of                P.O. Box 644                            
the Company                             Boston, MA 02102-0644                 
                                        
</TABLE>




                                                                              51
<PAGE>   45
OFFICERS AND DIRECTORS
MASSBANK CORP.

<TABLE>
<S>                                   <C>                                       <C>

OFFICERS                            BOARD OF DIRECTORS                        *Robert S. Cummings                        
                                                                               Senior Partner, Peabody and Brown   
Gerard H. Brandi                    Samuel Altschuler                                                                 
Chairman, President and             Executive Vice President                   Louise A. Hickey                    
Chief Executive Officer             and Director,                              Retired, Melrose-Wakefield Hospital 
                                    Sanmina Corp.                                                                     
Reginald E. Cormier                                                            Leonard Lapidus                     
Vice President, Treasurer and      *Mathias B. Bedell                          United States Government Official   
Chief Financial Officer             Retired, Bedell Brothers Insurance                                                
                                    Agency, Inc.                              *Stephen E. Marshall                 
Robert S. Cummings                                                             President, C.H. Cleaves Insurance   
Secretary                          *Gerard H. Brandi                           Agency, Inc.                        
                                    Chairman, President and                                                           
Donna H. West                       Chief Executive Officer,                  +Arthur W. McPherson                 
Assistant Secretary                 MASSBANK Corp.                             Certified Financial Planner         
                                                                                                                        
                                    Allan S. Bufferd                           Nancy L. Pettinelli                 
                                    Treasurer,                                 Executive Director,                 
                                    Massachusetts Institute of Technology      Visiting Nurse Association          
                                                                                                                        
                                   +Peter W. Carr                            +*Herbert G. Schurian                 
                                    Retired, Guilford Transportation           Certified Public Accountant         
                                    Industries                                                                        
                                                                              *Dr. Donald B. Stackhouse            
                                    Alexander S. Costello                      Dentist                             
                                    Editorial Page Editor,                                                            
                                    Lowell Sun Publishing Co., Inc.           *Member, Executive Committee         
                                                                              +Member, Audit Committee             

OFFICERS AND DIRECTORS

MASSBANK

OFFICERS

Gerard H. Brandi                   Gregory W. Bowe               Ana M. Foster                 Alice B. Sweeney  
Chairman, President and            Assistant Vice President      Compliance and                Assistant Comptroller      
Chief Executive Officer                                          Security Officer                                         
                                   Ernest G. Campbell, Jr.                                     Richard A. Tatarczuk       
Donald R. Washburn                 Collections Officer           Gerard F. Frechette           Assistant Vice President   
Senior Vice President, Lending                                   Loan Officer                  and Comptroller            
                                   Marianne J. Carpenter                                                                  
Donna H. West                      Assistant Treasurer           Rachael E. Garneau            Francis J. Walsh           
Senior Vice President,                                           Assistant Treasurer           Operations Officer         
Community Banking                  Charles F. Coupe                                                                       
                                   Information Officer           Margo E. Higgins              Margaret E. White          
Reginald E. Cormier                                              Assistant Vice President      Assistant Treasurer        
Vice President, Treasurer          Janet L. Daniels              and Human Resources Officer                              
and Chief Financial Officer        Assistant Vice President                                    Patricia A. Witts          
                                   Aunali Dohadwala              Brian W. Hurley               Assistant Treasurer        
David F. Carroll                   Auditor                       Assistant Vice President                                 
Vice President, Operations                                                                     Michael J. Woods           
                                   Karen J. Downs                Kenneth A. Masson             Assistant Vice President   
Thomas J. Queeney                  Assistant Treasurer           Assistant Vice President                                 
Vice President and                                                                             BOARD OF DIRECTORS AND     
Senior Trust Officer               Karen L. Flammia              Mindy S. Peloquin             EXECUTIVE COMMITTEE        
                                   Assistant Vice President      Assistant Treasurer                                      
Marilyn H. Abbott                                                                              Mathias B. Bedell          
Assistant Treasurer                Melissa J. Flanagan           Renald A. Robillard           Gerard H. Brandi, Chairman 
                                   Assistant Treasurer           Assistant Treasurer           Robert S. Cummings, Clerk  
Andrea S. Bradford                                                                             Stephen E. Marshall        
Assistant Vice President           Richard J. Flannigan          Lisa A. Sawyer                Herbert G. Schurian        
                                   Vice President, Trust         Assistant Treasurer           Dr. Donald B. Stackhouse   
                                                                                               Donna H. West              
                                                                                                 
</TABLE>



52